On December 28, 2020, the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) issued its first public guidance regarding Executive Order 13959, which previously had been issued on November 12, 2020 and prohibited U.S. companies and individuals from investing in securities issued by certain companies affiliated with the People’s Republic of China (PRC) military.
Notably, starting at 9:30 a.m. EST on January 11, 2021, any transactions in publicly-traded securities or securities that are derivative of (or designed to provide investment exposure to such securities) of certain OFAC-listed PRC-affiliated entities will be prohibited. OFAC has now advised that the initial list of prohibited “Communist Chinese military companies” is also located here in both PDF and CSV format, with additional identifying information. This list was initially included as an Annex to E.O. 13959.
OFAC subsequently issued additional guidance late on January 4, 2021, advising that U.S. persons are not required to divest their publicly traded securities investments in Communist Chinese military companies by January 11, suggesting that U.S. persons can continue to hold those investments but cannot engage in new transactions after that date, except in certain circumstances (e.g., for the purposes of divestment).
Subsidiaries and Affiliates
In the new public guidance, OFAC addressed the looming question of whether the 50% Rule would apply to the publicly traded securities issued by subsidiaries or affiliates of OFAC-listed Communist Chinese military companies. The answer is not necessarily, unless the subsidiary or affiliate is specifically identified by OFAC.
Under OFAC’s 50% Rule, entities that are owned 50% or more, in the aggregate, by a sanctioned actor or actors will be treated as blocked under OFAC sanctions, and therefore subject to many of the same restrictions.
OFAC has now advised via FAQ 857 that E.O. 13959’s prohibitions do not automatically apply to an OFAC-listed company’s subsidiaries or affiliates, unless that company’s subsidiaries or affiliates are specifically identified by OFAC pursuant to Section 4(a)(iii) of E.O. 13959. However, OFAC noted that it intends to list entities in the future that issue publicly traded securities and are either: (i) owned 50% or more by one or more Communist Chinese military companies identified in or pursuant to E.O. 13959; or (ii) controlled by one or more Communist Chinese military companies identified in or pursuant to E.O. 13959. Thus, while subsidiaries or affiliates are not automatically captured by E.O. 13959 as of right now, OFAC is signaling that it could target those entities in the future.
ETFs and Mutual Funds
One of the more significant provisions of OFAC’s recent public guidance are the restrictions on investing in U.S. or foreign funds, such as exchange-traded funds (ETFs) or mutual funds, that hold securities of Communist Chinese military companies.
OFAC advised that E.O. 13959 prohibits U.S. persons from investing in U.S. or foreign funds (such as ETFs or mutual funds) that hold publicly traded securities of a Communist Chinese military company, regardless of the securities’ share of the underlying index fund, ETF, or derivative. See OFAC FAQ 861. This means that if U.S. persons invest in a U.S. or foreign fund, and that fund holds any securities of a Communist Chinese military company, then U.S. persons would be prohibited from investing in that fund, regardless of the percentage of Communist Chinese military company securities in the underlying fund.
Accordingly, U.S. investors should assess their exposure in U.S. and foreign funds, including whether any contain underlying investments in the publicly traded securities of OFAC-listed Communist Chinese military companies.
Additional Guidance
OFAC issued additional guidance in the form of FAQs 858, 859, and 860.
OFAC clarified in FAQ 858 that E.O. 13959’s prohibitions apply to entities “with a name that exactly or closely matches the name of an entity identified in the Annex to E.O. 13959 . . . or subsequently identified pursuant to E.O. 13959.” FAQ 858 appears to be an attempt to address confusion over relevant issuers and equity tickers, to assist the public in identifying those issuers that are the subject of E.O. 13959 sanctions.
Additionally, OFAC made clear in FAQ 859 that it intends to interpret the term “publicly traded securities” to include securities “denominated in any currency that trades on a securities exchange or through the method of trading that is commonly referred to as ‘over-the-counter,’ in any jurisdiction.”
With respect to derivatives, OFAC provided guidance in FAQ 860 regarding the financial instruments that are covered by E.O. 13959’s prohibition on transactions in “securities that are derivative of, or are designed to provide investment exposure to” such publicly traded securities. Notably, examples of covered financial instruments include (but are not limited to): “derivatives (e.g., futures, options, swaps), warrants, American depository receipts (ADRs), global depository receipts (GDRs), exchange-traded funds (ETFs), index funds, and mutual funds,” to the extent such instruments also meet the definition of “security” as defined in Section 4(d) of E.O. 13959.
Divestment
Subsequent to the FAQs issued on December 28, 2020, OFAC published an additional FAQ late on January 4, 2021. In new FAQ 862, OFAC advised that E.O. 13959 does not require U.S. persons to divest their holdings in publicly traded securities (and derivative securities) of Communist Chinese military companies prior to January 11, 2021. It appears that U.S. persons may continue to hold their existing investments in Communist Chinese military company securities, but new “transactions” would be prohibited. We note, however, that Section 1(b) of E.O. 13959 permits certain purchases or sales of such securities for the purposes of divestment until November 11, 2021 that were held prior to January 11, 2021. We will await additional guidance from OFAC on this point.
In short, U.S. investors should assess their exposure to securities investments that could be impacted by E.O. 13959, with a particular focus on investments that contain holdings in the publicly traded securities of OFAC-listed Communist Chinese military companies. Implementation of these sanctions commences on January 11, 2021, and OFAC has indicated that it intends to list additional companies going forward.
If you have any questions or concerns about U.S. sanctions, please contact Bruce G. Paulsen (212-574-1533) or Andrew S. Jacobson (212-574-1477) at Seward & Kissel’s Sanctions Practice Group.
