When the head of the Mossad talks, people listen, to paraphrase the old E.F. Hutton commercials. So when the former chief of Israel’s vaunted spy agency, Ephraim Halevy, said recently that “the country has been slow to recognize the security threat that Chinese investment represents,” he sent shockwaves across Asia.

Irritated by such criticism, China’s foreign ministry asked for clarification following a statement by Israel’s chief of internal security service Shin Bet, Nadav Argaman, in January that “Chinese influence is risky, especially regarding strategic infrastructure assets.” Israeli officials eager to avoid a diplomatic crisis scuttled to calm fears and return Chinese-Israeli relations to normal.

China is Israel’s second largest trading partner after the US and, according to Tel Aviv-based research firm IVC, Chinese investment in the Israeli tech sector grew in 2017 and 2018 to $308 million and $325 million (through Q3), up from $274 million in 2016. But Israel finds itself between a rock and a hard place. As a close ally of the United States at a time of deepening rivalry, Israeli policymakers are under pressure to vet Chinese holdings in what the country considers to be national security assets.

Argaman and US National Security Adviser John Bolton, have called for Israel to set up a regulatory body to oversee sensitive commercial deals, similar to the US’s Committee on Foreign Investment. American military officials shivered spines in Israel’s security establishment when they hinted that the US may reduce the level of intelligence sharing with its Middle Eastern ally.

But Israel-China tech cooperation is in fact strengthening: Israeli artificial intelligence (AI) startups in non-military sectors are moving into China for its huge market and fast growth prospects, and Chinese investors are improving their ability to screen foreign deals.

Israeli companies like early-stage NewSight Imaging, maker of a chipset that enables 3D image sensing; Arbe Robotics, maker of high-resolution 4D imaging radar for autonomous driving; revenue-stage Riskified that delivers software-as-a-service (SaaS) fraud prevention solution for e-commerce transactions; and unicorn hopeful SimilarWeb, a digital market intelligence platform – all have an office in China with a country manager, and view it as a key market for long-term value creation.

Israeli Prime Minister Benjamin Netanyahu, a fervent promoter of his country’s tech prowess to the world, is anxious to see the startup nation gravitate toward China. During his 2017 visit to China, Netanyahu signed an agreement on innovation with Chinese president Xi Jinping, and since then the relationship between the countries has continued to warm. Last October Chinese Vice President, Wang Qishan, arrived in Israel as guest of honor at an innovation conference, followed by Alibaba founder Jack Ma and his entourage.

Warning signs

Fearing US retaliatory measures, Israel’s alarm bells are sounding in two areas. While strategic concerns may make Chinese bids less competitive for Israeli infrastructure projects, export restrictions on dual use technology are not likely to affect smaller Israeli tech companies with consumer or business products.

First are large infrastructure projects, spurred on by China’s Belt and Road Initiative, such as a 25 year contract for state owned Shanghai International Port Group to build and operate the Haifa Port. US military brass have hinted that as a result US navy ships may stay away from Haifa.

Other examples are China Railway Tunnel Group’s (CRTG) subsidiary, responsible for constructing light rail in Tel Aviv, and Beijing-based SinoHydro, which won a contract in 2016 to construct a hydroelectric power station in the Jordan Valley.

American officials are attempting to block Huawei’s efforts to win global market share in 5G mobile phone networks, and portray the Chinese telecommunications giant as a serial violator of US law. They worry that Huawei’s equipment could be installed with a “backdoor” to computer systems or encrypted data that bypasses the systems’ customary security mechanisms, enabling the Beijing government to collect intelligence on the US and Israel.

Second is Chinese investment in dual-use products, which former Mossad chief Halevy said was especially worrisome. These are products that have both military and commercial applications, such as drones and robots. Israeli defense-related technologies have been off-limits to China for years, but some artificial intelligence products that are used both for military and internal policing (considered civilian) are trickier to classify and thus may be newly deemed dual-use.

A multi-use technology such as AI can be separated into civilian and military applications. So most Israeli startups with civilian sector applications eyeing China, including digital commerce, smart manufacturing, digital healthcare, agriculture and food, will not draw the attention of national security regulators. Companies that risk falling into a dual-use definition often tackle the problem by creating new entities that separate defense-related business from purely commercial applications.

Roboteam shows how companies with military business can navigate dual use restrctions. The company, founded in Israel in 2009 and a supplier of tactical robots to the US Military, the FBI, and the Israeli army. The company is headquartered in Maryland and operates a factory in Pennsylvania, enabling it to function as a defense supplier to the US government. When a few years later Roboteam introduced a personal home robot, it used a separate business entity and brand called Temi to target the Chinese consumer. Roboteam has raised $62 million to date from investors including Chinese investment firm FengHe Fund Management, co-founded by John Wu, formerly the chief technology officer at Alibaba. However, in 2017 Roboteam filed a lawsuit against a Massachusetts-based competitor, Endeavor Robotics, following the competitor’s allegations that Roboteam is controlled by the Chinese government, which uses it to obtain U.S. military technologies.

No let up

The risk of being labeled dual-use will create a headache for a small subset of Israeli tech companies, and in certain cases will exclude them from the Chinese market. Israel’s security watchdog may prohibit certain deals to demonstrate their vigilance and deter potential violators. However, it is safe to assume that the great majority of Israeli startups making forays into China will be able to proceed unimpeded.

While a CFIUS-like body may make dealing-making more complicated, the motives for tech cooperation are strong enough to overcome such obstacles. Unlike in infrastructure, in which it is no more attractive to China’s champions than a small to medium-sized European country, or in natural resources, which it has little to offer, Israel punches above its weight in the tech sector with over 350 multinationals running an R&D center in the country and a dense ecosystem of more than 6,000 startups, according to Startup Nation Central, a research firm. China is most interested in this ecosystem, nourished for over 20 years with capital and expertise from Silicon Valley, which boasts legions of hardened startup founders and creative engineers.

Feeling squeezed out of Silicon Valley by security concerns, China hopes to fill in some of the gaps in its deep-tech and AI capabilities by operating R&D centers in the Tel Aviv area, as do Huawei and Alibaba. In addition, it hopes that with the promise of its huge market, ample sources of funding and a welcoming policy it can lure some Israeli startup founders to one of its tech hubs.

To be sure, dual-use products will come under greater scrutiny in the foreseeable future. However it will come as no surprise to see Israeli startup founders, whose home turf is of negligible size, developing products for Chinese consumers and businesses. In parallel, as Chinese investors are pushed by changes in China’s VC industry to hunt farther afield for the next AI unicorn, access to Israeli knowhow becomes a necessity. Don’t expect these powerful forces to let up any time soon.

Rami Blachman is a tech entrepreneur and venture capitalist based in Shanghai and Tel Aviv. He is a frequent speaker and writer on China cross-border tech investing and how it relates to Israeli startups.

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