Geopolitical, trade, and investment tensions between the United States and China continue due to differences on such issues as the Russia-Ukraine conflict, Taiwan, Xinjiang, Hong Kong, Tibet, the South China Sea, human rights, and more. US issuers should review their current exposure to the China market and adjust their risk factor disclosures in upcoming annual reports, as appropriate, to take into account recent developments.
Beginning with the Trump administration in 2017 and largely continuing with the Biden administration, the United States has taken a series of trade, international treaty, tax, and sanctions actions against China. These include the imposition of tariffs on a substantial quantity of Chinese imports; the imposition of sanctions on an expanded number of Chinese companies for their support of China’s military industrial complex or alleged human rights violations; enhanced reviews by CFIUS of foreign direct investments in the United States by Chinese companies; the detention by US Customs and Border Protection of products made in Xinjiang involving alleged human rights violations; and, more recently, the enhancement of extensive export controls on the semiconductor industry designed to impede Chinese semiconductor companies’ access to advanced technology.
These actions have in many cases triggered, or are expected to trigger, countersanctions or countermeasures from the Chinese government. It remains to be seen whether recent diplomatic meetings between President Biden and Premier Xi will have a positive effect on relations.
Additionally, in recent years, tensions between mainland China and Taiwan have further escalated, with China accelerating the development of its military capabilities in order to “reunite Taiwan by force.” The US government, which has maintained a longstanding policy of “strategic ambiguity” on whether to defend Taiwan in case of a military conflict, has steadily increased its support of Taiwan’s own defense capabilities and deterrence of China’s military actions against Taiwan. The newly passed Taiwan Policy Act of 2022, among other things, provides almost $4.5 billion in security assistance over the next four years. As countermeasures, China has significantly increased its air patrol and military exercises near the Taiwan Strait and imposed sanctions on US officials visiting Taiwan and US defense companies selling arms to Taiwan.
Military leaderships and civilian think tanks in various countries are openly contemplating the outbreak of hostilities with varying but specific timetables. In case of a military conflict between China and Taiwan, global manufacturers would likely lose access to advanced semiconductor chips and other products that are sourced from Taiwan. Such a conflict would also likely limit access to key Chinese ports and exporters due to both military actions and potential international sanctions, which would create significant disruption for industries that rely on supply chain in China.
Further action on China is expected from the Biden administration and Congress this year. Legislation relating to China—especially regarding supply chain security, unfair trade practices, intellectual property protection, data privacy, defense and national security, China’s inbound investments into the US and US outbound investment flows to China, Taiwan, human rights, and higher education—is one of the few areas of potential consensus between Republicans and Democrats.
As geopolitical tensions between the United States and China continue, issuers should consider carefully tailoring their risk factors to address specific risks facing their businesses related to China, and should benchmark these risk factors against what their peers are disclosing. While the risk factors of Chinese-based companies publicly traded in the United States offer a catalog of China-related risks to consider, including those risks for which the US Securities and Exchange Commission (SEC) has requested explicit disclosure through staff comment letters, many of these will not be relevant to US issuers doing business in China.
Reliance on generic risk factors related to the risks of doing business internationally may fall short of properly informing investors of the specific risks an issuer may face when engaging in certain China-related activities, and the SEC discourages such boilerplate disclosure.
While the SEC has not to date provided any tailored guidance on how US companies should consider disclosing risks related to doing business in China, the SEC’s Division of Corporation Finance’s Disclosure Guidance Topics pertaining to COVID-19 disclosure considerations and, in particular, the sample letter issued by the staff May 2022 in response to Russia’s invasion of Ukraine and related supply chain issues provide a useful analytical framework for considering the disclosure of China-related trade risk.
Applying the frameworks articulated in the Division’s guidance, companies should consider detailed risk factor disclosure, to the extent material or otherwise required, regarding the following:
In addition, since US–China trade tensions have increased, many companies have experienced heightened cybersecurity risks, increased or ongoing supply chain challenges, and volatility related to the trading prices of commodities, regardless of whether they have operations in China that likely warrant disclosure.
In addition to risk factor disclosure, financial statements may also need to reflect and disclose the impairment of assets, changes in inventory valuation, deferred tax asset valuation allowance, disposal or exiting of a business, deconsolidation, changes in exchange rates, and changes in contracts with customers or the ability to collect contract considerations.
Companies with significant and material exposure to these risks also should consider how these matters may affect management’s evaluation of disclosure controls and procedures, management’s assessment of the effectiveness of internal controls over financial reporting, and the role of the board of directors in risk oversight of any action or inaction related to increased US–China trade and investment tensions, including consideration of whether to continue or to halt operations or investments in China.
Specific outbound risks to consider include the following:
Specific inbound risks to consider include the following:
US issuers with China exposure and US-listed Chinese companies should work with outside legal counsel with both US and China expertise to review comprehensively the risk factors in their upcoming SEC filings. Companies should ensure the filings adequately reflect the risks they face from heightened US–China tensions with specific, tailored disclosures in order to satisfy applicable disclosure requirements, mitigate private civil litigation risks, and withstand potential regulatory scrutiny.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following:
*A solicitor of Morgan Lewis Stamford LLC, a Singapore law corporation affiliated with Morgan, Lewis & Bockius LLP
 The US-China trade war: A timeline, China Briefing News (2022).
 See CF Disclosure Guidance Topic No. 9: Coronavirus (COVID-19) (Mar. 25, 2020) and CF Disclosure Guidance Topic No. 9A: Coronavirus (COVID-19) Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources (June 2022).