China must rethink chip strategy in light of US sanctions
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China wasn’t doing that well before US sanctions on its silicon strategy; now it’s being forced to try a lot harder.
When it was founded in 2000, Grace Semiconductor aimed to build a chipmaking empire centred on Beijing but also make the most of political connections with the US. And with the son of former Chinese premier Jiang Zemin as one of its co-founders, the company was no stranger to forging geopolitical connections both inside and outside the country.
It only took a couple of years for divorce proceedings to reveal a consultancy contract worth $2m over five years with Neil Bush, younger brother of the then US President, George W Bush. In the wake of the Chinese industrialisation and globalisation reforms introduced by Deng Xiaoping more than a decade earlier which resulted in manufacturing expanding rapidly, Grace saw it as a logical move. In the current climate, such a connection seems unthinkable. In the early 2000s, the warnings about manufacturing migration came mainly from unions in Europe and the US rather than governments, though companies that set up in China found themselves having to deal with strict co-ownership rules and their intellectual property (IP) leaking away to local competitors.
By the time of Barack Obama’s second presidential term, attitudes towards the country had hardened. “We are going to ensure China plays by the same rules as everybody else,” he insisted to presidential challenger Mitt Romney in a 2012 debate.
China made it clear it was attempting to step up the pace of its technological development in 2014, announcing a plan to move as fast as possible to finFET technology at the 14nm node. At the time, Samsung and TSMC were just beginning to ramp up production of this type of process. Intel was already in production with its only slightly less dense 22nm offering.
The problem for the country is that despite being the destination for half the world’s chips, at least before the latest sanctions hit, according to International Business Strategies suppliers based outside China accounted for more than 80 per cent of chip sales. Many of the locally sourced components come from plants built by foreign companies, such as Intel, Samsung and SK Hynix and the two leading Taiwanese foundry suppliers TSMC and UMC.
A succession of five-year plans called for more locally sourced chips but with limited success. Grace was ultimately absorbed by Hua Hong Semiconductor, but the combined company is at least several generations behind the country’s leader SMIC, which had by 2021 established itself as the fifth-largest foundry company in the world, with a market share just over 5 per cent. Hua Hong, which absorbed Grace, lay in sixth place with a share of 2.5 per cent.
Ultimately, SMIC succeeded in putting together a 14nm process and has even managed to produce prototypes made with what it called a 7nm process without access to the same lithography technology available to competitors elsewhere. TSMC in Nanjing had begun ramping up the 16nm technology it had introduced in Taiwan more than five years earlier.
By that time, the tide had turned strongly against the Chinese suppliers, with focus publicly shifting from trade fairness to national security concerns. Donald Trump’s administration decided, after uncovering sales to heavily sanctioned Iran, to clamp down on telecoms company ZTE in the first of many similar trade bans on other Chinese suppliers.
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In his State of the Union address in early February this year, US President Joe Biden struck a more conciliatory tone. “We made clear, and I’ve made clear in my personal conversations, which have been many, with President Xi that we seek competition, not conflict.”
Though the tone sounds softer, the actions taken so far by the US government have been designed to deny China the ability to gain access to key technologies that the Asian country’s industries would need to compete in artificial intelligence, supercomputers and other sectors that the nation determined in its 14th five-year plan – covering the period up to 2026 – would be core to its development.
One important aspect of the US actions is their extraterritoriality. In a seminar examining the effect of the sanctions on companies in the electronics supply chain, David Wolber, lawyer at global law firm Gibson Dunn, pointed out that the actions cover “entirely foreign-made products that use US software or technology”.
Fang Xue, a partner at Gibson Dunn and chief representative of the Beijing office, adds: “It creates an effective embargo against providing to China technology, software and manufacturing equipment that can be used to make advanced integrated circuits and supercomputers.”
Even where transfers are not explicitly banned, the Export Administration Regulations (EAR) exploit the caution that most executives are going to feel about the trade-off between signing contracts with customers in mainland China – or even those they might suspect will ship parts to the country – and the likelihood of attracting stiff fines if the US decides the end customer was one of the EAR’s targets.
The boundary between what the US considers acceptable and not is far from clear. That can effectively extend the reach of the sanctions.
“A lot of manufacturing equipment uses the same set of software for 14nm and 28nm production,” says IDTechEx analyst Yu-Han Chang. Whereas China has little in the way of 14nm technology – only SMIC is able to run the technology today – several fabs currently operate 28nm lines.
‘US sanctions create an effective embargo against providing to China technology, software and manufacturing equipment that can be used to make advanced integrated circuits and supercomputers.’
Asian market analysis firm TrendForce noted in December 2022 that Wuhan-based memory maker Yangtze Memory Technologies Company (YMTC) is likely to suffer heavily from a squeeze on two fronts. The US Bureau of Industry and Security (BIS) placed it on the ‘entity list’ of bodies facing trade restrictions in mid-December, so the company would at best face long delays in obtaining the equipment needed to upgrade its fab to support future generations of high-density flash memory.
Competitiveness in this market relies on the ability to use advanced equipment to handle the deep etches that lie at the heart of 3D NAND flash. Leaders like Samsung expect to increase the number of layers into the hundreds in the coming years, using vertical packing as a way of increasing density without needing to move to more advanced lithography such as EUV, used primarily for 2D logic chips.
Even before YMTC’s addition to the entity list, TrendForce had already downgraded the firm’s 2023 bit-growth rate, a measure of its future competitiveness, from 60 per cent year-on-year to just 18 per cent. That has now turned into a forecast 7 per cent decline, “a complete reversal from the earlier projections”.
On the other side, customers have opted for safer choices when it comes to buying NAND devices for their computers and solid-state drives. According to TrendForce, non-Chinese PC makers that had qualified existing products from YMTC halted the process to look at other options, following the lead of companies such as Dell, which announced it would stop using all Chinese-sourced semiconductors by 2024. The likelihood is that the memory supplier will need to focus entirely on the domestic Chinese market.
Recent results from Huawei and SMIC suggest that retrenchment on mainland China will let YMTC keep going as a business short of a major recession in the country. Both Huawei and SMIC demonstrated in their latest results that they had been able to make up lost revenue with local business.
In its actions, the US is asking its trading partners: whose side are you on? There is some degree of carrot in the US actions. The CHIPS Act, passed in July 2022, provides $52bn to subsidise semiconductor production in the US, but companies that receive funding from it are blocked from constructing new fabs in China for a decade.
For suppliers, deciding whether to continue trading with China is a potentially costly decision either way. Back in 2018, Dutch lithography specialist ASML agreed to supply SMIC with some of its more advanced machines, which use extreme-ultraviolet (EUV) light sources, to provide a way for the Chinese foundry to build sub-10nm parts more easily. Already heavily delayed, negotiations between the Dutch government and the US mean the contract is now unlikely to be fulfilled any time soon. For ASML, the overall financial effect is limited. In its recent accounts, China made up just 15 per cent of ASML’s revenues.
The financial cost of lost business may be more damaging to the foreign owners of fabrication plants on the mainland, which include TSMC and the South Korean companies Samsung and SK Hynix, both of which have their own memory fabs located there. An inability to find customers for the Chinese sourced devices in the rest of the world may hurt them more compared to local suppliers such as YMTC, which may be able to count on increased government support. Overall, Korea’s total exports rose 6.1 per cent in 2022 to reach an all-time high but exports to China – its largest trading partner – fell 4.4 per cent.
The reductions will be compounded if China chooses to extend its own, currently secret, entity list, which bans certain suppliers from doing business with customers in the country. In a semiconductor economy where prices for memories and other chips have slumped, the pain of the lost business will be harder for suppliers to bear.
The US has even clamped down on the ability to produce the equipment that would enable an expansion of capacity for silicon processes already in production in China. Shanghai Microelectronic Equipment has developed lithography machines that could make chips for the 90nm node, first introduced in the west 15 years ago, and announced plans to move quickly to 28nm. But the company found itself on the BIS entity list a year ago. To continue development, the company will need to find more local sources of key components.
Even without the restrictions now in place, IDTechEx’s Chang estimates it would take seven years just for SMIC to catch up to today’s technology leaders. With the current restrictions, it is a far more difficult job. “The Chinese would have to design everything from software to equipment along with every manufacturing process on their own,” she says.
Two-track 5G
The sanctions on China are influencing how technology develops even outside the country. The development of two parallel 5G ecosystems now seems inevitable following the effective ejection of Huawei from western markets. However, this situation is not unusual for cellular: the 4G era was arguably the exception in that it was the first generation to reflect the idea of a global standard. Nation-level competition saw initial plans to create a unified 3G standard at the end of the 1990s fragmented into three different systems promoted by Europe, the US and China.
Western computer and networking suppliers have seen an opportunity in China’s removal from key contracts to push for a change in the way these systems are designed. The leading suppliers to the cellular operators focused on vertically integrated offerings that could offer guaranteed levels of service.
Huawei’s removal has seen a surge in market entrants who aim to take advantage of a shift towards the OpenRAN standard, which will allow low-cost ‘white box’ equipment to take on a much bigger role in managing the network.
Potentially, a multi-antenna base station could be assembled using products from three or four different vendors instead of being bought as a collection from one supplier. The risk is that the different products introduce additional latency or incompatibilities that the operator has to fix, instead of those problems being the responsibility of the supplier. For this reason, incumbent suppliers Ericsson and Nokia may be able to maintain their hold on the market even though operators like the idea of the cost savings and vendor choice OpenRAN might bring them.
In China, on the other hand, Huawei seems set to continue as the primary, vertically integrated supplier of the country’s cellular network equipment, with Swedish supplier and key 5G equipment provider Ericsson effectively denied access.
The OpenROAD sanctions detour
One of the ironies of the web of sanctions and export restrictions around technology is that Chinese and US teams in the military may wind up using the same electronic design tools. Five years ago, the US military-research agency Darpa created a programme to support the development of chips by the various defence agencies as well as other users who felt they were at risk of being locked out of competitive semiconductor technologies by the cost of commercial EDA tools, the vendors of which have increasingly focused on users working on high-volume or high-value products.
At the Design Automation Conference in 2022, Peter Gadfort, team leader for silicon technologies at DEVCOM US Army Research, said even the process of signing contracts for EDA tools had become a major burden and that the time-limited licences often did not dovetail with project timescales.
Moving to the open-source OpenROAD toolchain sponsored by Darpa and developed primarily by a team of US university researchers had allowed Gadfort’s team to overcome these issues and work on processes as advanced as 16nm.
As access to advanced chip-design tools is closed off, engineers in China may find themselves turning to the same, more easily obtained software. The Chinese government has already started calling on its local industrial leaders to focus squarely on another open-source initiative as access to advanced cores from the likes of Arm are closed off. The RISC-V architecture is already being used in a number of projects: 11 companies showed off their own designs at a conference in Shanghai late last year (2022). And the government itself has called on Alibaba and Tencent, which have used the architecture in accelerators for machine learning, to increase their use of RISC-V in place of western alternatives.
Though the term ‘open source’ implies easily obtainable, the situation is more complex than that. The same controls that prevent export of proprietary technologies to sanctioned states from the US also apply to source code under ‘copyleft’ licences. And some famous open-source contributors have advocated greater restrictions over who can access sources.
Coraline Ada Ehmke, creator of what she calls the Hippocratic licence, cited in a speech in early 2020 the locksmith parable used by Cold War era scientists to summarise their concerns over the use of technology for weapons. Ehmke argued open-source contributors should try to exercise more restrictions to their code in order to prevent it being used for weaponry or mass surveillance. Others feel open-source software should remain neutral, though the US government has already acted to reduce access from states it considers enemies.
OpenROAD’s core code repository, for example, is hosted by US-based Github, which has to conform to the US government’s Export Administration Regulations (EAR) and has acted on requests to restrict access to its site by users in Iran, Russia and Syria so far. Similarly, Google restricted access to Android in response to the sanctions placed on Huawei, which up to that point had been a major supplier of handsets able to run the operating system.
Because of access restrictions, the likely path, assuming the sanctions stay in place or are expanded, is that China-only forks of the major open-source technologies will grow more common if engineering teams decide not to develop their own direct equivalents.
One example is the Beijing Open-Source Chip Research Institute, which claims to have developed a competitor to one of Arm’s faster processor cores, called XiangShan. A version of the design, OpenXiangShan, is also available on Github. However, a bigger issue for Chinese users is whether they can have them made on competitive process technologies, as sanctions continue to throttle access to fab equipment and supplies.
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