Enhanced U.S. restrictions on the sale of advanced semiconductors to China will unsettle supply chains. S&P Global Ratings believes the rules are ambiguous. They create uncertainty about the sales and supply lines of some tech majors, amid a downturn in tech demand.

The new rules will hit the China sales and China operations of the very biggest global technology firms, including Intel Corp., NVIDIA Corp., Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC), Samsung Electronics Co. Ltd., and SK Hynix Inc.

U.S. restrictions are aimed at advanced chips for use in supercomputers, and on the export of high-end semiconductor manufacturing equipment into China.

The U.S. measures include the following restrictions:

• Stipulates new license requirements for certain advanced and high-performance computing chips and semiconductor manufacturing equipment destined for supercomputer or semiconductor development or production end use in China;
• Restricts U.S. persons from supporting the development or production of semiconductors at certain China locations without a license;
• Imposes rules on items used in semiconductor production and development that meet any of the following criteria:
• --Logic chips with nonplanar transistor architectures of 16 nanometers (nm), 14 nm, or below;
• --DRAM memory chips of 18 nm half-pitch or less; and
• --NAND flash memory chips with 128 layers or more.

Investors are unclear about how these measures will be applied, and how they might affect the sales and credit standing of rated tech firms. We address their frequently asked questions about the new controls.

Frequently Asked Questions

How broadly might these rules be applied?

The rules are aimed at controlling the export of advanced semiconductors and semiconductor capital equipment. Companies selling such products to China will need licensing approval from the U.S. Department of Commerce.

The stated goal, according to the U.S. trade representative, Katherine Tai, is to control products with end-use in China's military. The aim is not to be too broad-based and inhibit all of China's semiconductor production, according to the official U.S. messaging.

The licensing requirement also covers advanced chips and equipment made outside of the U.S. that rely on key U.S. components or technology, under the Foreign-Direct Product (FDP) Rule. Such foreign chip manufacturers would also need to apply for a license with the U.S. Commerce Department to export such products into China.

U.S. persons (including permanent residents) will require a license to support the development and production of chips in China. Such licensing requirements have prompted some U.S. chip equipment manufacturers, such as KLA Corp., to pull staff out of Chinese fabs.

Which firms will be affected?

These measures would affect semiconductor capital equipment, Chinese fabs, and certain chip designers. Applied Materials Inc. disclosed that in the fourth quarter (ending end-October) revenue could fall 6.5% because of the new restrictions. For Lam Research Corp., the restrictions could affect 12% of its calendar year 2023 revenue. KLA Corp. didn't quantify the sales decline, but did say it was pulling staff from Chinese fabs.

For chip designers, NVIDIA and Advanced Micro Devices Inc. (AMD) make graphic processing units (GPUs) often used for artificial intelligence (AI) applications and in high-performance computers. The measures will affect sales for both firms.

NVIDIA provided guidance on its fiscal third-quarter (ending in October) that included about US$400 million in potential sales to China. The new license requirements may hit these sales if customers do not want to purchase its alternative products. AMD said it does not believe the new rules will have a substantial hit on its business.

Intel, TSMC, Samsung, and SK Hynix have all received a one-year exemption to receive semiconductor equipment for their fabs in China. They have no clarity on whether they can extend the waivers beyond that.

Will China retaliate?

Our base case is that China will not retaliate with tit-for-tat restrictions on U.S. technology companies or products. That would hinder their own goal to close the technology gap with the U.S.

China will likely increase its investment in semiconductor industry. As China innovates, it will accelerate its consumption of domestically made chips and tech products. However, attaining complete self-sufficiency across the semiconductor supply chain will be very difficult. The supply chain is long and complex, with expertise spanning companies and nations.

We expect more U.S. technology companies will seek to diversify their supply chain away from China, given the rising geopolitical tension. The U.S. CHIPS Act was a first step toward creating a U.S.-based tech supply chain that could be self-sufficient, though the U.S. will likely face similar challenges as China in achieving self-sufficiency.

How will chipmakers that produce in China, such as TSMC and SMIC, be affected?

TSMC has some production in China, but the bigger implication will really be around end-demand. About 10% of TSMC's products are sold directly into China, some of which could be hit by the new U.S. restrictions. If we account for indirect sales exposed to end-demand in China, the total exposure is larger. Indirect sales include sales to U.S. companies such as NVIDIA and AMD, in cases where chips are for end-use in China.

Chart 1

Production of 7-nm and below comprise about half of TSMC's revenue. These sales could be more exposed depending on how restrictively the U.S. regulators implement the latest measures.

TSMC said during its third quarter earnings call that the U.S. rules will have a limited and manageable effect on operations. The company is still assessing the long-term implications.

The restrictions are more likely to have a greater effect on production of Semiconductor Manufacturing International Corp. (SMIC) relative to demand from its customers. Most of its end demand is in China, which should be relatively resilient as Chinese technology companies increase support for domestic suppliers. However, demand could weaken for some sales to North American customers as U.S. companies reconsider their reliance on supply from China.

Most of SMIC's revenues are for 28 nm semiconductors, or above. While such revenues are not not within the 16 nm threshold for controls on export of semiconductor capital equipment to China, the restriction on U.S. persons working at its fabs could prove disruptive to operations.

Chart 2

What are the implications for Chinese technology firms that rely on imported chips?

The effect should be negligible, so long as the measures are focused on military applications and advanced computing. Lenovo Group Ltd.'s and Xiaomi Corp.'s key products, smartphones and computers, are relatively commoditized and unlikely to fall under the scope of the restrictions.

Lenovo's server production could be affected, depending on how deeply the U.S. controls the export of certain GPUs to Chinese firms. However, the profit contribution from Lenovo's server revenues is small and the hit should be negligible.

From a component supply perspective, mid-range central processing unit (CPU) and GPU chips are not likely to face restrictions.

The measures relating to logic chips made using 16-nanometer and below technology nodes are aimed at U.S. technology and equipment for chip production in China, and are not a restriction on exporting such chips into China.

Chart 3

Will Asian firms with operations in China get caught in the crossfire?

For now, we see limited implications for companies based in South Korea and Japan. SK Hynix's announced reduction in capital expenditure is mainly related to declining demand and high inventory levels. On the restrictions, the company has also received a one-year waiver to import chip equipment for use at its Wuxi facility.

The firm faces uncertainties on long-term investment into China. Samsung also has significant operations in China that will require the same set of complicated decisions surrounding expansion.

In Japan, the most exposed companies are Sony Group Corp. and Renesas Electronics Corp., but the effects are likely low. Sony produces image sensor chips in China for use in smartphones. The new restrictions won't likely target such chips.

Renesas' chip products are for automotive and internet-of-things devices, which are also outside the scope of the new rules. Despite Renesas' meaningful China exposure, at about 20%-25% of revenues, the implications are not likely to be significant.

How will the U.S. actions change global supply chains?

In the near term, companies across the globe are reassessing the geography of their supply chains, which can present political risk. Within China, the world's biggest producer of electronics goods, U.S. measures could disrupt chip production.

In the longer term, the highly efficient and globally interconnected technology supply chain could bifurcate between China and the rest of the world. This could create localized mismatch in supply and demand of technology components or products.

For example, China is focusing its efforts on chip production; however, without key semiconductor equipment, such production may have to focus on mature chips. This could result in an oversupply of such chips. At the same time, China could face an undersupply of advanced chips.

Writer: Jasper Moiseiwitsch

Related Research

• U.S. Chips On A New Block With Expanded China Restrictions, Oct. 20, 2022
• Asia-Pacific Tech Firms Face Long-Term Risk From China Chip Restrictions, Oct. 14, 2022