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U.S. investors in Chinese venture capital funds are rushing to comply with new rules barring them from supporting companies developing artificial intelligence and other advanced technologies used by the People’s Liberation Army.
The Biden administration’s measures, which go into effect Thursday, impose civil and criminal penalties on U.S. companies that invest in Chinese companies involved in semiconductors, quantum computing, or AI systems that could be used by China’s military.
This rule imposes a significant due diligence burden on U.S. investors. Financial institutions with money tied up in Chinese investment funds will have to secure “binding contractual guarantees” that the money will not be used to acquire companies that violate the rules.
Some large investors have obtained such assurances from Chinese fund managers in recent weeks, but requests from other investors is said to have been rejected.
As tensions between the U.S. and China rise, many investors are responding by reducing or suspending new investments in China. Silicon Valley venture firms Sequoia Capital and GGV Capital were separated from their Chinese subsidiaries in 2024.
The rules take effect amid potential further tensions in U.S.-China relations due to the return of President-elect Donald Trump, who has vowed to raise tariffs on imports from China, and which is aimed at increasing the number of U.S. groups investing in companies around the world. highlighted the risks. The second largest economic power.
They also follow a period of growing bipartisan consensus in Washington that the United States needs to do more to prevent China from getting ahead of itself in critical technologies, especially those that are militarily sensitive. I am doing it.
A report released in February by the U.S. House China Committee said that U.S. venture capital firms have invested more than $3 billion in technology companies that directly advance China’s military advances.
Investors who receive guarantees will need to conduct due diligence to ensure that Chinese funds comply with regulations. This is particularly concerning because the country’s laws give governments and individuals the power to counter “discriminatory” foreign sanctions by other countries.
“The problem is that U.S. investors have binding contracts with some companies that they might otherwise violate,” said Roberts, a partner at the law firm King & Spalding. said Phil Ludwigson, who advises on national security risks associated with foreign investment. “That puts everyone in a difficult situation.”
The new rules could also reduce investment in sectors that are not prohibited in China because of the widespread use of AI.
“The USD Foundation has ended its commitment to China,” said an executive at a major US endowment fund. “The hurdle to making new commitments on the private front is 50,000 feet high.”
China reported its lowest annual foreign direct investment since the 1990s in 2023, while foreign ownership in China’s VC industry plummeted 60% to $3.7 billion in 2023, according to Dealogic .
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In contrast, over the past decade, Silicon Valley venture capitalists, wealthy family offices, and public pension and endowment funds across the United States known as “limited partners” have invested billions of dollars in China’s technology sector. did.
HongShan, Sequoia Capital’s former China operation, raised nearly $9 billion in 2022, about half of it from U.S. LPs.
Founded in 2005 with a $20 million investment from the endowment fund of Yale University, where founder Zhang Lei studied, Hill House has grown into a $65 billion technology investment powerhouse.
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 invest 1% to 3% of their portfolios in China.
The 72 largest public pension funds in the United States injected $68 billion into China between 2020 and 2023, according to a report by the think tank Future Union.
