On March 23, 2023, the CHIPS Program Office at the Department of Commerce (DOC) released a proposed rule and request for comment outlining a series of “national security guardrails” for the $39 billion in federal incentives for semiconductor manufacturing released by the CHIPS and Science Act of 2022 (CHIPS Act or Act). The guardrails are designed to limit the extent to which companies receiving CHIPS Act incentives could expand semiconductor investments in “countries of concern”—China, Iran, Russia, and North Korea. Commerce stated that “These guardrails will advance shared national security interests as the U.S. continues coordinating and collaborating with allies and partners to make global supply chains more resilient and diversified.”

These proposed guardrails augment stringent export controls on semiconductor equipment to China imposed in October 2022 and the January 2023 U.S.-Japan-Netherlands pact limiting chipmaking tool exports. Commerce Secretary Gina Raimondo said that the guardrails will “help ensure that malign actors do not have access to the cutting-edge technology that can be used against America and our allies.” The Treasury Department concurrently promulgated draft rules to align CHIPS Act tax credits with the DOC guardrails.

The CHIPS Act established an Incentive Program making federal incentives (including grants, loans, and loan guarantees) available for the construction, expansion, and modernization of U.S. semiconductor fabrication, assembly, testing, and advanced packaging facilities. It also allocates funding to support research and development in semiconductors and associated materials and production equipment.  

• The CHIPS Act requires incentive recipients to enter into an agreement with the DOC prohibiting any "significant transaction" involving the "material expansion of semiconductor manufacturing capacity" in countries of concern.
• The proposed rules do provide two exceptions to the prohibition for legacy semiconductors. The first applies to a recipient’s existing facilities or equipment for manufacturing “legacy semiconductors” that exist on the date of the award so long as the facility does not undergo a “significant renovation”. The second applies to new facilities so long as at least 85 percent of its output is incorporated in end products used or consumed in the host country.
• The proposed DOC rules also prohibit incentive recipients from knowingly participating in joint research or licensing with a foreign entity of concern that relates to a technology or product that raises national security concerns.
• Existing plants in a country of concern may upgrade their technology but U.S. export controls may apply.

CHIPS Act restrictions are to remain in place for 10 years after receipt of federal incentives. Recipients who violate the restrictions are subject to the claw back of up to the full amount of the federal incentives received.

The proposed new rules define CHIPS Act terms and clarify its restrictions:

• “Material expansion of semiconductor manufacturing capacity” means an increase in a production facility’s capacity by 5 percent or more.
• A “significant transaction” means transactions of $100,000 or more.
• “Legacy semiconductor” means (1) a digital or analog chip of the 28-nanometer generation or older; (2) a DRAM memory device with a half-pitch greater than 18 nanometers or a NAND flash memory device that is less than 128 layers and does not use emerging memory technologies; or (3) any other device designated by DOC.
• Certain devices are categorized as “not legacy semiconductors,” including chips essential to national security, including FinFET devices, and chips packaged utilizing 3D integration.
• The proposed rule states than an “existing facility” is defined by its level of semiconductor manufacturing at the time of the required incentives agreement with DOC, and that a facility that undergoes “significant renovations” is no longer an “existing facility.” 
• “Significant renovation” means addition of a new production line at a legacy chipmaking plant or other actions that increase the plant’s capacity by 10 percent or more. The concept of “significant renovation” is not found in the CHIPS Act itself, and substantially reduces the scope of the exemption for legacy semiconductors produced in countries of concern as set forth in the Act.
• “Technology licensing” is defined as “a contractual agreement in which one party’s patents, trade secrets or know-how are sold or made available to another party.” Incentive recipients and their affiliates are prohibited from engaging in joint research or technology licensing with a foreign entity of concern on technology or products that raise national security concerns.
• “Foreign entities of concern” are entities which are subject to a long and sweeping list of U.S. designations, including blacklisted firms, companies based in “countries of concern,” Chinese “Military Industrial Complex Companies,” companies owned, controlled by, or subject to the jurisdiction of the government of a country of concern, agents of such entities, and designated terrorist organizations.

U.S. allies are aligning with the new export restrictions. In June 2023,  the U.S., the UK, Canada, Australia and New Zealand pledged to “formally” coordinate their export control enforcement regimes to enhance their effectiveness, minimize gaps and foster joint investigations and coordinated enforcement actions. On June 30, 2023, the government of the Netherlands unveiled the details of a new regulation that would prohibit the domestic chip equipment maker ASML from exporting advanced immersive deep ultraviolet lithography equipment (DUV) to China, a move which would foreclose that country’s ability to produce the most advanced semiconductors.  On July 23, Japan—one of the world’s leading makers of chipmaking equipment and materials—added 23 items to its export control list affecting China, including extreme ultraviolet lithography machines used to produce high performance chips with line widths of 10 to 14 nanometers or less.

Potential Impact on Korean and Taiwanese Chipmakers

The public reaction from firms with major existing chipmaking facilities in China to DOC’s proposed restrictions has been muted. But, many U.S. and non-U.S. corporations have privately expressed deep misgivings regarding the potential negative effects to the global semiconductor supply chain. The long-run cumulative effect of Western semiconductor technology restrictions—including export controls—will likely force a fundamental reordering of chipmaking investments away from China, imposing major cost and operational burdens on firms with a substantial China presence. However, it may also increase the likelihood of supply chain disruptions and raise prices for semiconductor consumers.  

Korean firms are particularly vulnerable. One industry analyst observed that “companies like Samsung and SK Hynix have a high proportion of their production capacity invested in China. If they cannot upgrade production processes or expand capacity, their business will be greatly affected.” He continued: “It is still a brutal fact that South Korean semiconductor manufacturers will face barriers to investments in the China market for the next 10 years.” 

The Korean government has asked DOC to review the criteria restricting CHIPS Act incentive recipients from expanding facilities in countries of concern. Following the announcement of the new U.S. export controls, DOC issued waivers to Korea’s SK Hynix and Samsung Electronics and to Taiwan’s TSMC to enable these firms to continue to bring advanced semiconductor technology and related equipment into China for one year. The waivers, which expire in October 2023, will reportedly be extended, a move that some critics warn will undermine the U.S. effort to limit China’s chipmaking capabilities.

• Samsung is currently producing 128-layer NAND flash memories at its Xi’an plants in China  where it has invested $26 billion. These plants account for 40 percent of Samsung’s global NAND production. Devices made at these factories appear to be “legacy semiconductors” according to draft DOC regulations, making them subject to a 10 percent cap on capacity expansion for wafer production.
• SK Hynix is producing DRAMs in the 10-20 nm range at facilities in Wuxi and a fab for 96 and 144-layer NAND flash memory in Dalian. Together, they represent investments of $20 billion and about half of SK Hynix’s DRAM production. These facilities also appear to be engaged in production of “legacy semiconductors” as defined by the draft regulations and thus are subject to a 10 percent capacity expansion limit.

These Korean producers believe they have sufficient production capacity in China and do not foresee the need for expansion over the near term. However, U.S., Dutch, and Japanese export controls on chipmaking equipment could severely restrict future upgrades to their production technology in China . SK Hynix’s Wuxi operations, for example, will be harder hit by the extension of export controls on deep ultraviolet lithography equipment (DUV) than by DOC’s proposed quantitative limits on expansion of legacy semiconductor facilities. SK Hynix has hinted that if the equipment controls are not lifted it might dismantle its factories in China, move the equipment to Korea, and “leave China for good.”

Taiwan’s TSMC is currently bringing online a 28-nanometer wafer fabrication plant in Nanjing, China, characterizing it as “the sweet spot for our embedded memory applications.”  Total investment for this project is reportedly $2.9 billion. However, Taiwanese observers view the proposed U.S. guardrails as potentially resulting in the suspension of TSMC’s Nanjing expansion program. Alisa Liu, a senior semiconductor research fellow at the Taiwan Institute for Economic Research, observes that “The chance of TSMC further expanding production in China is low” in light of U.S.-China friction. “It is expected that TSMC will slow down its investment in the country and focus on building production capacity in the U.S., Japan and even Europe in the future, with Taiwan remaining a production hub.”

Industry Reaction

27 individuals and entities have responded to the request for comments on the draft DOC guardrails rules. For the most part, these consist of generalized expressions of concern over unintended consequences and in particular, what is characterized as an overreach by the Department with respect to the term “significant renovation.” The Semiconductor Industry Association (SIA), representing U.S. semiconductor device makers, states that the proposed “definition of ‘significant renovation’ is found nowhere in the text of the CHIPS Act and needlessly narrows the scope of the exemption adopted by Congress.” The Semiconductor Equipment and Materials Institute (SEMI), representing U.S. chipmaking equipment and materials companies, recommends striking the definition of “significant renovation” as not intended by Congress to limit on the existing facilities exception. The Korean Government asked the U.S. to review its proposed definition of “material expansion, legacy semiconductor and other key terms.” Samsung and SK Hynix submitted confidential comments which, although not publicly available, seek modifications of DOC’s definitions.

TSMC’s submission also publicly aired several concerns with the draft guardrails, including:

• The proposed definition of “material expansion” would “cause ordinary efficiency and productivity improvements to existing production lines to violate the Manufacturing Expansion Prohibition”. Instead, they propose a definition of “material expansion” based on the expansion of cleanroom space.
• The proposed definition of “material transaction” based on the $100,000 ceiling is too inflexible and should be replaced by case-by-case determinations by DOC of what constitutes a “material transaction.”
• The proposed definition of “existing facility” does not “account for upgrades and productivity improvements during ordinary course of business operation.”

Supply Chain Concerns

Several comments suggest that the implementation of the guardrails as currently drafted could adversely affect complex, globalized supply chains in a manner not intended by Congress when it enacted the CHIPS Act:

• The U.S.-China Business Council points out that the applicability of the guardrails’ expansion and renovation restrictions on legacy production is unclear for companies supplying inputs, componentry, and semiconductor manufacturing equipment, or do back-end work for legacy chip producers in countries of concern.
• Momentive Technologies, the only U.S.-based producer of quartz for semiconductors, states that the proposed guardrails make it disadvantageous to apply for CHIPS Act funding and may induce it to move its operations outside the U.S..
• The Korean Semiconductor Industry Association (KSIA) warns that the inclusion of patents in the definition of “‘technology licensing’ will unnecessarily impede ordinary business transactions that are essential to the semiconductor ecosystem.”  Similarly, the law firm Miller and Chevalier cautions (on behalf of an unnamed client) that the current definition of “technology licensing” might deter patent cross-licensing transactions and limit CHIPS Act recipients’ participation in international standards-setting activities. Many companies participating in international standards-setting bodies are “foreign entities of concern.”
• Daikin U.S. Corporation, a maker of fluoropolymers and other exotic materials used in semiconductor manufacturing, currently produces these materials outside the U.S. but is considering establishing production in the U.S. with CHIPS Act funding. However, Daikin warns that if its Japan-based parent company is subject to the guardrails—a prospect that is unclear—Daikin would “likely be forced to stop pursuing CHIPS incentives out of concern that in the future [the parent] might choose to build or expand its semiconductor materials assets in a country of concern” unknown to Daikin U.S..

China’s Initial Reactions

It is important to note that China is demonstrating that it is not without leverage with respect to the global semiconductor supply chain.  In July 2023, China imposed export controls on gallium and germanium, materials which, according to the Biden Administration’s 100-day supply chain review report, are used in key emerging technologies in military systems, autonomous vehicles,  renewable energy and 5G communications.  Gallium and germanium are used to make high-performance compound semiconductors that can handle high power, frequency and voltages.  The U.S. has not produced gallium since 1987, and relies on China for over 50 percent of its needs.  Similarly, the U.S. produces some germanium but depends on imports from China for about 53 percent of its requirements.  The Chinese government stated that the new export controls were not related to measures by the U.S. and its allies to limit chip technology exports to China.

U.S. export controls on technology exports to China may presage additional U.S. measures to curtail U.S. investments in strategic, technology-intensive industries in China. On August 9, 2023, President Biden issued an Executive Order which would create a regulatory mechanism limiting outbound investments in the semiconductor, quantum computing and artificial intelligence industries, while requiring notifications for investments in other sectors.   The Treasury Department has released a Notice of Proposed Rulemaking in connection with the proposed curbs, inviting stakeholder input.

Shared Goals but Overly Restrictive

The stated purpose of the draft guardrails is to ensure that CHIPS Act incentives do not directly or indirectly benefit “countries of concern,” a goal that appears to be shared across the political spectrum and broadly throughout the semiconductor ecosystem. That said, industry reactions to date suggest that the guardrails as currently drafted are viewed as unnecessarily restrictive and will have unintended, adverse effects on semiconductor supply. Western firms with chipmaking operations in China appear to be contemplating shutting those operations down, a move that will exacerbate global shortages of semiconductors over the near term. In addition, the comments by infrastructure firms like Daikin and Momentive Technologies suggest that the guardrails may have counterproductive and unanticipated effects on global chipmaking supply chains, including incentivizing investments by materials and equipment suppliers outside of the U.S. They also seem to place major burdens on the firms of key allies which may undermine support for looser but more sustainable controls.

In short, these reactions suggest that the current language and especially the thresholds envisaged for the proposed guardrails appear to be too stringent and may well be counterproductive in terms of global supply and the health of the global supply chain, ultimately undermining U.S. policy objectives.

Sujai Shivakumar is director and senior fellow of the Renewing American Innovation (RAI) Project at the Center for Strategic and International Studies (CSIS). Charles Wessner is a nonresident Senior Advisor to the RAI project and teaches Global Innovation Policy at Georgetown University. Thomas Howell is an international trade attorney specializing in the semiconductor industry and a consultant with the CSIS Renewing American Innovation Project.