Government Regulation

How the U.S. Targets China's Military-Civil Fusion Efforts

In recent years, China’s Military-Civil Fusion (MCF) strategy has taken center stage, showcasing the country’s efforts to improve its military capabilities by tapping technologies developed in the commercial sector.

By
Larry Sussman
March 20, 2024
I

n recent years, China’s Military-Civil Fusion (MCF) strategy has taken center stage, showcasing the country’s efforts to improve its military capabilities by tapping technologies that have been developed in the commercial sector. This strategy, which is aimed at fusing civilian research and commercial ventures with the nation’s defense industrial base, has not only drawn comparisons to the U.S. concept of “civil military integration” (CMI) but has raised eyebrows for its unprecedented scale and ambition.

Over the last decade, growing international attention has focused on the extent to which China is elevating MCF incentives to unprecedented heights, posing challenges to U.S. military supremacy and eclipsing its own forays into CMI.

A major milestone in China’s elevation of MCF (军民融合) came in 2017 with: (1) the establishment of the Central Commission for Military Civilian Fusion Development (中央军民融合发展委员会) (CCMCFD), (2) the release of a special 13th Five-Year Plan for Science and Technology MCF Development by the Ministry of Science and Technology (S&T Plan), and (3) the State Council’s formulation of the Artificial Intelligence Development Plan (AIDP)1.

The CCMCFD is the most significant because under China’s nomenklatura system Party entities outrank their state counterparts. The CCMCFD is now a top level Chinese Communist Party (CCP) entity, which has, in turn, catapulted MCF to the highest level of national strategy. The S&T Plan meshes with this mandate by setting forth a long list of specific MCF initiatives, among which is the furtherance of what now amounts to at least 32 national level MCF innovation demonstration zones throughout the nation2. The artificial intelligence development initiative addresses the high-tech aspects of warfare with substantial national, provincial, and local budget allocations with the aim of achieving the “mutual military-civilian transformation of AI technology.”

Credit: “Innovate to Dominate: The Rise of the Chinese Techno-Security State” Tai Ming Cheung, Cornell University Press, 2022

From the U.S. perspective, the direction of these developments can be summarized in the words of Dr. Christopher Ashley Ford, a former Assistant Secretary of State for International Security and Nonproliferation:

“If any given technology is in any way accessible to China … and officials there believe it can be of any use to the country’s military and national security complex as Beijing prepares itself to challenge the United States for global leadership, one can be quite sure that the technology will be made available for those purposes – pretty much no matter what.”

U.S. MCF Classifications

In the hopes of maintaining its military edge, the U.S. has begun rolling out initiatives aimed at identifying and classifying firms linked to China’s military-civil fusion programs. For instance, there are now multiple, overlapping and evolving U.S. government classifications of Chinese and foreign entities in the MCF regulatory space. The following table summarizes the current definitions, enforcement mechanisms, and the primary U.S. government enforcement agency with jurisdiction.

Chinese Military Companies (CMCs)

The CMC classification is primarily aimed at countering China’s MCF strategy. Enforced under Section 1260H of the National Defense Authorization Act (NDAA) for Fiscal Year 2021, the essence of the MCF aspect of the CMC classification involves a determination by the Department of Defense (DOD) regarding whether a specific company contributes to the "Chinese defense industrial base" as a "military-civil fusion contributor." 

 

The DOD employs multiple criteria to reach this conclusion.  The eight criteria currently in use are outlined in the table below (with actual company examples).

In addition to "military-civil fusion contributors", a CMC includes entities under direct or indirect ownership, control, or beneficial ownership by, or acting as an agent of, the People’s Liberation Army (PLA) or any other organization under the Central Military Commission of the Chinese Communist Party, whether officially or unofficially.

 

While the DOD has publicly identified just 63 Chinese military companies (CMCs), WireScreen maintains a regularly updated collection of nearly 700 companies that meet the MCF criteria should they begin to directly or indirectly operate in the U.S.

Until recently, the CMC classification merely served to alert the public about entities that support China's military modernization objectives. However, its implications have now broadened significantly. In accordance with Section 805 of the NDAA for Fiscal Year 2024 (enforceable from June 30, 2026), the DOD is not only barred from engaging in contracts with these entities but is also prohibited from contracting with any other entity for goods or services "produced or developed" by them or entities under their control.

Credit for funds chart: “Innovate to Dominate: The Rise of the Chinese Techno-Security State” Tai Ming Cheung, Cornell University Press, 2022

The Power and Perils of Classification

Moving forward, the CMC criteria could become a pivotal flashpoint for additional U.S. regulatory action targeting MCF risks. Already, other U.S. regulations which overlap on MCF policy themes make reference to the CMC criteria. Recently, the CMC criteria was invoked for export control and other agency appropriations, cementing its status as a significant warning signal for the global business community.

Still, some Chinese companies have disputed their CMC classification. While there is no formal dispute process, the DOD is supposed to update the list annually, based on new information. Previously, several companies have lost their CMC status, often because they were no longer operating in the United States. It has been reported, for example, that Hesai Technology, a Chinese firm that develops light detection and ranging (LIDAR) solutions is considering filing suit against the U.S. Department of Defense over its designation as a CMS. Notably, in Xiaomi v. The Department of Defense, the Chinese smartphone giant prevailed and managed to remove its designation as a CCMC (i.e., the CMC predecessor classification discussed below)4. Also, the venture capital firm IDG Capital is reportedly seeking to dispel its recent inclusion on the CMC list. The DOD has not released details about how the CMC criteria was applied to IDG — which has been one of the most prominent investors in Chinese tech startups — and the precedent raises the prospect that other private equity firms could also be designated as military firms.

Military End Users (MEUs)

As part of its national security efforts, the U.S. government also works to restrict the sale or export of certain items to so-called Military End Users (MEUs). The MEU regime differs from the CMC regime in that MEUs are not solely driven by lists. Within the MEU framework, both an MEU rule and a list of MEU companies exist, with the former carrying greater significance. Under the MEU rule, items outlined in Supplement No. 2 to Part 744 of the EAR are subject to licensing requirements if the exporter is aware the item is intended, wholly or partially, for a "military end use" in China or by a Chinese "military end user," regardless of location5. Operating on a presumption of denial, obtaining a license once the rule is triggered is expected to be highly challenging.

Additionally, the BIS maintains a list of MEUs, which are predominantly Chinese entities. Notably, the MEU list represents only a subset of the MEU rule. The MEU list serves as a convenient reference for the public to identify companies already designated as military end users. However, the MEU rule applies universally to companies meeting the military end user criteria, regardless of whether or not they appear on the list.

The underlying U.S. policies behind the MEU classification, aimed at mitigating national security risks, manifest in several key areas:

  • The Export Control Classification Numbers (ECCNs) in Supplement No. 2 to Part 744 encompass a wide array of items, including consumer goods. These range from basic electronics and off-the-shelf software to legacy semiconductors, testing equipment, and various standardized components.

  • "Military end uses" refer to any item, such as commodities, software, or technology, that aids in the operation, installation, maintenance, repair, or production of military items. "Military end users" include entities facilitating such end uses, extending to civilian companies engaging with the Chinese defense sector. The definition captures civilian companies with minimal or episodic involvement with the Chinese defense sector. (WireScreen also identifies some firms that records indicate are or have been defense contractors with the Chinese military, or PLA.)

  • Shipments to China valued below $2,500 necessitate electronic export information (EEI) reporting via the Automated Export System (AES), contrary to the general exemption for such low-value shipments. Thus, even routine consumer shipments (e.g., via FedEx) require disclosure of the ultimate Chinese end-user, transaction parties, and ECCN classification. Failure to comply incurs penalties of up to $1,360 per day for consumers, with separate penalties for carriers. The AES system aids the U.S. Commerce Department’s Bureau of Industry and Security and U.S. Customs and Border Protection in monitoring shipments.

Given the expansive definition of military end users, WireScreen's ability to identify companies located within various MCF zones, bases, and parks can facilitate the due diligence essential for MEU testing.

Credit: BIS

Military, Security, or Intelligence Services End Users (MSIEUs)

The Export Control Reform Act of 2018 (ECRA) gave the BIS more power to oversee U.S. individuals and entities involved in supporting foreign military, security, or intelligence services. This authority applies even if the support doesn't involve items regulated by the EAR. ECRA originally read “...the President shall control…the activities of United States persons, wherever located, relating to specific… foreign military, or intelligence services.” In 2022, the word “security” was added after the word military. Military-intelligence ordinarily refers to any intelligence or reconnaissance organization of the armed services (army, navy, marine, air force, or coast guard); or national guard. Presumably, this will be updated to include the national police, government intelligence, and other reconnaissance organizations.

The BIS enacted regulations under this ECRA authority in 2021 because of China, stipulating that U.S. persons are prohibited from aiding military-intelligence end-uses or users. "Military-intelligence end use" encompasses the development, production, operation, installation, maintenance, repair, overhaul, or incorporation into military items intended to support the functions of such end users, including intelligence organizations of the armed and security services. The definition of "support" extends broadly to encompass transmitting items to these end users, facilitating transfers within the country, or engaging in contracts, services, or employment that may benefit them, irrespective of export control status6.

As will be discussed in our next article entitled, “Controlling Artificial Intelligence in the Chinese Supply Chain,” this authority was invoked once again, pertaining to China in 2022, in order to regulate activities linked to supporting the development or production of semiconductors. While the BIS has yet to apply this authority to Chinese security services, such a move is believed to be imminent.

Chinese Military Industrial Complex Companies (NS-CMICs)

The NS-CMIC classification is based on Presidential authority under Executive Order 14032, titled "Addressing the Threat from Securities Investments that Finance Certain Companies of the PRC." NS-CMICs, as determined by the U.S. Treasury Department’s Office of Foreign Assets and Control (OFAC), are companies that meet one of two criteria: (1) involvement in the defense and related material or surveillance technology sector of China's economy, or (2) ownership or control by, or of, a NS-CMIC or a company meeting NS-CMIC criteria. Notably, NS-CMICs can include private enterprises. This classification's rationale is distinctly linked to countering national security threats, particularly those posed by China’s MCF strategy. The prohibition against U.S. persons engaging in transactions involving NS-CMIC securities extends to the purchase or sale of such securities, including publicly traded derivatives or investment vehicles linked to them. This restriction applies globally, as NS-CMIC securities can be traded across international markets and stock exchanges, making the application of the classification extraterritorial in scope.

Communist Chinese Military Companies (CCMCs)

The CCMC classification can be viewed as a predecessor of the CMC. It originated from Section 1237 of the Fiscal Year 1999 National Defense Authorization Act (NDAA). Unlike the CMC, CCMC status is linked to specific persons listed in Defense Intelligence Agency publications VP–1920–271–90 (September 1990) or PC–1921–57–95 (October 1995), including any entity owned or controlled by the People’s Liberation Army engaged in commercial services, manufacturing, production, or exporting.

However, the significance of being classified as a CCMC was overshadowed by the emergence of the NS-CMIC classification as of August 2, 2021. Under Executive Order 13959, U.S. persons are banned from investing in CCMC securities and their subsidiaries.

The transition to the NS-CMIC classification re-casted the ban on certain Chinese securities investments and authority for the NS-CMIC classification from the Department of Defense (DOD) to OFAC.

Although not all named CCMCs transitioned to NS-CMICs, the CCMC classification continues to serve as a red flag for the business community and is subject to cross-referencing by other regulatory regimes. For instance, CCMCs are scrutinized in Military End User (MEU) rule diligence. Moreover, the NS-CMIC classification broadened the scope of the securities trading prohibition, encompassing entities beyond the former CCMCs. WireScreen diligently monitors such red flags for each entity in our collections.

 

Unverified List Companies (UVLs) and the Entity List

While the classifications discussed above are tailored for addressing Military-Civil Fusion (MCF) concerns, broader U.S. regulatory classifications also play a role in MCF countermeasures. Specifically, the Unverified List (UVL) is emerging as a comprehensive category for MCF-related issues, while the Entity List imposes more severe consequences on MCF actors. Recently, the Bureau of Industry and Security (BIS) has utilized the UVL and Entity List together to strengthen enforcement efforts regarding both MCF and non-MCF end-users, particularly in relation to on-site end-use checks conducted in China and other countries.

The BIS encountered persistent and lengthy scheduling delays for these end-use checks in China, prompting the establishment of escalation rules for cases of sustained non-cooperation (for China and all other countries). Under these rules, if 60 days elapse without the requested check being performed, the BIS will add Chinese entities to the UVL. Placement on the UVL results in these entities being barred from acquiring subsequent parts and services related to the original export. Subsequently, if another 60 days pass without compliance, these entities are transitioned to the more severe U.S. Entity List. Being placed on the Entity List entails a blanket prohibition on all exports subject to the EAR.

Following the implementation of these rules on October 7, 2022, China promptly scheduled pending end-use checks, leading to the removal of tens of Chinese companies from the UVL7. This innovative approach is seen as a more effective method for investigating potential MCF-related risks, particularly in situations where discerning the end uses and users proves challenging.

Separately, the BIS continues to add Chinese companies to the U.S. Entity List, including with FDPR, footnotes (see our blog regarding FDPR) for MCF reasons. The BIS recently added 41 Chinese companies to the Entity List citing China’s military modernization, support of military-civil fusion activities, and the PLA’s aerospace programs including airships and balloons8. The Entity List provides the broadest export control coverage in that it is not based on a subset of ECCNs. WireScreen maintains a flagging system for those entities moving in and out of the UVL and Entity List classification regimes.

More Classifications on the Way: MCF Research Institutions

Beyond company-related and U.S. person-related controls, Congress is advancing additional measures targeting Military-Civil Fusion (MCF). In the National Defense Authorization Act (NDAA) for Fiscal Year 2023, Congress mandated the Secretary of Defense and the Director of National Intelligence to commence cataloging academic, research institutions, and institutions of higher education involved with China’s MCF strategy. This heralds the potential creation of a new regulatory category for MCF-related controls.

Although these agencies have yet to finalize their public lists of such entities, WireScreen has compiled a collection of institutions closely linked to China’s defense industrial base. Our research reveals that these institutions have made over ten thousand investments in private commercial companies. This underscores the importance of monitoring the involvement of academic and research institutions in China's MCF strategy, as their activities can significantly impact national security and economic interests.

Defense & Security Affiliated Research Universities Collection in WireScreen

Conclusion

This paper introduced the bulk of MCF related classifications: CMCs, MEUs, MSIEUs, NS-CMICs, CCMCs, UVLs, SDNs, DPLs, and soon to come research institutes. The landscape is obviously complex, overlapping, and evolving in real time. Moreover, this is not the end of the story. More classifications and end-use controls regarding China are unfolding in Washington. One of the major questions is how such statutes will be enforced. On the face of the various definitions and ultimate end-use tests, full enforcement of all programs could capture a large number of deals and trade transactions directly and indirectly involving China.

The WireScreen platform not only tracks the above classifications (and others) on a stand-alone company basis but also on an affiliate basis by way of propagating red flags. This allows our users to rapidly identify classification, end-user status, and other sanctions risks throughout a group ownership structure. As the State Department reports9, companies listed as Chinese Communist Military Companies, for example, have more than 1,100 subsidiaries. Such large corporate groups with substantial affiliation and cross-ownership is common in this area. Rapidly understanding risks through affiliation is a critical part of the due diligence process.

1 There are other major developments, including a MCF Strategy Outline adopted by the CCMCFD and even a draft MCF Development Law.

2 See https://cset.georgetown.edu/publication/the-13th-five-year-special-plan-for-st-military-civil-fusion-development/

3 The DOD does not disclose the specific criteria used for each entity. Examples provided are based on WireScreen industry classification datasets and other open source information.

4 This was a successful preliminary injunction which led the DOD to remove Xiaomi by agreement. (https://casetext.com/case/xiaomi-corp-v-dept-of-def).

5 The MEU rule also includes Belarus, Burma, Cambodia, Russian, Venezuela, and China includes Hong Kong. Military end use is defined based on International Traffic in Arms Regulations (ITAR) regulations for munitions and specified ECCNs under the EAR. Military end users are defined to include not only the national armed services but also national guard and national police, government intelligence or reconnaissance organizations. The ITAR regime is outside the scope of this article.

6 It should also be noted that the MSIEU rules also apply to items. For items, they follow the same formulation as the MEU rules (i.e., items intended entirely or in part for a Chinese end-use or end-user) but with a broader scope because they apply to any item subject to the EAR (not just Supplement No. 2 to Part 744 items).

7 See https://www.bis.doc.gov/index.php/documents/about-bis/newsroom/press-releases/3196-2022-12-15-bis-press-release-entity-list-additions-and-unverified-list-modifications-1/file

8 https://www.federalregister.gov/documents/2023/02/14/2023-03193/additions-to-the-entity-list

9See https://2017-2021.state.gov/communist-chinese-military-companies-listed-under-e-o-13959-have-more-than-1100-subsidiaries/.

Larry is an experienced lawyer who worked for over 20 years as a partner and Head of China at O’Melveny & Myers in Beijing, and as a partner at Hogan Lovells. As Special Counsel at WireScreen, he specializes in analyzing Chinese ownership structures and their associated national security and sanctions implications.

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