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Econographics February 3, 2022

Foreign Direct Product Rule: Is Russia the next Huawei?

By Annie Froehlich

Evolving events in Russia have gripped international audiences – in part because proactive or responsive action by the US Government could impact global markets.  Experts are anticipating the possibility of new economic sanctions taking aim at Russian military and government officials, banks and financial institutions, and extractive industries, among other targets. New sanctions could include additional designations to the Office of Foreign Assets Control’s Specially Designated Nationals (SDN) and Blocked Persons List.

US persons are prohibited from engaging in dealings with SDNs, as well as with entities majority-owned, individually or collectively, by one or more SDNs. Given the prevalence of the US Dollar and other US touchpoints, many global financial transactions are subject to US sanctions prohibitions; accordingly, SDN designations can be severely damaging to those parties’ operations and activities, and can present various challenges for those required to comply with the prohibitions.

In readying a compliance response, domestic and global companies alike should also be mindful of another powerful US tool. The US Department of Commerce (Commerce) is speculated to be considering deploying a Russia-focused Foreign Direct Product Rule (FDPR). In addition to more traditional export controls, such as country-based licensing requirements and list-based restrictions, the FDPR can cripple its targets’ ability to source critical items produced from US-origin technology.

The FDPR expands the jurisdictional reach of the US Export Administration Regulations (EAR). The EAR is the principal commercial and dual-use regime regulating exports, reexports, and transfers of US-origin items, items in the United States (regardless of origin), and foreign-produced items comprising threshold amounts of controlled US-origin content.  The FDPR enables regulation of a broader range of items – specifically, items produced outside the United States that are: (1) the direct product of National Security (NS)-controlled US-regulated technology and software; or (2) are produced from plants, or major components of plants, that are the direct product of US-regulated NS-controlled technology and software.  In simple terms, foreign-produced items can fall within the scope of US regulation even if they do not actually incorporate US-origin content, as long as they are produced from covered US-regulated technology or software.

Commerce expanded the FDPR in 2020 in response to rising concerns about Chinese telecommunications giant Huawei’s threats to US national security, economic integrity, and supply chain security (Huawei FDPR). At the time, Huawei was already in Commerce’s cross hairs after many of its international affiliates were added to the agency’s Entity List.  Those designations precluded the listed parties from receiving any item subject to the EAR (including, as noted, certain foreign-produced items incorporating US-origin content) without a regulatory license.  The Huawei FDPR effectively broadened the scope of foreign-produced items that can be regulated under the EAR – and therefore licensable.   In short, the Huawei FDPR enlarged the range of US technology and software whose use outside the United States would subject foreign-produced items to US regulatory control, and required licensing for the provision of such items to Huawei, or for transactions involving such items to which Huawei is a party. 

When first issued, the Huawei FDPR intended to limit Huawei’s ability to procure chips, which are critical components in telecom systems and devices. As many chips are produced from US-indigenous technology, the Huawei FDPR restrictions even impact standard off-the-shelf chips used in common everyday products, such as smartphones and tablets. Accordingly, the Huawei FDPR restrictions can apply to chip manufacturers outside the United States who supply Huawei.  By some accounts, Huawei suffered a 30% revenue loss in 2021, ostensibly because of this rule.

If Russia advances further into Ukraine, it may be confronted with a version of the FDPR applied to Huawei. The contours of possible new restrictions remain shrouded, but they seem likely to be driven by US national security concerns, as in Huawei’s case. Here, they would likely focus on hindering Russia’s ability to procure crucial chips, integrated circuits, and microprocessors, as well as other advanced technologies derived from US-origin sources. These resources are needed to support key industry sectors in Russia, such as defense, civil aviation, maritime, and artificial intelligence, among others. 

So far, the threat of the FDPR or other regulatory action has not induced the Kremlin to stand down, but Russia may soon join Huawei in realizing the potency of these measures. If regulatory actions are imposed, assessing exposure and implementing appropriate compliance responses will be challenging. Companies around the world will need to assess their export and supply chain activities for possible US touchpoints, ensure that their products, technologies, and software are properly export-classified, and determine if their activities directly or indirectly involve targeted parties. Export classification is both compliance-critical and technically complex. Engaging qualified external experts may be prudent in some circumstances. Best practices could also be informed through engagement with industry counterparts or seeking agency guidance.

Only time will tell if Russia will be the next Huawei?

Annie Froehlich is a nonresident senior fellow with the Atlantic Council’s GeoEconomics Center. Ms. Froehlich is a special counsel at Cooley LLP.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Image: modern industrial factory for the production of electronic components - machinery, interior and equipment of the production hall