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American investors in Chinese venture capital funds are scrambling to comply with new rules that bar them from backing companies that develop artificial intelligence and other advanced technologies used by the People’s Liberation Army.
The Biden administration’s measures, which take effect Thursday, impose civil and criminal penalties on U.S. entities that invest in Chinese companies involved in semiconductors, quantum computing or AI systems that could be used by the Chinese military.
The rules impose a heavy burden of due diligence on US investors. Institutions with money tied up in Chinese investment funds must provide a “binding contractual guarantee” that their money will not be used to buy companies that break the rules.
Some large investors have received such assurances from their Chinese fund managers in recent weeks, but requests from others have been rejected, according to people who advise large pension and endowment funds on compliance planning.
Many investors have responded by reducing or pausing new investments in China amid rising tensions between Washington and Beijing. Silicon Valley venture firms Sequoia Capital and GGV Capital spun off their Chinese entities in 2024.
The rules come into force at the moment when US-China ties could be further tightened by the return to office of President-elect Donald Trump, who has pledged to increase tariffs on Chinese imports, underscoring the risks for US investment groups in the world’s second-largest economy.
They also follow a period of growing bipartisan consensus in Washington that the US must do more to prevent China from advancing in key technologies, particularly militarily sensitive ones.
A report by the US House China Committee in February said that the US risk capital companies have invested more than $3 billion in technology companies that have directly fueled China’s military advances.
Investors granted guarantees will need to conduct due diligence to ensure their Chinese funds are following the rules. This is of particular concern since the country’s laws empower the government and private individuals to take countermeasures against “discriminatory” foreign sanctions by other states.
“The problem is that American investors are signing binding contracts with some entities that would otherwise be bound to break them,” said Phil Ludvigson, a partner at law firm King & Spalding, which advises on national security risks associated with foreign investment. “It puts everybody in a difficult situation.”
The new rules could also reduce investment in non-prohibited sectors in China due to the widespread use of artificial intelligence.
“U.S. dollar funds are done committing to China, period,” said the chief executive of a major U.S. hedge fund. “The barrier to taking on new liabilities on the private side is 50,000 feet high.”
China reported the lowest annual foreign direct investment since the 1990s in 2023, while foreign capital in China’s VC industry fell 60 percent in 2023 to $3.7 billion, according to Dealogic.
By contrast, over the past decade Silicon Valley venture capitalists, wealthy family offices and public pension and fund funds across the US – known as “limited partners” – have poured billions of dollars into China’s technology sector.
HongShan, a former Chinese company of Sequoia Capital, collected almost 9 billion dollars in 2022, with about half coming from US panels.
Hillhouse, which was launched in 2005 with a $20 million investment from the Yale University Foundation, where its founder Zhang Lei studied, has grown into a $65 billion technology investment powerhouse.
Other big US investors in China include the $460 billion California Public Employees Retirement Fund and the $260 billion New York State Common Retirement Fund, both of which have between 1 percent and 3 percent of their portfolios invested in the country.
According to a report by think-tank Future Union, the 72 largest US public pension funds pumped $68 billion into China between 2020 and 2023.
