May 19, 2020

US/CHINA: New Huawei restriction will spark retaliation against US companies

BY Gabriel Wildau

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( 5 mins)
  • The US Commerce Department issued new rules designed to further restrict Huawei’s access to advanced semiconductors.
  • Beijing has promised to retaliate against US technology companies, but regulators will seek to avoid actions that inflict collateral damage on China’s own technology industry.
  • Risks to the phase-one trade deal are rising, but for now the deal still appears to be proceeding on a separate track from the conflict over Huawei.

The US Commerce Department published a new rule on 15 May aimed at denying Huawei’s access to advanced semiconductors and chipsets manufactured by Taiwan Semiconductor Manufacturing Co (TSMC). As previously discussed, the rule requires TSMC and other companies that use US hardware and software to produce semiconductors for Huawei to obtain a license from Commerce’s Bureau of Industry and Security (BIS).

A significant step towards de-coupling

Though the latest rule is not as restrictive as the toughest proposals that the administration of US President Donald Trump has considered, the rule is nevertheless a significant win for administration hardliners. These officials were dismayed to see advanced chips continuing flowing to Huawei even after the entity list action in May 2019.

The rule does not ban sales of equipment that is produced entirely by offshore units of US-based companies, which means that some components will continue to flow to Huawei, but many of the most advanced components require US-origin technology. The Semiconductor Industry Association warned that the rule “may create uncertainty and disruption” to the supply chain.

A day before the rule was announced, TSMC said that it would build a USD 12bn semiconductor foundry in Arizona with support from the US government. That deal likely represents the first in a series of new policiesdesigned to reduce reliance on China-centric supply chains for key products. Some chatter had suggested that TSMC’s commitment to the new factory would persuade US regulators to abandon the new Huawei licensing requirement, but that bargain did not happen. TSMC has reportedly stopped accepting orders from Huawei – its second-largest customer behind Apple – though the rule allows existing orders to ship until 14 September.

Commerce issued the new regulation as an interim final rule, which means it takes effect immediately but could be revised in response to public comments. In addition, some lawyers and industry observers raised doubts about whether the rule’s technical language fully implements the broad objectives described in the summary preamble. Commerce published the complete rule on 15 May, and the rule was scheduled to be formally issued in the Federal Register on 19 May, but last-minute rewrites are currently underway that may delay formal issuance. The impact on Huawei and TSMC also depends on whether BIS will grant licenses to enable at least some continued TSMC sales to Huawei. But given that the rule’s stated intention is to deny Huawei access to equipment, this appears unlikely.

Retaliation expected

Though Huawei has prepared for this action by stockpiling chips, the rule deals a significant blow to the company, whose ability to produce advanced smartphones and mobile base stations could be compromised within about four months.

China’s Commerce Department on 17 May accused the US of using “so-called national security concern as an excuse” and said it will take “all necessary measures” to safeguard Chinese companies’ rights and interests. Global Times, a state media publication, reported that Beijing will retaliate by adding US companies to China’s “unreliable entities list“, naming Apple, Qualcomm, Cisco, and Boeing as possible targets. Beijing ostensibly created the unreliables list last May in response to the original US action against Huawei, but the list has so far never been used. In addition to the list, China could also launch investigations of these or other US companies under the Cybersecurity Review Measures or the Anti-Monopoly Law, the paper reported.

The challenge for Beijing will be to formulate a tit-for-tat response that does not inflict collateral damage on China’s domestic industry by further narrowing Chinese companies’ access to valuable US technology. Targeting a consumer-focused company like Apple could achieve this goal. For US companies that produced genuinely irreplaceable products, use of the anti-monopoly or cybersecurity laws could enable Beijing to inflict financial pain and legal hassles without cutting off the actual flow of technology.

Impact on phase-one trade deal

The latest US action adds to risks that the phase-one trade deal could fall apart. As previously discussed, the deal is under threat from the increasing prominence of anti-China themes in the US presidential election, combined with the unlikelihood that China will be able to meet the purchase commitments enshrined in the trade deal. Tensions over Huawei are an additional risk factor.

The threat against Boeing would be a particular problem for the trade deal, which obligates China to increase imports of US manufacturing goods by USD 77.7bn over two years. Aircraft purchases make up a definite portion of that commitment, though the exact amount is not public. Chinese retaliation against Boeing, if carried out, could signal an unwillingness to fulfill this provision of the deal.

Ultimately, however, China still probably prefers to keep Huawei and other technology tensions on a separate track from the trade deal. Given the other downward pressures facing China’s economy, top leaders will seek to avoid an additional hit from snapback tariffs. If China retaliates using its unreliable list or with legal probes as discussed above, Beijing may feel that it has satisfied the requirement of tit for tat and does not need to disrupt the trade deal.

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