Will the U.S. chip control on China escalate? In any case, domestic substitution is a must

The U.S. government has been exploring specific forms of chip export controls to China, which could accelerate the localization of semiconductor manufacturing that China has already started.

Text: Finance and Economics E Law Fan Shuo

Editor|Zhu Tao

On October 17, local time, the Bureau of Industry and Security (BIS) of the U.S. Department of Commerce revised the interim final rule on semiconductor export controls to China issued on October 7, 2022, expanding the scope of control on the export of advanced chips to China.

In the upgraded export control rules, the United States has revised the criteria for the identification of advanced computer semiconductor chips for the first time, replacing the previous criteria for bidirectional transfer rate and floating-point computing power with total processing performance and performance density.

The new rules require U.S. companies to obtain permission from the U.S. government to export advanced chips to more than 40 countries around the world to prevent non-Chinese companies from buying chips for resale to China, which further shrinks export channels to China. The new rules also expand the scope of the U.S. long-arm jurisdiction, expanding the number of countries that need to apply for semiconductor manufacturing equipment licenses from China to 21 countries. In addition, two Chinese chip companies, Bichen Technology and Moore Threads, have been added to the "Entity List" involved in the development of advanced computing chips, and there are currently 13 companies on the "Entity List" that require a BIS license to manufacture chips for these companies.

In the face of the new regulations, the first to face the impact is the A800 and H800 high-performance GPUs sold by Nvidia (NASDAQ:NVDA) in China. According to the original export control rules, the two-way transmission rate of advanced computing chips exported to China shall not exceed 600GB/s. As a result, NVIDIA's two high-performance GPUs, the A100 and H100, designed specifically for AI computing, cannot be exported to China. However, since the third quarter of 2022, Nvidia has successively launched the A800 and H800 "special" for the Chinese market. According to public information, the peak computing power of the A800 is the same as that of the A100, but the peak transmission rate is reduced from 600GB/s to 400GB/s.

Although the new rules claim that they will come into effect after 30 days of public consultation. But the U.S. government has closed the 30-day "window." On the evening of October 24, local time in the United States, Nvidia issued an announcement saying that on October 23, local time, the U.S. government notified Nvidia that the ban on GPU chips that had previously restricted exports took effect immediately, and the models involved included Nvidia A100, A800, H100, H800, and L40S.

A cloud service provider told Caijing E Law that his company placed an order for cloud servers equipped with multiple A800 in May this year, but these servers have not yet been delivered. At present, the shipment cycle of high-end servers equipped with A800 is more than half a year, and after the export control upgrade, his company still places several new server orders, but is pessimistic about whether it can be delivered.

Huang Leping, chief analyst of the technology and electronics industry at Huatai Securities, told Caijing E Law that the control measures will delay the development of China's AI model in the short term. But at the same time, it will also force China's AI large model companies to transfer their development platforms to domestic chip platforms such as Huawei and Cambrian. The above-mentioned cloud service manufacturers also believe that after the implementation of the new control measures, although most manufacturers are still wait-and-see, domestic AI chips will become an alternative choice.

01 Will the control measures be upgraded?

Huang Leping believes that the United States' control of semiconductor equipment this time still revolves around restricting China's development of advanced processes below 14nm, which is consistent with the previous thinking.

Liao Shengqiang, a partner at Morgan Lewis LLP, who has represented Chinese clients in U.S.-related international trade export controls, economic sanctions, intellectual property protection and cross-border dispute resolution on many occasions, told Caijing E Law that the 2022 control rules are relatively broad in terms of wording, and many important words lack clear definitions, resulting in many enterprises being very confused about how to apply the rules in specific situations. On the other hand, the U.S. government is also figuring out how to apply export control restrictions within an effective but reasonable scope. "It is foreseeable that this rule will continue to be updated in the future." Liao Shengqiang said.

Liao Shengqiang believes that the overall framework of the new regulations continues the 2022 control rules and has not undergone fundamental changes. However, in terms of specific rules, the new regulations obviously further tighten export controls, such as expanding the scope of control, refining the entry settings, and adding risk signals. In addition, the revisions to the new regulations also reflect several important control ideas of the U.S. government, including regulatory measures to prevent export control bypass, and the combination of multilateral and unilateral controls.

Specifically, the new regulations will make total processing performance and performance density indicators for advanced computer semiconductor chips, which Liao believes is to prevent companies from bypassing the restrictions on all chips through "chiplet" technology. Chiplets, also known as "chipsets", refer to the separation of each component originally integrated in the same system-on-chip (SoC) into multiple chiplets with specific functions, which are manufactured separately and then interconnected with each other through advanced packaging technology, and finally integrated into a system-on-chip.

The new regulations also make extensive adjustments to the ECCN codes and corresponding technical notes related to semiconductor manufacturing equipment, revoke the ECCN code 3B090 in the original control rules, and reduce the minimum component content calculation standard for 3B001.f.1.b.2.b related items (lithography equipment) to 0%. According to industry analysts, this move is intended to strengthen the control ability of semiconductor manufacturing equipment that is not originating in the United States. Liao Shengqiang believes that the content and parameters of 3B001 overlap greatly with the controlled equipment of Japan and the Netherlands, so it is very likely that this is a rule update adopted by the United States in accordance with the tripartite agreement between the United States, Japan and the Netherlands in January this year. "The U.S. government has been hoping for alliances with other countries to jointly undermine China's chip capacity, and is also working to push for multilateral export controls on China's access to semiconductor equipment." Liao Shengqiang analyzed the financial E method.

Regarding the scope and prospects of the implementation of the new regulations, Liao Shengqiang said that the U.S. Department of Commerce has greater discretion in the practice of law enforcement in the field of export control, and its overall export control enforcement (especially for China) shows an increasingly tightening trend. For example, in April this year, Seagate Technology, a U.S. hard disk drive manufacturing company, was fined a historic $300 million by the U.S. Department of Commerce for allegedly selling hard drives to Huawei in violation of export controls. On October 5, U.S. Secretary of Commerce Raimondo publicly stated at a congressional hearing that the Commerce Department needs different tools and more enforcement resources to enforce the export control regime.

Liao Shengqiang believes that on some details of the new regulations, the U.S. Department of Commerce may make some adjustments after the consultation is over. At the same time, the future development of diplomatic relations between China and the United States will have a direct impact on the degree of export control enforcement in the United States. If relations between China and the United States can be relaxed, the United States may relax its export control enforcement.

After the original control rules came into effect in 2022, a number of U.S. giants still export products to China. For example, Nvidia sells reduced versions of its high-performance GPUs, the A800 and H800, to the Chinese market. Intel launched the Chinese version of the deep learning accelerator Gaudi 2 in July 2023, reducing the 24 Ethernet ports integrated in the international version to 21. Intel said that the accelerator card launched for the Chinese market will not be much different in performance, and Gaudi2 and the next generation Gaudi3 will continue to support Chinese customers under the condition of legal compliance.

After the regulatory rules are upgraded, can Chinese and American semiconductor companies bypass the new regulations? Huang Leping, chief analyst of technology and electronics at Huatai Securities, told Finance E Law that the new regulations have made detailed restrictions on total computing power, computing power density and other indicators, and it is not easy to find alternatives.

Liao Shengqiang believes that companies cannot independently assess the response measures based on the literal meaning of the new regulations, and that some so-called "bypass" regulatory structures may appear to be able to exploit loopholes in certain rules, but their compliance is risky. Some structures may even constitute malicious circumvention of U.S. export control controls, which may constitute aggravating circumstances. Even if these schemes appear to be formally compliant under the existing rules, they may still cause US regulators to keep a close eye on the relevant companies, and it is not ruled out that the rules may be updated to plug loopholes, or the existing rules may be interpreted strictly in law enforcement investigations.

"As chip exports to China have gradually become a normalized and stable policy rule, the most important thing for chip companies is whether they can find an effective response during the current transition period." Liao Shengqiang said.

02 Accelerate the process of localization?

The "sudden" move by the U.S. export controls could accelerate the localization of semiconductor manufacturing that China has already started.

Counterpoint, a market research agency, said in August that Chinese companies such as Tencent and Baidu had purchased a large number of reduced versions of the A800, but it was uncertain whether these orders would be cancelled.

Zhang Guobin, a veteran of the semiconductor industry and CEO of Electronic Innovation Network, believes that in the short term, the U.S. control measures will restrict the training of China's large models. But in the long run, this can promote Chinese manufacturers to develop independent and controllable chips to a certain extent, and increase market share. Huang Leping also believes that the localization of AI chips has become a mandatory option for AI companies.

Market participants have already given a timetable. In August 2022, UBS Securities analyst Jimmy Yu said that looking ahead to the next three years, the adoption rate of China's domestic chips will gradually increase to between 30% and 50%, and the self-sufficiency rate of semiconductor equipment will also continue to rise, with some mature equipment - such as etching and cleaning machines - expected to account for about 70% of the entire market.

However, IC Insights, a U.S. semiconductor industry research company, is pessimistic. IC Insights believes that even by 2026, China's local self-sufficiency rate in semiconductor chips will increase to 21.2% at most, and its semiconductor output value may only account for more than 8% of the global semiconductor market.

In fact, since the U.S. Department of Commerce began to control the export of semiconductors to China in 2022, China's semiconductor manufacturing industry chain has begun to show a trend of accelerating localization.

In semiconductor manufacturing, there are multiple supply chain links. SPDB International reports show that semiconductor companies in Chinese mainland have different development speeds in different links. Relatively speaking, Chinese mainland companies have developed faster in semiconductor design and semiconductor packaging and testing, and have the ability to compete with world-class companies. However, there are obvious disadvantages in the wafer foundry of semiconductors and the IP (patents), software tools, semiconductor equipment and materials in the upstream of semiconductors. As the United States continues to exert pressure on China's semiconductor industry, it has become much more difficult for Chinese mainland wafer manufacturing to catch up with advanced processes.

Wafer foundry refers to the manufacture of integrated circuits that are commissioned by other fabless semiconductor companies to specialize in the processing of finished wafers. In the wafer foundry process, the lithography machine is the key equipment. ASML, based in the Netherlands, is the world's top and strongest lithography machine manufacturer, and is currently the only manufacturer in the world that can manufacture EUV (extreme ultraviolet lithography) lithography machines. EUV lithography machines are used to manufacture chips with processes of 7nm and below, while DUV (deep ultraviolet lithography) can only manufacture chips with processes above 7nm. At present, ASML's state-of-the-art EUV lithography machine has never been sold to Chinese customers.

In June 2023, the Dutch government issued new export control regulations on advanced semiconductor equipment, restricting the export of the latest models of deep ultraviolet lithography equipment to China. Exporters are required to apply for a licence for the relevant advanced semiconductor equipment listed in the regulations. On September 1, ASML confirmed that the Dutch government had issued an export license to the company, and that ASML would still be able to ship the TWINSCAN NXT:2000i and subsequent immersion lithography systems to customers by the end of this year.

The U.S. Department of Commerce's new export control regulations impose export restrictions on semiconductor manufacturing equipment, including lithography machines, revoke the ECCN code 3B090 in the original control rules, reduce the minimum component content calculation standard for 3B001.f.1.b.2.b related items (lithography equipment) to 0%, and expand the licensing requirements for semiconductor manufacturing equipment to more than 20 countries.

ASML said after the release of the new US regulations that according to the information received so far, ASML believes that the number of Chinese mainland wafer fabs involved in advanced chip manufacturing that are applicable to the new regulations is limited. In the medium to long term, these export control measures may affect the ratio of sales volume between different regions.

With the impact of export controls, wafer foundries in Chinese mainland are turning to domestic equipment manufacturers. After analyzing the bidding of Chinese wafer fabs, Huatai Securities found that from January to August 2023, Chinese foundries opened bids for a total of 182 devices, of which a total of 86 devices came from domestic manufacturers, accounting for 47.25%. From July to August 2023, Chinese suppliers received a 62% share. In 2022, the localization rate of Chinese wafer foundries was 39.1%, and in 2021, this figure was 27.4%.

Huang Leping said that their team counted the revenue of 22 major listed semiconductor equipment companies in China. In the first half of fiscal 2023, the combined revenue of overseas major listed companies in China and the revenue of major Chinese listed companies decreased by 4%, of which the combined revenue of Chinese companies increased by 40%. The market share of China's front-end equipment companies increased from 11% in the first half of fiscal 2022 to 16.6% in the first half of fiscal 2023. This confirms the upward trend of the localization rate from another side.

However, Huang Leping is still worried about the prospect of localization of some chip manufacturing core equipment. He said that in the core equipment such as lithography machines, the current domestic equipment cannot meet the needs of domestic foundries. It remains to be seen how much the new semiconductor equipment control policy will have an impact on the expansion progress of domestic foundries.