ZTE Ban Weighs on Electronics Supply Chain

ZTE Corp. was the primary target but a decision by the U.S. Department of Commerce restricting the sale of electronics components to the Chinese telecommunications equipment manufacturer is reverberating throughout the industry. Executives at component suppliers, distributors and OEMs said they are monitoring the situation and have implemented further supply chain vetting actions to avoid getting sucked into the unfolding saga.

Many suppliers to ZTE are believed to have suspended sales to the company until the issues it has with the Dept. of Commerce have been cleared up. Rather than apply for an export license to ship American-designed components and equipment to ZTE the suppliers are simply curbing or halting most transactions with the company until further notice, according to Industry observers speaking on condition of anonymity due to the delicate nature of the situation.

Sources said they believe the U.S. government is unlikely to approve any applications for export licenses involving ZTE or any of its affiliates. In many cases, some companies are even extending the cautionary approach to other Chinese high-tech companies, especially those involved in the production of electronic equipment that require components having dual-use potentials, they said.

If not resolved soon the restrictions imposed on suppliers to ZTE could cripple the company. Like many of its rivals in the data and networking equipment market, the Chinese company relies heavily on components produced by or based on technologies developed by U.S. technology product suppliers. And, while the restriction was imposed primarily on U.S. manufacturers, it also affects products manufactured elsewhere in the world with American-made components. In an industry dominated by American semiconductor and component suppliers, the number of parts made without significant U.S. input are few. Furthermore, to avoid coming under the radar of U.S. regulators, many electronics components suppliers and OEMs are expected to simply shun any and all orders from ZTE, sources said.

The order restricting the sale of components to ZTE was issued on Monday by the Bureau of Industry and Security, (BIS) a division of the U.S. Department of Commerce responsible for “implementation and enforcement of export controls for commercial technologies and for many military technologies.” The agency’s Office of Export Enforcement helps to monitor and “deter the export of items, which, in the hands of unreliable users, can prove damaging to U.S. national security and foreign policy interests,” it said on the Commerce Department website.

The Bureau of Industry and Security on Monday said it added ZTE and “three affiliated entities” to a list of “foreign entities that are subject to specific license requirements for the export, re-export, or transfer of items subject to the Export Administration Regulations,” because the Chinese company sold certain products to Iran in violation of U.S. laws.

“The principal basis for the addition of these entities were two ZTE corporate documents entitled ‘Report Regarding Comprehensive Reorganization and the Standardization of the Company Export Control Related Matters’ and ‘Proposal for Import and Export Control Risk Avoidance,’ BIS said in a report on its website. “These documents outline a ZTE-developed scheme to violate U.S. export control laws by establishing, controlling, and using a series of ‘detached’ (e.g., shell or front) companies to illicitly re-export controlled items to sanctioned countries without authorization.”

ZTE, one of the telecommunication equipment sector’s fastest growing enterprises, said it is working with the U.S. government to find a resolution to the ban but also noted in a filing with regulators in Hong Kong that it was uncertain about the outcome of the discussions. China waded in with comments from the foreign minister this week, condemning the U.S. action and noting this could damage relations between the two countries.

Resolution Uncertain

At this point there’s very little China could do to extricate ZTE from the problem. The U.S. government has become highly sensitive on the transfer of dual-use technologies to countries and entities it believes threaten American interests. In the last year it has revised the Export Administration Regulations “to expand controls for national security reasons” and recently expanded “license requirements for exports and re-exports to Hong Kong of items controlled for national security reasons.”

The continued modification and frequent updates of the export restriction terms can be problematic for electronics manufacturers. OEMs and members of their supply chains have to remain alert to avoid falling afoul of the regulations, according to industry sources. In December, for example, the Bureau of Industry and Security expanded its rule on the export of microprocessors that can be modified for military use. It said:

This rule expands the scope of § 744.17 of the Export Administration Regulations. In addition to the license requirements set forth elsewhere in the EAR, you may not export, re-export or transfer (in-country) microprocessors, or associated "software" and "technology" for the "production" or "development" of such microprocessors without a license if, at the time of the export, re-export or transfer (in-country), you know, have reason to know, or are informed by BIS that the item will be or is intended to be used for a 'military end use' or 'military end user'.”

What this means is that electronics manufacturers can be sanctioned not just for ignoring clearly stated government restrictions but also for not being vigilant enough to know that their products could be used for unapproved military equipment. This explains why everyone is being so cautious about continued association with ZTE and why the telecom equipment maker faces a major, crippling danger now that it has come under the radar of the U.S. government.

Recognizing the severity of the problem facing it as a result of the restrictions, ZTE has been swift to inform investors and other stakeholders that it has initiated actions to resolve the situation. In a statement on the corporate website, ZTE chairman, Hou Weigui, provided detailed information on the restriction action and explained how the company is working to resolve the challenge. He said:

The board of directors of the Company (the “Board”) wishes to inform shareholders and potential investors of the Company that the Bureau of Industry and Security of the Department of Commerce of the United States of America (“U.S.”) has added the Company, ZTE Kangxun Telecommunications Ltd., ZTE Parsian and Beijing 8 - Star International Co. to the Entity List on 7 March 2016 (the “Decision”).

Pursuant to the Decision, with effect from 8 March 2016, suppliers of items subject to the Export Administration Regulations shall be required to apply for a license for the supplies of such items to the Company and the other three companies, and a license review policy of presumption of denial shall apply.

The Company is conducting a thorough assessment on the potential impacts of the restriction measures on the business and operation of the Group. As at the date of this announcement, the Company has been and will continue to be cooperative in the investigations by the U.S. relevant governmental department, and has been actively facilitating communications with the U.S. governmental department to search for a solution.