Our Take: financial services regulatory update – November 01, 2024

• What happened? On October 28th, the Treasury Department finalized regulations for a new outbound investment review program which aims to prevent “countries of concern” from benefiting from U.S. outbound investments in sensitive economic sectors. The final regulations build upon the framework in the Biden Administration’s August 2023 Executive Order, August 2023 Advance Notice of Proposed Rulemaking, and the July 2024 Notice of Proposed Rulemaking.
• What are the key elements and what changed from the proposal? The outbound investment review program prohibits or requires notification of certain transactions by U.S. persons (including citizens, residents and entities organized under U.S. law) involving covered foreign persons in three product categories: 1) semiconductors, 2) quantum technology, and 3) artificial intelligence (AI) – in named “countries of concern.”
  • Covered transactions: The final rule specifies the subjects of transactions that would be either prohibited or notifiable across the three product areas, as well as covered transaction types including acquisition of an equity interest or contingent equity interest; certain debt financing that affords certain rights to the lender; the conversion of a contingent equity interest; a greenfield investment or other corporate expansion; a joint venture; and certain investments as a limited partner (LP) or equivalent in a non-U.S. person pooled fund.
  • Knowledge standard: The rule specifies that a U.S. person are prohibited from “knowingly” engaging in prohibited transactions, specifying that knowledge of a covered transaction includes: “...(1) actual knowledge that a fact or circumstance exists or is substantially certain to occur; (2) an awareness of a high probability of a fact or circumstance’s existence or future occurrence; (3) reason to know of a fact or circumstance’s existence.” Relative to the proposal, the final rule includes more detail on what Treasury considers to be reasonable due diligence and clarifies that it will consider the totality of facts and circumstances related to the transaction.
  • Notification requirement: Details of a transaction subject to the notification requirement need to be filed with Treasury no later than 30 days after the transaction is completed or the U.S. person acquires knowledge of it.
  • Exemptions and exceptions: The final rule allows U.S. persons to seek an exemption on the basis that the transaction is in the national interest of the U.S. It also outlines certain types of transactions that are excepted, including publicly traded securities; buyouts of country of concern ownership; intracompany transactions; binding commitments entered into prior to the rule’s effective date; and certain syndicated debt financings. Relative to the proposed rule, the final rule adds certain transactions between a U.S. person and its controlled foreign entity; employee compensation in the form of stock or stock options; and certain derivatives.
• What’s next? The final regulations will be effective on January 2nd, 2025.

Our Take

New legal liability for a wide scope of transactions. Although this new outbound investment program is centered on three areas of technology, the definitions of covered persons and transactions could capture a broad range of transactions and investments. Firms that currently are or may become involved with investments related to semiconductors, quantum technology, and AI will need to ramp up their due diligence programs, capabilities, technology, and resources to ensure that they do not engage in prohibited transactions or fail to file a required notification. In order to prepare for the final program, firms should prioritize the following activities over the coming months:

• Inventory planned investments to identify potentially covered transactions.
• Assess the ability of existing compliance programs to facilitate review of proposed investments, including whether all parties to transactions provide enough information to determine whether they are covered foreign persons.
• Develop and implement mitigation strategies and controls for scenarios when covered transactions are identified, including technology-enabled monitoring solutions.

These notable developments hit our radar recently:

• Treasury targets third-country sanctions evasion. On October 30th, the Treasury Department sanctioned 275 individuals and entities across 17 jurisdictions involved in supplying Russia with advanced technology and equipment, including those involved in illicit procurement networks and financial facilitators used to evade previous sanctions.
• FATF updates list of jurisdictions with AML/CFT/CPF deficiencies. On October 30th, the Financial Crimes Enforcement Network (FinCEN) announced that the Financial Action Task Force (FATF) updated its lists of jurisdictions with deficiencies in standards for anti-money laundering, countering the financing of terrorism, and countering the financing of proliferation of weapons of mass destruction (AML/CFT/CPF). The FATF added Algeria, Angola, Côte d’Ivoire, and Lebanon to its list of Jurisdictions Under Increased Monitoring and also removed Senegal from the list.
• Swap dealers continue to face compliance challenges. Since the implementation of the Dodd-Frank Act over ten years ago, swap dealers and security-based swap dealers have undertaken significant efforts to implement and maintain processes and systems to comply with its reporting requirements, including updates issued by the CFTC in 2022. In this Our Take Special Edition, we examine the root causes of swaps reporting deficiencies, summarize key changes resulting from the CFTC reporting rewrite, and outline actions swap dealers can take to address both areas.