US investors in Chinese venture capital funds are adjusting to new regulations that prohibit them from investing in companies associated with artificial intelligence and other advanced technologies utilised by the People’s Liberation Army. These measures initiated by the Biden administration are set to commence on Thursday, imposing both civil and criminal penalties on US entities that support Chinese firms engaged in sectors such as semiconductors, quantum computing, and AI systems potentially beneficial to China’s military capabilities.
The Financial Times reports that these new rules impose an extensive due diligence requirement on American investors, who must obtain “binding contractual assurance” from Chinese fund managers that their investments will not be directed towards companies contravening these regulations. While some major investors have recently acquired such assurances, other requests from different entities have reportedly been declined.
In response to the mounting pressures and tensions between the US and China, many investors have opted to scale back or halt new investments in China. Notably, prominent Silicon Valley venture firms such as Sequoia Capital and GGV Capital severed ties with their Chinese operations earlier this year. This shift comes at a time when the relationship between the two countries is at a pivotal juncture, exacerbated by the anticipated return to office of president-elect Donald Trump, who has committed to increasing tariffs on Chinese imports, further complicating investment prospects in China.
These regulatory changes are a manifestation of the growing bipartisan inclination within Washington to mitigate the risk of China advancing in critical technological fields, particularly those linked to military applications. A report published by the US House of Representatives China committee noted that American venture capital firms had allocated over $3 billion to technology companies that could propel China’s military development.
Investors who have gained contractual assurances now face the daunting task of conducting thorough due diligence to confirm adherence to the newly established regulations. This situation poses a particular challenge, as Chinese legislation allows both the government and entities within China to retaliate against what they consider “discriminatory” foreign sanctions. Phil Ludvigson, a partner at King & Spalding, outlined these risks, stating, “The problem is that US investors are signing binding contracts with some entities that may be otherwise bound to violate it. It puts everyone in a tough spot.”
The implications of these regulations extend beyond the prohibited sectors, potentially impacting investments in other areas of China’s economy due to the pervasive integration of AI technologies. An executive from a significant American endowment fund remarked, “US dollar foundations are done committing to China, period. The hurdle for making new commitments on the private side is 50,000 feet high.”
Recent statistics illustrate a stark decline in foreign investment in China, with the nation recording its smallest annual foreign direct investment since the 1990s. Furthermore, capital influx into China’s venture capital sector plummeted by 60 per cent in 2023, totalling $3.7 billion, as indicated by Dealogic.
The historical context of US investment in China reveals a stark contrast, as Silicon Valley venture capitalists, family offices, and public pension and endowment funds have invested billions in Chinese technology firms over the past decade. Sequoia Capital’s former China entity, HongShan, amassed nearly $9 billion in 2022, with about half of this capital sourced from US limited partners. Similarly, Hillhouse Capital, which commenced operations in 2005 through a $20 million commitment from Yale University’s endowment, has evolved into a $65 billion technology investing powerhouse.
Major institutional investors such as the $460 billion California Public Employees’ Retirement Fund and the $260 billion New York State Common Retirement Fund have maintained between 1 per cent and 3 per cent of their portfolios in Chinese investments. According to a report by the Future Union think-tank, the 72 largest US public pension funds injected $68 billion into China from 2020 to 2023. As regulatory dynamics change, the landscape of US investment in China remains uncertain, influenced heavily by geopolitical considerations and evolving technological dependencies.
Source: Noah Wire Services