In August 2022, the United States enacted a spate of new laws and a main theme running through was to rebuild America's leadership in the emerging strategic industry chains and high-tech sectors globally and to reduce its reliance on China:
On August 9, the CHIPS and Science Act of 2022 (the "CHIPS Act") was promulgated to provide subsidies or funding to certain corporations with a view to attracting them to shift advanced semiconductor manufacturing to the United States or its allies, and to impose restrictions on the investment of those corporations receiving financial assistance in the semiconductor industry in China or other foreign countries of concern;
On August 12, the U.S. Department of Commerce’s Bureau of Industry and Security ("BIS") issued an interim final rule to control the export of certain EDA software, which is called the "mother of Chips" and necessary for chip design (the "EDA Control Rule"); and
On August 16, the U.S. government promulgated the Inflation Reduction Act of 2022 (the "Inflation Reduction Act") to link tax credits for the purchase of U.S. electric vehicles and the advanced manufacturing corporations to the sources of critical mineral materials and components contained in EV batteries. Such tax credits are not applicable if the sources of such products do not satisfy the applicable percentage of the value of the critical materials or components contained in EV batteries that are extracted, manufactured or assembled in the North America or any country with which the United States has a free trade agreement[1], and which of course, excludes China in effect.
While "CASE" (i.e. connectivity, autonomous, sharing and electric) represents the key trend in the automotive industry, chips and batteries play important roles in such process as they are the core components determining the performance of vehicles. With its "Overtaking on Curves" strategy, China accounts for nearly 60% of the global electric vehicle market, overtaking the United States as the world's largest auto market. This transfer of power in the automotive market, together with the reform of the energy system, the narrowing technology gap, and the "chip shortage" caused by the Covid-19 pandemic, has made China's electric vehicle industry a target for all the above mentioned U.S. policis.
Automotive Chips: Competition on all Fronts over R&D, Production and Sales
Automotive chips are undoubtedly one of the focuses of the CHIPS Act among various sectors using chips. Automotive chips, including system-on-chips (SoCs) and microcontroller units (MCUs), have been widely used in powertrain, body, cabin, chassis, safety and other fields of automobiles. The vast majority of automotive chips used in automobiles are legacy semiconductors (i.e. 28 nanometer process technology or older). However, SoCs, which are advanced semiconductors (i.e. process nodes under 28 nanometer), perform core processing and computing tasks in smart cabins, automatic driving and other key controllers. The competition around advanced automotive chips is essentially the competition for the future of intelligent vehicles. Although the United States has an overwhelming superiority in terms of design and R&D of semiconductors, the U.S. share of the global semiconductor market has decreased from 37% in 1990 to the current 15%, of which its production of advanced chips is almost reduced to zero. Conversely, China (including the Taiwan region), South Korea and Japan account for approximately 75% of the global chip supply, as a result of continuous investments in the semiconductor industry. The CHIPS Act and the EDA Control Rule revolve around the R&D and manufacturing of automotive semiconductors and therefore impose series of hurdles for the supply chain of advanced chips for China's electric vehicle industry.
1.Covered Entities Being Prohibited from Materially Expanding Advanced Semiconductor Manufacturing Capacity in China
According to the CHIPS Act, the U.S. government will provide about $52.7 billion in subsidies over the next five years to the U.S. semiconductor manufacturing industry, of which $50 billion will be invested through a Chips for America Fund to boost chip manufacturing and R&D capacities in the United States. "China Guardrails Provision" draws wide attention among Chinese automotive companies, which requires that the entity receiving funds shall enter into an agreement with the U.S. government specifying that, during the 10-year period beginning on the date of the award, it (including any member of its affiliated group) may not engage in any significant transaction involving the material expansion of semiconductor manufacturing capacity (i.e. establishment of new capacity or expansion of existing capacity) in the People’s Republic of China (the "PRC") or other foreign countries of concern (including Russia, Iran and DPRK), unless (1) it is an existing facility or equipment for manufacturing legacy semiconductors; or (2) the significant transactions involving the material expansion of semiconductor manufacturing capacity produces legacy semiconductors and predominately serve the market of a country of concern. Similar to the CFIUS process, the CHIPS Act provides that an entity that receives funds shall notify the U.S. Department of Commerce of any restricted investment and that, if it considers there exists possibilities that the investment may violate the agreement, it may prohibit the transaction or take mitigating measures such as restricting investors' access to sensitive information and products; if the entity receiving funds fails to make proper notification, the full amount of the award may be forfeited.
The definitions of the key terms such as "material expansion", "significant transaction" and "semiconductor manufacturing" in the above provisions are still unclear and remain to be further clarified when the U.S. government introduces applicable rules in 2023 and in future enforcements. However, it could be interpreted from the existing provisions that existing and expanded investments in legacy semiconductors that meet certain conditions are not subject to restrictions; given the fact that the chips currently used in intelligent vehicles are mostly legacy semiconductors, the Chinese Guardrails Provision may have a limited impact on the chips used in the automotive industry at the current stage. In addition, the threshold for a corporation to fall into the affiliated group of the entity that receives funds is relatively high, which means one or more chains of includible corporations connected through stock ownership with a common parent, and in general, at least 80 percent of stock of a member, by both voting power and value, must be owned by the parent or by another corporation in the chain[2]. So if a covered entity invests through another entity in which such covered entity holds less than 80% of the shares, the investment might not be subject to the restrictions either. Therefore, despite the restrictions under the Chinese Guardrails Provision, there is still room for investment and development in the chip sector. For instance, any transaction conducted by a covered entity involving the establishment of new semiconductor manufacturing capacity that produces legacy semiconductors in China and predominately serves the Chinese market should not be subject to any restrictions, but it remains to be seen whether the investment made by a covered entity through an entity in which it owns less than 80% of the shares could be completely exempt from the Chinese Guardrails Provision.
2.U.S. Covered Entities Being Prohibited from Engaging in R&D Collaborations with Chinese entities of Concern
The impact of the CHIPS Act is not limited to chip manufacturing, but has been extended to chip R&D by virtue of the Creating Helpful Incentives to Produce Semiconductors for America Act enacted in 2021 (the "2021 CHIPS for America Act")[3]. First, a covered entity under the CHIPS Act must not be a foreign entity of concern; second, if the U.S. government determines that the covered entity has engaged in any R&D collaborations or reached any licensing arrangement with a foreign entity of concern that involves a technology that raises national security concerns, it may require a full clawback of the award from the covered entity. This R&D restriction is largely subject to the discretion of the U.S. government (e.g., what constitutes national security concerns and how to define a foreign entity of concern), which is hard to be assessed objectively at the current stage. Take the foreign entity of concern as an example, it not only includes any foreign terrorist organization and any entity on the SDN list, but also includes "any entity owned by, controlled by or subject to the jurisdiction or direction of a government of a foreign country that is a covered nation", including China, Russia, Iran, and DPRK. This definition is broad and vague, but what is clear is that the government authorities and state-owned enterprises in China (and certain other foreign countries) should be considered as the foreign entities of concern. However, there is great uncertainty about whether an enterprise that is not state-owned would constitute a foreign entity of concern, as it depends on how to interpret "an entity subject to the jurisdiction or direction of the Chinese government". At present, there is no precise guidance as to how this term should be applied. However, based on the application of other U.S. orders concerning supply chains[4] in past practice, the possibility of applying a broad interpretation to the "foreign entity of concern" could not be precluded, i.e., it could include any entity subject to the jurisdiction of the PRC, and it is unclear whether it includes entities located within or outside the PRC with a certain percentage of its shares owned by the PRC shareholders. If the U.S. government interprets the "foreign entity of concern" broadly, any joint R&D or licensing efforts between any corporation with PRC shareholders (even including overseas entities) and any international chip corporation would be likely to be subject to the provisions of the CHIPS Act.
3.Export License Required for Export of EDA Software for Designing 3 nanometer and below Chips to China
Export control has been an important tool used by the United States to restrict Chinese companies’ development of chips and the Chinese semiconductor companies have frequently been placed on the BIS Entity List. EDA software, known as the "Mother of Chips" in the industry, is a mighty part of the modern chip design process. The BIS amended the Export Administration Regulations in the form of the EDA Control Rule, an interim rule, and added four technologies including the ECAD software (i.e. EDA software) specially applied to the design of the GAAFET structure integrated circuits to the Commerce Control List. GAAFET, standing for Gate-All-Around Field Effect Transistor, is considered the key technology to break through the 3 nanometer technology nodes for the semiconductor industry. Therefore, by implementing the EDA Control Rule, the United States currently restricts the exports of the 3 nanometer and below process technology. As China is a controlled country of the U.S. for national security purposes, a license is required to export the above ECAD software to China, and it therefore restricts Chinese chip companies from cooperating with international chip companies on the R&D of advanced semiconductor.
4.Export License Required for Export of Advanced Semiconductor with 6 nanometer or 7 nanometer Process Technology to China
The U.S. government's "concerns" about chips are not limited to manufacturing, research and development, and its tool box is not limited to formal and official policies, either. In late August, two world-renowned fabless semiconductor companies announced respectively that they had received notices from the U.S. government, restricting their exports of certain models of advanced (6 nanometer or 7 nanometer) semiconductors to China and requiring them to obtain prior export licenses from the BIS for export and re-export.
In summary, although the above U.S. policies or government actions, which mainly involve research, development and manufacturing of the advanced semiconductor with the 28 nanometer or below process technology, have a limited impact on the automotive industry at present, in the long run, competition on all fronts around advanced chips will exert a profound influence on the layout of industry chains regarding chips required for the development of intelligent vehicles in the future and will hinder China’s development of intelligent vehicles.
Batteries: Encouraging "Localization" under the Guise of Subsidies
The Inflation Reduction Act follows the same policy logic as the CHIPS Act to link tax credits for the purchase of U.S. electric vehicles to the sources of the components and critical materials contained in EV batteries, aiming at supporting "Made in the USA" and enhancing the U.S. competitiveness in the sectors of electric vehicles and clean energy.
The Inflation Reduction Act provides that only electric vehicles that meet the following "critical mineral" and "battery component" requirements will qualify for the tax credit (up to $7,500) for each vehicle:
With respect to critical minerals, the percentage of the value of the critical minerals contained in a battery that were extracted or processed in the United States or in any country with which the United States has a free trade agreement in effect, or recycled in North America, is equal to or greater than the applicable percentage, which starts at 40% in case of a vehicle placed in service before January 1, 2024, and will increase by 10% for each year a vehicle is placed in service, until up to 80%; and
Similarly, with respect to battery components, the percentage of the value of the components contained in a battery that were manufactured or assembled in North America (i.e. the United States and Canada) is equal to or greater than the applicable percentage, which starts at 50% in case of a vehicle placed in service before January 1, 2024, and will increase by 10% for each year in which a vehicle is placed in service, until up to 100%.
In addition to the source requirements, the Inflation Reduction Act further restricts subsidies in terms of manufacturing entities, that is, if (i) any critical minerals contained in a battery were extracted, processed, or recycled by a foreign entity of concern, or (ii) any components contained in a battery were manufactured or assembled by a foreign entity of concern, the preferential policies shall not apply to the relevant vehicle. A foreign entity of concern under the Inflation Reduction Act includes any "entity owned by, controlled by or subject to the jurisdiction or direction of a government" of a foreign country that is a covered nation, including China, which is similar to the definition of a "foreign entity of concern" set forth in the CHIPS Act. If this definition, when implemented in practice, excludes not only China's state-owned enterprises, but also Chinese companies that are not stated-owned and even their overseas companies as discussed above, from eligible suppliers of critical minerals or battery components, it will have a broader impact on the upstream and downstream of the China’s battery industry chain.
Furthermore, at the corporate level, the Inflation Reduction Act encourages advanced manufacturing in the form of a tax credit, by providing to companies engaging production of critical minerals and batteries in the United States a tax credit of up to 10% of the cost incurred with respect to product of such critical minerals and batteries for a certain period.
With tax credit policies for both consumers and companies, the Inflation Reduction Act in effect puts the electric vehicles using critical minerals (e.g. lithium, nickel, and cobalt) or battery components from China or other countries that are not free trade agreement partners of the United States in an unfavorable market position, forcing electric vehicle manufacturers to choose more battery components and critical minerals from North America and its trading allies in the battery supply chain.
As the impact of the Inflation Reduction Act on the normal market order has aroused a lot of attention in the international community, a well-known American electric vehicle company has reportedly suspended its plans to manufacture battery cells in Germany. It is reported that the European Union is assessing whether the Inflation Reduction Act violates WTO rules, and that South Korea is also considering filing a lawsuit against the Inflation Reduction Act in WTO when necessary. The Ministry of Commerce of China also expressed concern in respect of the U.S. discriminative subsidies related to the electric vehicles, suggesting that these measures are not consistent with the WTO principles such as "most favored nation" and "national treatment".
Similar to the CHIPS Act, the Inflation Reduction Act forces "decoupling" by means of interventions through fiscal policies to split the global EV battery supply chain. But the difference is that the Chip Act focuses more on the future competition of smart electric vehicles, while the impact of the Inflation Reduction Act on the upstream and downstream of China’s electric vehicle battery supply chain is imminent.
Recommendations for China's Automotive Industry
As the impact of the U.S. continuous and systematic "Made in the USA" policies on China's automotive industry cannot be overstated, the automotive industry and its upstream and downstream sectors in China need to pay close attention to the measures adopted by the United States in the sectors such as chips and batteries, conduct a comprehensive evaluation of the short, medium and long-term effect of those measures, and prudently plan in response to them. The following strategies could be considered:
To reduce reliance on advanced semiconductors based on U.S. technologies, actively seeking alternative suppliers or substitute technologies for semiconductor R&D and manufacturing, and build close partnership cooperation (including equity cooperation) with Chinese semiconductor technology companies;
To layout mineral resources for batteries production in countries that have signed or is about to sign a free trade agreement with the United States, or carry out strategic and equity cooperation with the upstream companies that possess those mineral resources;
When making investment in the upstream and downstream of the automotive industry chain (e.g. chips, minerals, batteries), to prudently evaluate the impact of the series of the U.S. policies on target companies based on their shareholding structures and business models; and
In the event that the relevant U.S. policies materially affect fair market competition causing harm to relevant market entities, to assess the feasibility of taking countermeasures and filing lawsuits at multilateral trade organizations.
Taking on obvious protectionist overtones, the CHIPS Act and the Inflation Reduction Act have changed the international order of fair competition and the international trade strategies against subsidies that the United States usually addressed and attempted to achieve the U.S. technological leadership by "decoupling" in the world’s most dynamic and innovative market of electric vehicles. However, as technological innovation and market demand are inextricably connected, the United States will undoubtedly lose the impetus in technological development and iteration brought about by an open and fully competitive market to a considerable extent. The United States has utilized its cutting-edge scientific and technological strengths and intricate legal tools to enhance its leadership in the global technology and automotive industries, manifesting the power generated by the interaction between technologies and law. The rapid changes in geopolitics and transformation of energy structure presents both crises and opportunities for China's automotive industry. Only by achieving innovation and breakthrough in key technology sectors and making good use of legal weapons, can China truly break the siege and finally become a leader of global technology in the future.
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Currently, there are 20 countries, including Canada, Australia, South Korea, Singapore, Israel and Mexico. Please see the detailed list of countries on the website：https://ustr.gov/trade-agreements/free-trade-agreements.
The "affiliated group" adopt the definition in tax law. For more details, please refer to the Internal Revenue Code § 1504 (a).
The CHIPS Act amends the CHIPS for America Act and provides funding support for semiconductor incentives thereunder. The provisions referenced herein are set forth in Chapter 72A, Title 15 Commerce and Trade, United States Code Service.
Federal Register : Securing the Information and Communications Technology and Services Supply Chain, please see: https://www.federalregister.gov/documents/2021/01/19/2021-01234/securing-the-information-and-communications-technology-and-services-supply-chain.
