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American investors in Chinese venture capital funds are racing to comply with new rules that prohibit them from backing companies that develop artificial intelligence and other advanced technologies used by the People's Liberation Army.
The Biden administration's measures, which take effect Thursday, impose civil and criminal penalties on US entities that invest in Chinese companies working in semiconductors, quantum computing or artificial intelligence systems that could be used by the Chinese military.
The rules impose a heavy burden of due diligence on US investors. Institutions with money tied up in Chinese investment funds must obtain “binding contractual guarantees” that their funds will not be used to buy companies that violate the rules.
Some large investors have obtained such guarantees from their Chinese fund managers in recent weeks, but requests from others have been rejected, according to people who advise pension funds and large endowments on compliance planning.
Many investors have responded by scaling back or halting new investments in China amid escalating tensions between Washington and Beijing. Silicon Valley venture firms Sequoia Capital and GGV Capital will separate from their Chinese entities in 2024.
The rules will come into effect at the time US-Chinese relations It could be further strained by the return to office of President-elect Donald Trump, who has pledged to raise tariffs on Chinese imports, highlighting the risks US groups face from investing in the world's second-largest economy.
It also follows a period of growing bipartisan consensus in Washington that the United States must do more to prevent China from advancing key technologies, especially militarily sensitive ones.
A report by the China Committee of the US House of Representatives last February said that America Venture capital Companies have invested more than $3 billion in technology companies that have directly fueled China's military progress.
Investors who received the guarantees will have to do due diligence to ensure their Chinese funds follow the rules. This is of particular concern because the country's laws enable the government and individuals to take countermeasures against “discriminatory” foreign sanctions imposed by other countries.
“The problem is that American investors are signing binding contracts with some entity that they may be obligated to violate,” said Phil Ludvigson, a partner at the law firm King & Spalding, who advises on national security risks related to foreign investment. “It puts everyone in a difficult position.”
The new rules could also reduce investment in sectors not blocked in China due to the widespread use of artificial intelligence.
“USD institutions have finished committing to China,” said an executive at a large US endowment fund. “The hurdle to making new commitments on the private side is 50,000 feet.”
China reported its smallest annual foreign direct investment since the 1990s in 2023, while foreign capital in China's venture capital industry fell 60 percent in 2023 to $3.7 billion, according to Dealogic.
By contrast, over the past decade, Silicon Valley venture capitalists, wealthy family offices, public pension funds and endowments across the United States — known as “limited partners” — have invested billions of dollars in China’s technology sector.
Hongshan, the former Sequoia Capital company in China, It raised nearly $9 billion in 2022, about half of which comes from US limited companies.
Hillhouse, which was launched in 2005 with a $20 million investment from the endowment fund of Yale University, where its founder Zhang Li studied, has grown into a $65 billion technology investment powerhouse.
Other major US investors in China include the $460 billion California Public Employees' Retirement Fund and the $260 billion New York State Joint Retirement Fund, both of which invest between 1 percent and 3 percent of their portfolios in China. .
The 72 largest US public pension funds pumped $68 billion into China between 2020 and 2023, according to a report issued by the Future Union Research Foundation.
