CHIPS Act China Guardrails: The Goldilocks Challenge

Guardrails walk a fine line between industry wants, Congressional demands, and presidential priorities

The following article is by Arrian Ebrahimi of the Chip Capitols substack

Last week’s implementation proposal for the CHIPS and Science Act’s national security guardrails shows that the US Department of Commerce prefers its porridge not too hot, not too cold, but just as Congress intended.

The Commerce Department first teased this proposed rule in its February Notice of Funding Opportunity, where it opened applications for semiconductor manufacturing grants. The guardrails proposal stems from a requirement in the CHIPS and Science Act that the Commerce Department prohibit companies receiving CHIPS grants from expanding capacity in China for ten years. If a grant recipient violates these guardrails, the Commerce Department can claw back federal funding.

The Treasury Department simultaneously released its own proposed rule that includes nearly identical claw-back rules relating to the semiconductor manufacturing investment tax credit, also passed as part of the CHIPS and Science Act. Treasury defers directly to the Commerce’s proposed rule on nearly every significant aspect of the guardrails — demonstrating that Commerce holds the reigns.

Though only proposed rules, they clearly demonstrate the Biden administration’s preferred flavor of technology policy. It did not go for the lukewarm porridge proposed by chipmakers which called for a narrower implementation of the China guardrails. Nor did officials go for a fiery hot porridge, where they could have adopted restrictions akin to Taiwan’s policies of reviewing any investment bound for mainland China. Instead, the proposed rule takes a Goldilocks approach, following the letter and spirit of Congress’s mandate in the CHIPS and Science Act. Commerce plans to implement the CHIPS guardrails as lawmakers intended — nothing more and nothing less.

Porridge Too Cold — Industry’s Hopes

Semiconductor manufacturers never argued too aggressively against the CHIPS guardrails. As I wrote in a previous Chip Capitols article, chipmakers had to be restrained in their critique of restrictions for expansion in China because Congress was preparing to shell out over $70 billion in taxpayer subsidies to the industry.

Chipmakers’ recommendations for the guardrails were always marginal in nature. Intel, for example, only sought to ensure that the definition of “legacy semiconductor” remained flexible — so that older generations of technology could be progressively built in China as the leading edge advances. Since passage, the Semiconductor Industry Association, Intel, Micron, and Texas Instruments have all urged that the restrictions on expansion in China be limited to the wafer fabrication stage of manufacturing and exclude other stages like assembly, test, and packaging (ATP).

It’s not suprising that the Biden administration didn’t adopt these narrow recommendations. Two key questions remain unresolved in the proposed rule, however, offering chipmakers a narrow lane to shape the guardrails more to their liking:

• “Final Products” Undefined: The rule says eighty-five percent of a legacy chip fab’s output must be incorporated into final products in the Chinese market for such a fab to be exempt from the guardrails. The Commerce Department did not, however, define what “final products” are. Will inserting a legacy chip into a windshield wiper assembled in Hangzhou, but subsequently shipped to a car factory in Germany, count as incorporation into a final product in China? Chipmakers will likely press the Commerce Department to include sales to first-order customers in this definition.

• Mitigation of National Security Risks: The statute allows the Commerce Department to take steps short of grant claw-backs, working with companies to mitigate violations of CHIPS guardrails. The rule, however, offers neither further clarity as to how Commerce will decide whether to pursue mitigation versus claw-backs, nor what sort of mitigation measures it may offer; industry advocates will likely seek clarity on this front. (Notably, the Treasury Department's proposed rule offers to waive the tax credit claw-back only if a violating expansion in China is “ceased or abandoned within 45 days.” Though the CHIPS and Science Act did not explicitly give Treasury the mandate to mitigate violating expansions — as it did to the Commerce Department — chipmakers will likely urge Treasury officials to leave room for measures short of full claw-backs.)

The Commerce Department has taken the charge on shaping the Biden administration’s semiconductor guardrail policies, as well as giving industry time to advocate changes. Perhaps Commerce’s porridge will cool somewhat after the sixty-day notice and comment period ends — but for now, the dish is plenty warm.

Porridge Just Right — Congressional Intent

The proposed rule would carry out the CHIPS and Science Act in both letter and spirit, showing a Commerce Department eager to reflect the Biden administration’s ‘Sullivan Doctrine’, as well as avoiding the public fiasco of CHIPS Act subsidies flowing through the books of semi firms only to end up supporting manufacturing in China.

• The statute requires Commerce to prohibit CHIPS grant recipients from engaging in significant transactions expanding advanced manufacturing facilities in China. To that end, the rule defines “significant transaction” to include expenditures as low as $100,000 or increases in production capacity as low as five percent. As chipmakers will make clear in their comments, this provision captures nearly everything beyond basic maintenance costs for existing facilities.

• It provides exemptions for companies to expand “legacy semiconductor” capacity in foreign countries of concern, so long as this capacity primarily serves China’s domestic market.The rule places a high bar on companies to qualify for the exemption, saying that “predominantly serving [the Chinese] market” means at least eighty-five percent of a facility’s output is incorporated into final products consumed in China. This high standard prevents the legacy chip exemption from undermining the broader purpose of the guardrails. Notably, the rule goes a step beyond what Congress passed in statute, saying expansions that qualify for the exemption may not add new production lines or grow capacity by over ten percent. In their comments, chipmakers may argue that this provision stands out from the rest of the rule by narrowing the statute beyond what Congress intended.

• Statute leaves the Commerce Department discretion to define “legacy semiconductors” that qualify for guardrail exemptions. In a surprising move, the rule proposes granting the Commerce Department significant leeway to disqualify legacy chip facilities from guardrail exemptions: “semiconductors critical to national security” are not considered to be legacy chips. Industry advocates have long repeated export control guru Kevin Wolf’s years-old refrain: the administration should “announce an actionable definition [of] what ‘national security’ means in the context of using export controls to address China-specific policies that are outside the scope of traditional non-proliferation objectives.” Still not having an actionable definition of national security, this provision could allow the Commerce Department to limit the guardrail exemptions to be as narrow as Congress’s most hawkish instincts.

• Statute makes no reference to the Commerce Department’s October 2022 semiconductor export controls, which rolled out after the passage of the CHIPS and Science Act. The rule bridges this gap by aligning the guardrails’ prohibited technology thresholds for memory chips to existing export controls, but its threshold for logic chips is more restrictive than that of existing export controls. Memory chip producers and logic chip producers may react quite differently in their comments as a result.

Porridge Could Have Been Hotter — Taiwan’s China-Bound Investment Review

We’ve already covered how the CHIPS guardrails are an innovative new tool in the US’s policy arsenal for economic competition with China. By offering grants in return for guardrails, the CHIPS and Science Act staunches chipmakers’ opposition to trade restrictions. It also spares US trade negotiators the arduous task of convincing allied governments to adopt the strictest parts of the US’s China policies by enticing foreign semiconductor companies to voluntarily accept guardrails in return for grants. Even so, one other government’s restrictions on trade with the People’s Republic of China offer extra spice that Commerce officials appear to have chosen not to add to the rule.

In December 2020, Taiwan’s Ministry of Economic Affairs (MOEA) amended its Regulations Governing the Approval of Investment or Technical Cooperation in Mainland China. The amended law adds the selling or licensing of specific technologies to the list of “technical cooperation” subject to government approval. Specifically, the law forbids both the direct transfer and licensing of technology to mainland Chinese entities, as well as indirect exchanges done through third-party companies.

The US Commerce Department’s proposed rule prohibits joint research and technology licensing for companies receiving CHIPS grants, but it does not suggest as stringent an implementation plan as Taiwan’s law. The US rule extends the limit on technology licensing to a grant recipient’s affiliates, but it does not clearly capture third parties who may subsequently engage in joint research or strategic product sales with a prohibited Chinese entity. This all provides a key valve for non-export-controlled US semiconductor technology to reach Chinese customers indirectly via companies that do not receive CHIPS Act funds, and which are therefore not subject to guardrails on IP transfer and licensing.

Little Room Left For Loosening

Stakeholders have sixty days to submit comments on the proposed rule, but chipmakers will be hard-pressed to give counteroffers substantially veering from the Commerce Department’s course.

Certainly, Commerce left some limited areas of its rule vague, and industry could leverage these provisions to cool down the guardrails. As seen in the case of Taiwan’s limits on technology transfer, however, the areas of vagueness could also flip the other way, becoming hotter and more stringent.

The next few months will be telling and exciting. As semiconductor companies send in their applications for CHIPS grant funding, the Commerce Department will finalize the rule that binds grant winners’ futures in China. Will companies find Commerce’s guardrails porridge too hot for their taste, and ultimately reconsider whether it’s even worth it to take CHIPS Act money to expand production in the US? Will China step up to the plate with sweeter subsidies offers (or threats to neuter current production) to make the decision harder for the companies who already have China production or dependencies and are on the fence? Will China hawks in the 118th Congress find the porridge too cold and demand that Commerce act beyond the statute written in the law?

Stay tuned to the comment box (or, if you are sane, just keep following our coverage) for what happens next in this great American policy experiment!