Malaysia is tightening regulations on its rapidly growing data center industry, a move that experts say could complicate Chinese companies’ access to advanced U.S.-made artificial intelligence (AI) chips amid heightened U.S. export controls and mounting geopolitical pressures.

For years, Malaysia has been an attractive destination for global technology giants, including major Chinese firms, to establish data centers. Factors driving these investments include relatively inexpensive land and electricity, strong digital demand, and the country’s strategic location. According to industry analysis, more than half of the data center capacity under construction across five major Asian growth markets is now committed in Malaysia, especially in the southern state of Johor. This region has emerged as a regional investment hub, boasting billions of ringgit in approved projects and dozens of operational data centers as of mid-2023.

The surge in data center construction, however, has raised concerns among Malaysian officials over power grid limitations, water consumption, and the potential for the country to become a "backdoor" for China to access U.S.-restricted chips. The United States has increasingly pressured Malaysia to ensure that its territory is not used to circumvent U.S. export restrictions on high-performance AI chips, particularly those manufactured by NVIDIA Corp (NVDA).

In response, the Malaysian government has imposed stricter measures. In 2023, a permit system was introduced covering imports and transit of all chips, including those subject to U.S. controls. Most recently, the trade ministry announced that, effective immediately, the export, transshipment, or transit of high-performance AI chips of U.S. origin now requires a trade permit. Exporters and importers must give at least 30 days’ advance notice for items not expressly listed as strategic, a move designed to close regulatory loopholes and regulate chip flows more tightly. Violators face strict legal consequences, according to the ministry.

Authorities have also established a vetting committee for new data center projects, which reportedly rejected a notable portion of applications in 2023 due to concerns about unsustainable water or electricity use. Approval rates are improving as companies adjust to the new requirements, local officials say, but the regulatory bar remains significantly higher than before.

These changes come amid accusations from U.S. officials and industry observers that Chinese AI companies have been sidestepping chip export controls by using Malaysian data centers. According to reports, some Chinese engineers have physically transported hard drives loaded with data from Beijing to Kuala Lumpur, utilizing Malaysian facilities equipped with advanced NVIDIA AI servers to train models outside of China’s tightly scrutinized digital landscape. Companies have employed legal structures, including Singapore-registered subsidiaries, to exploit regulatory gray areas before shifting to local incorporation as Singapore tightened its own controls.

In parallel, the Malaysian government, led by Trade Minister Zafrul Aziz and Digital Minister Gobind Singh Deo, has set up a task force to further regulate the data center industry’s dependence on NVIDIA chips. The task force’s creation follows American pressure to ensure that high-end chips are not being shipped to unapproved entities in China, particularly after a $390 million Singapore fraud case involving alleged illegal sales of Nvidia chips to China. (ft.com)

This increasingly complex landscape is shaped by geopolitical factors and multi-layered trade relations. Malaysia – a partner in China’s Belt and Road Initiative (BRI) – has seen leading Chinese tech giants open major data center campuses in Johor. In one notable case, a leading Chinese company spun off its overseas data center business to operate independently, a strategy interpreted by analysts as an effort to diversify clients while managing exposure as U.S.-China trade tensions escalate.

Amid these shifts, the U.S. launched new technology export rules, such as the Artificial Intelligence Diffusion (USAID) regime. These measures favor U.S.-based hyperscalers and trusted countries, and could restrict AI chip exports to Tier-2 markets like Malaysia, hitting non-verified end users with capacity caps and conditional quotas. According to analysts cited by Xinhua, this evolving policy framework introduces a “structural risk” that could temper Malaysia’s previously explosive data center growth and cloud its long-term prospects as a regional digital hub.

Financial markets appear sensitive to these developments. NVIDIA Corp (NVDA), whose high-end chips are central to AI advancements worldwide, was last seen trading at $177.17 per share on U.S. markets, reflecting a minor decline as investors digest global regulatory changes and uncertainty in supply chains.

Collectively, Malaysia’s regulatory tightening marks a pivotal shift for the future of data center investment in Southeast Asia, especially as U.S. export controls, infrastructure bottlenecks, and sustainability standards converge to reshape the region’s critical role in the global AI ecosystem.