Qianer Liu in Hong Kong and Kathrin Hille in Taipei

In China’s southern tech hub of Shenzhen, employees at chipmaking start-up PXW Semiconductor Manufactory began to panic after the US put their company on a trade blacklist last week.

“Most team leaders and executives are in emergency meetings, but the rest of us are not allowed to discuss such a ‘sensitive’ matter,” an employee said, adding that their boss’s office door remained closed on Friday, one day after the US added PXW to the “entity list” along with 35 other Chinese companies.

American suppliers are barred from exporting to companies on the list without approval, which in many cases is expected to be denied. Analysts said the latest blacklisting was “housekeeping” to close loopholes in sweeping measures imposed in October, which allow Washington to block Chinese access to high-end chips and the talent and tools to make them.

“It is a game of whack-a-mole,” said Douglas Fuller, an expert on the Chinese chip industry at Copenhagen Business School. “Whenever Washington comes up with sanctions, there are new projects popping up which they then try to block.”

The US started using export controls to rein in China’s technological rise by putting Huawei on the entity list in May 2019. Since then, Washington has added many more Chinese tech enterprises, including surveillance companies, chipmakers, drone developers, smartphone makers and institutes suspected of supplying the People’s Liberation Army.

Some of the companies targeted last week, including PXW, are only just starting to develop their semiconductor business and thus more vulnerable than established players such as Huawei.

“The US government has mastered the Chinese semiconductor supply chain and knows who the priorities are and who are with future potential,” said Brady Wang, a Taiwan-based analyst at research firm Counterpoint.

PXW has strong support, including funding from the Shenzhen government and the leadership of a former Huawei executive. The company has ordered equipment from various US companies scheduled to arrive next year, but it might now never receive it, according to two company employees.

Another unexpected addition to the list is Hefei Core Storage Electronic, a company founded by former staff of Taiwanese chip design company VIA Technologies to develop a homegrown alternative to Intel-based PC processors. “It is a bad surprise,” said a Hefei Core Storage engineer. “Nobody expected that we would be on their radar.”

A western trade official said the US might have discovered the Hefei company was working on processors suitable for supercomputers or supporting China’s development of advanced memory chips — areas targeted by the October controls.

“The US is developing an increasingly detailed understanding of the industry in China, including players you would have considered as obscure,” the official said.

But the list also contains more prominent companies.

Yangtze Memory Technologies, China’s largest memory chip maker, was already hit hard by the October controls. The company had halted its expansion and asked US equipment manufacturers to return down payments for previously ordered tools, said a senior engineer at YMTC.

“At that time, we could still consider retreating to [making less advanced] chips, but now our fate is all but sealed,” he said, referring to the near impossibility of getting licences approved for equipment to expand production after being put on the entity list.

YMTC had already suspended talks with Apple on supplying memory chips for iPhones in China. Research company TrendForce predicts it could be forced to exit the market for advanced 3D Nand flash products by 2024 as it has lost critical support from toolmakers to compete with rivals on this particular memory technology.

Washington also included a prominent developer of chipmaking equipment: Shanghai Micro Electronics Equipment, which represents China’s only hope of developing homegrown lithography machines, the critical advanced chipmaking tool currently dominated by Dutch company ASML.

The company’s lithography machines rely on imported components and have never run in mass production. “There is still a long way to go,” said a Shanghai official who handled SMEE’s development project. But the official pointed out that the company had formed teams of experienced staff to replace ASML field workers who were providing services but later withdrawn due to US export controls.

“SMEE doesn’t have personnel who are US persons like some other Chinese chip equipment makers,” Fuller said. “Therefore the controls on US persons included in the October measures are less effective.”

Another key addition is Shanghai Integrated Circuit Research and Development Center, a company believed to be connected to Huawei’s efforts to increase domestic chip manufacturing. Huawei denies its involvement.

“ICRD had it a long time coming,” the western trade official said. “We have been expecting them to be blacklisted for two years because the US will try to crack down on any company that comes anywhere near Huawei’s chip development projects.”

None of the companies in this article responded to a request for comment.

The list also takes aim at China’s development of high-performance chips. It features chip design house Cambricon Technologies and its nine subsidiaries. It also subjects them and their incubator at the Chinese Academy of Sciences to a “foreign direct product rule”, which prevents them from obtaining supplies or services that contain a certain amount of US technology.

Cambricon was funded by Alibaba and the Shanghai government before listing on China’s tech-centric Star market in 2020. It sources intellectual property from UK-based Arm and design tools from US suppliers Cadence and Synopsys. It also relies on Taiwan’s TSMC for manufacturing its chips.

“If the friction between China and the US intensifies . . . it may have a significant adverse impact on the company’s future product development and supply chain,” Cambricon said in its latest fundraising document.

That fate could await other Chinese start-ups, analysts believe. “There is a lot more out there on the chip design side,” Fuller said.

As US export controls bite, Chinese manufacturers of equipment needed to make semiconductors are expected to benefit from a rush of domestic orders, though executives and analysts warn the boost could be shortlived.

Since Washington introduced sweeping restrictions on October 7 to limit Chinese companies’ ability to obtain or manufacture advanced computer chips, Yangtze Memory Technology, China’s largest memory chip maker, has issued at least 20 tenders for a broad range of chipmaking equipment.

“The current strategy is that if there is workable domestic semiconductor production equipment, even though [the suppliers] need help, we will buy from Chinese companies. If not, we shop from non-US vendors, mostly Japanese,” said a senior YMTC engineer.

“I anticipate most of the orders would end up in the hands of domestic suppliers who would prioritise clients like us, but there are still quite a few pieces beyond their capability,” the person said.

The company will instead replace US toolmakers such as KLA and Applied Materials with Japanese ones, including Hitachi and Tokyo Electron, in a sign of how homegrown suppliers still lag foreign rivals with their technology.

To make matters worse, Chinese chipmakers’ loss of access to certain irreplaceable US-made tools has halted the majority of construction projects for production facilities that drive domestic equipment makers’ business.

Chinese semiconductor equipment revenues tripled between 2018 and 2021, driven by domestic chipmakers’ aggressive expansion, according to research by Sanford C. Bernstein. But the investment group estimates a mere 15 per cent of equipment demand from Chinese chipmakers was covered by homegrown suppliers this year, far short of an ambitious government target of 30 per cent.

The export controls will hold this crucial sector back even more, analysts said. “They may want to step up self-sufficiency in terms of chip manufacturing equipment in reaction to the export controls, but in fact, localisation will be slower as a result of the controls,” said Mark Li, semiconductor analyst at Sanford C. Bernstein in Hong Kong. “The biggest bottleneck is that their customers, because of lack of access to foreign equipment, will be unable to expand more.”

Three people with direct knowledge of the situation said that while YMTC has not cancelled or postponed already placed equipment orders, the company’s plans to expand are suspended. ChangXin Memory Technologies, YMTC’s smaller rival, has also put some expansion plans on hold, according to one person familiar with the matter.

Analysts at Jefferies predict this disruption to the capital spending plans of Chinese chipmakers, especially in the memory segment, will lead to a dramatic drop in demand for semiconductor production equipment over the next few years.

YMTC and CXMT should still have enough equipment to meet their expansion plans next year, but “if they cannot access advanced equipment from the US and cannot find good enough alternatives from Japanese or European suppliers, they will probably have to stop expansion entirely”, Jefferies analyst Nick Cheng wrote in a research note. As a result, China’s total investment in chipmaking tools would drop from the analyst’s previously forecast $26bn to $18bn in 2024, and from $24bn to $16bn in 2025.

That would rob Advanced Micro-Fabrication Equipment, one of China’s largest chip equipment makers, of a quarter of Jefferies’s forecast revenue for 2025. ACM Research, an AMEC rival, would lose nearly 20 per cent of projected revenue for that year, the note predicted.

The chip companies did not respond to a request for official comment.

Despite stockpiling efforts, several equipment companies could also be hit by the inability to procure foreign components for their products.

“Only the assembly part of our products is completely based in China, while the rest requires foreign technology and components . . . just limitations on components can easily choke us,” said a senior engineer at AMEC.

In addition, the equipment makers are facing a talent drain as engineers seek higher-paying jobs in chip design houses and semiconductor manufacturers.

“Chinese equipment companies should also worry about the stability of their existing R&D team as we have received quite a lot of inquiries from equipment engineers regarding switching to other sectors that have not been affected as much by the new sanctions,” said a Shanghai-based headhunter.

In the face of the mounting challenges, the response from some equipment companies is to explore greater collaboration with their rivals.

“The new sanctions are forcing companies like us to seek further co-operation with each other,” said an AMEC manager. “Executives from several companies, including ACMR, AMEC and others, are breaking walls and have had meetings on this.”