This post was made available to clients May 4, 2018. We have provided additional updates below and are available to answer any comments or questions you may have about the current and potential impacts of the ZTE case.
SUMMARY
The Committee of Foreign Investment in the United States (CFIUS) announced a ban that makes it illegal for American companies to supply ZTE with components and technology, through intermediaries or otherwise, effective immediately, for 7 years. CFIUS says this is due to the discovery that ZTE was selling US goods to Iran despite American sanctions in 2017.
ZTE is reportedly not taking move lightly and appears to be ramping up a plan to protect itself legally in the US court system. ZTE’s mobile phone manufacturing is heavily reliant on American-made chips and the sudden disruption of their supply chain threatens the company’s very survival. American companies provide ZTE with an estimated 25-30% of the components used in the Chinese firm’s products. This includes smartphones and telecommunications network. American chip-maker Qualcomm, one of ZTE’s top suppliers, says the loss of their business will have major consequences for their bottom line. Other major business partners in the US include Google’s Alphabet, Texas Instruments Inc., and GlobalFoundries.
In 2017, ZTE pled guilty in a Texas federal court to breaking American sanctions laws and paid $890 million in fines. In March of this year, authorities discovered that ZTE had lied about the resulting discipline of employees involved in the trade with Iran.
The Trump administration, under section 301 of the Trade Act, is currently investigating Chinese intellectual property disputes, including ZTE and Huawei. The first few months of the investigation resulted in 25% tariffs on 1,300 products from China in April. US trade representatives are expected to finish talks May 4th although no major breakthroughs are expected. In the meantime, it looks like the newest list of tariffs coming from the White House will continue to make progress towards becoming law. In regard to CFIUS, the organization has kept especially busy under US President Donald Trump, stopping acquisitions such as Broadcom’s takeover of Qualcomm, which would have been one of the biggest deals in the history of technology. There is currently a bill in Congress seeking to expand the organization’s power to include scrutiny of proposed joint ventures between firms abroad and the US.
The US government has also taken action in order to restrain Huawei’s involvement in the US. China’s biggest telecom company, officials in the CIA, NSA, and FBI released a statement in February of this year warning Americans against using Huawei phones. In March, US President Donald Trump blocked Singapore’s Broadcom from a $117 billion acquisition of Qualcomm over concerns it might give Huawei an advantage in their development of 5G technology. There has been ongoing suspicion in high levels of the government over Chinese investment into high-tech industries and selling of equipment. For example, Lenovo, a Chinese technology company, was caught selling laptops with pre-installed malware, thought to be part of Chinese espionage efforts, to the United States back in 2014. The company has reached a settlement in 2017 with the US Trade Commission.
FAO GLOBAL ASSESSMENT
As part of the country’s Made in China 2025 initiative – a program designed to encourage domestic production and less reliance on foreign imports — one of Beijing’s biggest goals for the next few decades is to maximize its capacity for technological manufacturing and innovation. In order for that to happen, these sort of sudden disruptions in supply chains cannot happen. There have been major moves even before the ban’s announcement to insulate themselves from this in big investments in creating an industry for Chinese chip production. China has the capital and consumer market to make it work but the road ahead is unlikely to be a smooth ride, especially if crises like the ban on exports to ZTE continue. If Huawei is also targeted by such bans, it is unlikely Beijing will be coming to the negotiating table ready to make concessions. The country’s burgeoning tech industry seems to a major sticking point for government leaders. Further unexpected big changes like the ban with ZTE will not be inviting signs for other Chinese companies looking to invest in the United States. This means less money for fledgling startups and businesses looking to expand, limiting growth across many industries in both China and the U.S. Cutting off integration between U.S. and Chinese tech companies may actually force Beijing to double down on efforts to create near-peer technology and achieve parity with the U.S. For national security experts, this is a fine line and not always clear.
The recent developments in ZTE’s future have dampened the investment climate from China in high-tech business sectors to the US, albeit the interest to invest is still there. This situation is exasperated by legislation passed in the US Senate mid-June that would give the CFIUS additional oversight powers in approving foreign investment. US tech companies should be aware of the political and legal environment of pursuing a deal if their product be considered of interest to national security. Unfortunately, many American firms will need to look elsewhere for investment injections if this political climate towards Chinese investment continues.
Update as of May 9, 2018: On May 9, ZTE was forced to shut down their operations due to the United States ban made by the US Department of Commerce in mid-April. Just a few days later, President Trump tweeted that he was going to work with President Xi to get ZTE “back to business.”
Update as of June 1, 2018: FAO Global CEO, Brandon Hughes, recently returned from a visit to China in May and had the opportunity to meet with persons who were involved in the ZTE case on the Chinese end. At the time, ZTE was the primary client for many smaller Western & Chinese product and service providers, and the announcement of the ban forced cancellations and immediate suspensions of many significant contracts threatening the viability for downstream suppliers.
Update as of June 7, 2018: On June 7, ZTE agreed to pay a $1 billion penalty and deposit $400 million in escrow in a settlement that would lead to the Chinese telecommunications manufacturer regaining access to the American market. The escrow account would act as collateral should ZTE violate the terms of the deal. President Trump made the offer as part of show of good will but Senate Republicans have already started movement to pass legislation that would overturn the agreement.
Related Links
- CNN – China’s biggest tech companies have reason to be worried
- CNBC – China’s ZTE warns US ban will put it into an immediate ‘coma’ but also hurt American companies
- Reuters – ZTE tells suppliers China trade row may be factor in US ban
- The New York Times – Trump Blocks Broadcom’s Bid for Qualcomm
- South China Morning Post – Why US sanctions on ZTE might turn out to be the best thing for China’s microchip ambitions
- Reuters – China says US Section 301 probe does not objectively view China’s progress in IP protection
- Reuters – Timeline: Next steps, deadlines in US-China trade fight
- Xinhua Net – US companies suffer amid punitive ban against ZTE
Analyst Bio
Adriana Ray – Asia Policy Analyst
Adriana Ray is an Asia Policy Analyst at FAO Global where she researches and writes on Economic, Security, and Political issues in the region. Adriana is currently a graduate student at Georgetown University’s School of Foreign Service where she is pursuing a Masters in International Security. She is also an alum of Tsinghua University and Furman University.
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