Issue 3, March 2023 PDF Version
Intersections, a news digest published by CNA's China and Indo-Pacific Security Affairs Division, describes the interplay between the People's Republic of China's (PRC's) technology acquisition efforts, US and partner nation responses to these efforts, and the critical and emerging technology risks for the US defense industrial base. This issue features a section on the actions US allies and partners are taking to secure supply chains for critical minerals vital to their national security. We also cover recent examples of policy measures the PRC is taking to promote acquisition of foreign technology, including using the domestic legal system against foreign firms. Although these specific measures are new, many reflect recurring tactics that the PRC uses to protect and promote domestic industries.
Partner Responses to Chip Export Controls
Support from allies and partners is a key element in the potential effectiveness of the US semiconductor export controls. In particular, the US needs the support of key countries in the chip-making supply chain, most importantly Japan, the Netherlands, South Korea, and Taiwan. In the previous issue of Intersections published in January, we reported on Japan's and Taiwan's initial reactions to the US export controls. In this issue, we give an update on Japan's reactions and summarize debates on US export controls in the Netherlands and South Korea.
Japan and the Netherlands join trilateral agreement with the US that would restrict exports of semiconductor manufacturing equipment to the PRC. On January 27, the Financial Times reported that the US, Japan, and the Netherlands have reached a tentative trilateral agreement to restrict the export of semiconductor manufacturing tools to the PRC. The agreement follows the unilaterally imposed export restrictions on chip-making equipment by the US in October 2022 and is the fruit of two years of US negotiations with Japan and the Netherlands.
On March 8, the Netherlands trade minister confirmed key details of this agreement in a letter to the Dutch parliament. While the letter did not specify exactly which technologies would be restricted, it did note that the Netherlands' existing export controls, which since 2019 have prohibited the export of state-of-the-art Extreme Ultraviolet Lithography (EUV) chip-making machines to the PRC, would be "expanded" to include other "most advanced" types of equipment. In a statement responding to the letter, leading Dutch chip-making equipment manufacturer ASML said it had not received any additional information about the definition of "most advanced" equipment, but would interpret the letter as referring to select types of "immersion DUV" chip-making machines-a slightly less cutting-edge but still very advanced technology. ASML is the world's sole manufacturer of EUV, and a major manufacturer of immersion DUV machines.
The US, Japan, and the Netherlands are home to some of the world's most advanced chip-making equipment companies, including KLA, Tokyo Electron, and ASML. The Straits Times cites analysts who state that denying the PRC access to the most advanced US, Dutch, and Japanese chip-making equipment would prevent it from developing its own cutting-edge semiconductor chip-manufacturing capabilities. However, as of early March, the Japanese government has still not given specifics on what export controls it will implement. Akira Amari, an influential Japanese lawmaker, has said that Japan is likely to implement less stringent restrictions than the US. Whether Japan joins the US and Netherlands in rigorously implementing the trilateral agreement will have a significant impact on the US and Dutch controls' effectiveness.
South Korea faces numerous challenges to comply with US chip export controls. As discussed above, Japan and the Netherlands have signed a trilateral agreement with the US in support of the US semiconductor export controls. In addition, as covered in the previous issue of Intersections, Taiwan has said it will support the controls. Although South Korea has not decided how it will respond to the US controls, its decision whether to support or not will have a significant impact on their effectiveness, given the size of leading South Korean chip producers and their extensive investments in the PRC.
South Korea faces key challenges to complying with the US export controls. First, South Korean chip producers Samsung and SK Hynix have plants in the PRC. Samsung operates two chip fabrication plants ("fab plants") in the city of Xi'an, which represented nearly 43 percent (in 2021) of the company's "total NAND flash production capacity" (a particular type of memory chip). Second, SK Hynix, which also produces memory chips, is facing potential restrictions on upgrading lithography equipment in its Wuxi, China, plant because of the US restrictions. Samsung and SK Hynix have both been "granted a one-year waiver to temporarily steer clear of chip-making tools import restrictions to their Chinese fab plants," according to the Korea Herald. Finally, and of note, South Korea also relies heavily on China as a market for its semiconductors, with chip exports to China representing 40.6 percent of the country's total volume.
Ally and Partner Tech Protection
US Partners, Allies Developing Critical Minerals Strategies
US allies and partners have taken significant steps toward reducing reliance on the PRC for critical minerals production. The US Geological Survey defines a critical mineral as one that is "necessary for the manufacture of high technology devices, national defense applications, and green growth-related industries," yet "is at risk for supply disruption." Minerals can be critical either because of uneven or scarce geographic distribution or because certain countries dominate extraction, refining, and processing. For example, China controls about 90 percent of worldwide rare earths processing and 60 percent of lithium processing.
Canada releases new Critical Minerals Strategy. In December 2022, Canada unveiled a new Critical Minerals Strategy designed to shape the nation's approach to mining, processing, and utilizing critical minerals. The strategy notes Canada's "extremely fortunate position of possessing significant amounts of many of the world's most critical minerals" and calls increased demand for critical minerals in green energy and other applications "a generational opportunity." The strategy lays out several measures, including streamlining Canada's mine permitting process, providing support and tax incentives for companies seeking permits in certain prioritized minerals, and pledging to support projects that "decrease or remove reliance on foreign critical mineral inputs." Also of note, the strategy pledges to "seek regulatory harmonization" with the US and has also been coordinated with similar strategies in Australia, Japan, and other countries.
Australia taking steps to overhaul critical minerals strategy, including promoting alternatives to PRC investment. The Australian government and companies have recently expressed an intention to reduce Australia's reliance on the PRC for refining and processing of critical minerals, seeking instead to develop its own capacity in these areas. The following are examples:
- In November 2022, a government scientific research agency issued an Australian Silicon Action Plan that addresses the potential for Australia to exploit its considerable silicon resources- a key material for solar panels-to develop a domestic solar panel supply chain.
- In November 2022, two Australian cabinet officials gave speeches to a mining industry gathering in which they emphasized Australia's critical minerals sector as a strategic opportunity.
- Australian mining firms are investing in friendly countries. According to an October 2022 BBC report, Australian firm Lynas Rare Earths has been contracted by the US Department of Defense to build a "multimillion-dollar processing facility" in the US.
These steps and others are building up to Australia's expected update to its critical minerals strategy , which is to be released in 2023. Of note, in the meantime, PRC firms continue to seek investments into Australia's critical minerals industry. In December 2022, for example, PRC firm Tianqi Lithium announced it was seeking a joint investment in Western Australia with an Australian firm to develop a lithium processing facility.
European Union (EU) seeking to reduce economic reliance on PRC for critical minerals. In recent months, EU leaders have made statements about the EU's economic reliance on the PRC and are considering actions to reduce this reliance in strategic areas, notably critical minerals, while continuing to maintain robust trade ties with China. Notable recent developments in this area include the following:
- In January 2023, Europe's largest deposit of rare earths was discovered in Sweden. Currently, no rare earths are mined in Europe, and the PRC supplies 98 percent of the rare earths the EU uses.
- ·This discovery comes as the European Commission is formulating a Critical Raw Materials Act , which aims to "strengthen EU supply chains" for materials such as rare earths, lithium, and polysilicon. The act will likely be released in March and is expected to provide policy on subsidizing production, processing, and strategic reserves of critical raw materials.
The Critical Raw Minerals Act is one part of a broader EU-wide push to strengthen the EU's self-reliance in strategically critical sectors while not fully decoupling from the PRC. In January 2023, European Commission President Ursula von der Leyen gave a speech at the World Economic Forum at Davos in which she said that the EU should focus on "de-risking rather than decoupling" from the PRC. Von der Leyen asserted that the EU needs to "work and trade with China," while also criticizing the PRC for subsidies that unfairly benefit PRC companies and practices that restrict EU companies' market access.
Taiwan's Outbound Investment
Taiwan's Foxconn faces fines for mainland PRC investment in semiconductor-related company. In January, Taiwan's Ministry of Economic Affairs fined Foxconn Industrial Internet (a.k.a. "Foxconn")-the world's largest electronics manufacturer -10 million New Taiwan Dollars (USD $329,088) for "making an unauthorized investment in Tsinghua Unigroup," a PRC chip company. Originally a unit within China's elite Tsinghua University, Tsinghua Unigroup underwent a major corporate restructuring in 2022 and now has a PRC provincial government-owned investment fund as its largest shareholder. Taiwan is working to protect its technology from transfer to mainland China, and noted that the fine was the result of Foxconn's failure to seek required regulatory approval for the deal. Taiwan's Ministry of Economic Affairs reviews outbound foreign direct investment into the PRC mainland in critical sectors, such as semiconductors.
PRC Technology Efforts
Efforts to Boost PRC Semiconductor Industry
The China Integrated Circuit (IC) Fund restarts investment projects for PRC domestic firms. Amid the pressure from US export controls on advanced chips, PRC investors are trying to channel funds to "mature tech nodes," which are not subject to the US restrictions. The China Integrated Circuit Industry Investment fund ("China IC Fund") was created by the PRC government in 2014 to provide support to the industry. According to a South China Morning Post report, PRC firm Hua Hong Semiconductor Group will receive approximately $6.7 billion USD in investment for a wafer fabrication plant in eastern Wuxi in Jiangsu Province. Per the report, the new fabrication plant will focus on 12-inch wafers to complement the production of 8-inch wafers that are currently produced at three plants in Shanghai.
Initial public offering (IPO) approvals and local government actions complement Beijing's efforts to ensure access to mature chips. As major semiconductor manufacturing firms plan new investments in mature node production, nine PRC firms were approved for IPOs in late 2022, and the South China Morning Post reports that these firms could "raise a total of US $2.5 billion" on the Shanghai Star Market. Per the report, IPO applications include companies involved in integrated chip design, packaging, and a wafer foundry; the wafer foundry is associated with Semiconductor Manufacturing International Corporation, a major PRC chip firm. In Shenzhen, local authorities approved a business license in December 2022 for the Electronic Components and Integrated Circuits International Trading Center Company, which is backed by 12 state-owned enterprises and a variety of other shareholders. This trading center is meant to create "an international sourcing platform for semiconductors" and help further China's "self-sufficiency strategy."
PRC Regulatory Changes
China adds two US defense contractors to sanctions list in response to Taiwan arms sales. In February 2023, the PRC Ministry of Commerce (MOFCOM) announced that US defense contractors Raytheon and Lockheed Martin would be added to the PRC's Unreliable Entity List (UEL)-a PRC sanctions list created in 2020. The MOFCOM announcement stated that the two contractors were added to the list for undermining China's "national sovereignty and territorial integrity" through repeated arms sales to Taiwan. This marks the first time the MOFCOM has added foreign companies to the UEL. In the announcement, MOFCOM stated that it intends to impose the following penalties on the two US firms:
- Raytheon and Lockheed are prohibited from engaging in import or export activities or investments related to the PRC.
- The two companies' senior managers are not allowed to travel to the PRC, and senior managers for both companies who are currently located within the PRC will be forced to leave.
- Raytheon and Lockheed must each pay a fine equal to double the amounts of each company's contracted arms sales to Taiwan since the creation of the UEL in 2020. According to the MOFCOM, if either company does not pay the fine within 15 days of the announcement, that company will face "additional fines" and other unspecified measures "in accordance with the law." As of the time of writing, it is unclear whether the PRC has actually implemented any fines or other penalties.
The impact of the sanctions remains to be seen. Although Raytheon and Lockheed have no defense sales with the PRC, they do supply some components to China's commercial aviation industry. Worth watching is whether Beijing will be willing to rigorously enforce the above UEL penalties on Raytheon and Lockheed even if doing so entails disruptions to the PRC's commercial aircraft programs.
New regulation to require data exports leaving the PRC to undergo security assessment. According to December 2022 guidelines issued by the PRC State Council, data transmissions that cross the PRC border must undergo a "security review." The State Council's new guidelines come more than a year after the June 2021 passage of China's Data Security Law , which requires the PRC government to create and implement export controls on certain categories of data deemed sensitive. The guidelines, and a related set of regulations released by the PRC Ministry of Industry and Information Technology in December 2022, require "important" and "core" industrial data to be stored within the PRC. These measures exemplify how the PRC is increasingly using legal means to advance its interests, including control over data flows.
Critical and Emerging Tech
US investment in PRC AI sector is prevalent. In February 2023, the Center for Security and Emerging Technology at Georgetown University released a report on US investments in PRC AI companies between 2015 and 2021. The report argues that US investments in the PRC AI sector are common, but far from dominant, with investment transactions involving US investors accounting for 37 percent of the total funding raised by PRC AI companies. Most US investments in PRC AI companies were early-phase venture capital funding, which often involves transferring knowledge and network contacts alongside money. In certain circumstances, venture capital funding may also facilitate transfers of technological know-how.
The report also found instances of US investments in companies with ties to the PRC Party-state. For example, in 2016, the US tech giant Qualcomm invested in a Beijing based start-up called 7Invensun, which works in the field of eye-tracking, eye-motion control, and facial identification. 7Invensun has collaborated with the China Academy of Launch Vehicle Technology, a major PRC state entity involved in the development and manufacturing of space launch and ballistic missile systems.
US chips used in PRC nuclear weapons research, despite export controls. According to a January 2023 article in The Wall Street Journal, the PRC state-run China Academy of Engineering Physics (CAEP) has obtained semiconductor chips produced by US companies despite US export controls. The article describes CAEP as the PRC's top nuclear weapons research institute and notes that CAEP was placed on the US Entity List in 1997. The article states that the types of chips procured by CAEP are difficult for the PRC to mass-produce domestically. However, US versions of these chips are widely available on the open market in the PRC. The article's review of official procurement documents from CAEP indicates that the academy was able to obtain these chips through third-party PRC resellers. This is an example of the PRC buying technology-how PRC state and military institutions take advantage of extended supply chains, shell companies, and third-parties to legally obtain technologies that would otherwise be inaccessible to them.
PRC courts nullify patents, support domestic firms in accessing foreign intellectual property (IP). In February 2023, The Wall Street Journal reported that the PRC mobilized its domestic courts to help PRC companies access foreign technology. According to the article, the PRC has strengthened IP protections in areas such as luxury clothing while using court decisions to weaken or nullify those protections in other areas considered important by the PRC. For example, the article notes that in 2021, a PRC court ruled that a Japanese company had broken an antitrust law by refusing to license its rare earth magnet technology to a PRC company. That same year, another PRC court dismissed a suit by an American company claiming that PRC companies had stolen and patented proprietary automotive sensor technology.
Patent nullification can also affect supply chain security. The article discusses how since 2017, AS&E, an American maker of X-ray security scanning systems, has competed with cheaper systems made by the PRC state-owned Nuctech, which AS&E alleges copied its proprietary systems. According to the article, after AS&E complained to Nuctech, AS&E's PRC patent was invalidated. AS&E has argued that widespread usage of Nuctech systems could pose security risks, theorizing that Nuctech's government connections mean it could send data from its systems to PRC authorities. This example shows how the PRC government shapes its domestic legal environment to gain access to foreign technologies that it has identified as critical.
PRC Strategic Guidance & Investment Funds
The China IC Fund provides capital to firms working on chip manufacturing, in accordance with the National Integrated Circuit Industry Development Promotion Outline. However, in 2022, the China IC Fund faced corruption allegations and was investigated by the PRC Ministry of Industry and Information Technology's Commission for Discipline and Inspection. Foxconn's semiconductor manufacturing plant in Wuxi, discussed above, appears to be the first major project since the corruption investigation, which may indicate that the China IC Fund is resuming normal operations. The China IC Fund, and related municipal investment funds, have provided financial support to PRC companies, such as NavTech, in acquiring foreign technology. In 2016, NavTech acquired Sweden's Silex Microsystems, which specialized in manufacturing micro-electromechanical systems, or MEMS-a component of some types of chips. For more on this case and how government guidance and national and local investment funds fund technology transfer, see pages 23-24 of our report on technology acquisition efforts.