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U.S. investors in Chinese venture capital funds are racing to comply with new rules that prohibit them from backing companies developing artificial intelligence and other advanced technologies used by China’s People’s Liberation Army.
The Biden administration’s measures, which took effect Thursday, impose civil and criminal penalties on U.S. entities that invest in Chinese companies involved in semiconductors, quantum computing or artificial intelligence systems that could be used by China’s military.
These rules place a heavy due diligence burden on U.S. investors. Institutions whose funds are linked to Chinese investment funds must obtain “binding contractual assurances” that their funds will not be used to acquire companies that violate the regulations.
In recent weeks, some large investors have received such assurances from their Chinese fund managers, but others have had their requests rebuffed, said people who advise large pension funds and endowments on compliance planning.
As tensions grow between Washington and Beijing, many investors have reacted by reducing or suspending new investments in China. Silicon Valley venture capital firms Sequoia Capital and GGV Capital spun off from their Chinese entities in 2024.
The rules come as relations between China and the United States are likely to be further strained by President-elect Donald Trump’s return to office. risk.
At the same time, there has been a growing bipartisan consensus in Washington for some time that the United States must do more to prevent China from gaining a lead in key technologies, especially military-sensitive technologies.
A report by the U.S. House of Representatives China Committee in February stated that U.S. venture capital firms have invested more than $3 billion in technology companies that directly promote China’s military advancement.
Investors who receive the guarantee must conduct due diligence to ensure that Chinese funds comply with the rules. This is a particular concern because the country’s laws empower governments and private individuals to take countermeasures in response to “discriminatory” foreign sanctions imposed by other countries.
“The problem is that U.S. investors are entering into binding contracts with entities that might otherwise breach their contracts,” said Phil Ludvigson, a partner at law firm King & Spaalding who advises foreign investors Provide advisory services on investment-related national security risks. “It puts everyone in a difficult situation.”
The new rules may also reduce investment in non-prohibited industries in China due to the widespread use of artificial intelligence.
“The U.S. dollar foundation is no longer committed to China,” said a senior executive at a large U.S. endowment fund. “The barrier to new commitments from the private sector is 50,000 feet high.”
China reported the lowest annual foreign direct investment in 2023 since the 1990s, while foreign investment in China’s venture capital industry plunged 60% in 2023 to $3.7 billion, according to Dealogic.
In contrast, over the past decade, Silicon Valley venture capitalists, wealthy family offices and public pension and endowment funds across the U.S. – known as “limited partners” – have invested in China’s technology sector. billions of dollars.
Hongshan, the former China business of Sequoia Capital, raised nearly $9 billion in 2022, about half of which came from U.S. limited partners.
Hillhouse Capital was founded in 2005 with a $20 million investment from Yale University’s endowment (its founder Zhang Lei studied at Yale University) and has grown into a technology investment giant worth $65 billion.
Other large U.S. investors in China include the $460 billion California Public Employees Retirement Fund and the $260 billion New York State Common Retirement Fund, both of which have between 1% and 3% of their portfolios invested in China.
According to a report by the think tank “Future Alliance”, between 2020 and 2023, 72 of the largest public pension funds in the United States injected US$68 billion into China.
