U.S. Enacts Sanctions Legislation, Imposes Export Control Changes in Response to China's National Security Law for Hong Kong

Today, after unanimous passage by the U.S. Congress, President Trump signed into law the Hong Kong Autonomy Act (“HKAA”) in retaliation against China for its “Law on Safeguarding National Security in the Hong Kong Special Administrative Region” (the “National Security Law”), which came into force on June 30, 2020. Congress considers the National Security Law to conflict with China’s international obligations under the Joint Declaration¹ and the Basic Law² with respect to Hong Kong. For more than two decades these measures have provided for Hong Kong’s autonomy and the principle of “one country, two systems.”

The HKAA provides for the imposition of sanctions on two categories of persons:

• Foreign persons (including individuals and entities) who are found to be contributing to China’s alleged failure to observe its international obligations regarding Hong Kong; and
• Foreign financial institutions that are found knowingly to conduct one or more “significant” transactions with a person in the first category.

Separately from the HKAA, the U.S. Commerce Department's and the U.S. State Department’s export control regulators announced in late June that they will no longer treat exports and other transfers to Hong Kong more favorably, based on license exceptions and other measures, than exports to the rest of China.

HKAA: Sanctions on Foreign Persons Contributing to China’s Alleged Violations of International Obligations

The HKAA instructs the U.S. Secretary of State, within 90 days of the law’s enactment (today), to identify in a report to Congress foreign persons who have been, are attempting to, or are currently materially contributing to the failure of the Government of China to meet its obligations under the Joint Declaration or the Basic Law (“Identified Contributors”). A person “materially” contributes to such failure if the person:

• took action that resulted in the inability of the people of Hong Kong to:
  • enjoy freedom of assembly, speech, press, or independent rule of law; or
  • participate in democratic outcomes; or
• otherwise took action that reduces the high degree of autonomy of Hong Kong.

After an Identified Contributor is included in a report to Congress or any update thereto, the President may (i) impose blocking sanctions on such Identified Contributor, which would prohibit any person from transacting in any property that is subject to U.S. jurisdiction in which the foreign person has any interest, and (ii) deny a visa to and exclude from the United States the Identified Contributor, subject only to limited United Nations or other applicable international obligation exceptions. Within one year of the date on which an Identified Contributor is included in such a report, the HKAA requires the imposition of blocking and visa sanctions on such foreign person.

HKAA: Sanctions on Foreign Financial Institutions that Transact with Identified Contributors

Between 30 and 60 days after the Secretary of State issues the report to Congress regarding Identified Contributors (approximately 90 to 150 days from today's HKAA enactment), the Secretary of the Treasury is to identify in a report to Congress foreign financial institutions that knowingly conduct any “significant” transaction with one or more Identified Contributors (“Identified Financial Institutions”).

The HKAA authorizes imposition of ten types of sanctions against Identified Financial Institutions. Not later than one year after a foreign financial institution’s inclusion in a report to Congress, the President must impose at least five sanctions from the below menu of ten sanctions. Within two years of the date on which a financial institution is included in such a report, the President must impose all ten types of sanctions on the Identified Financial Institution.

Menu of Sanctions Targeting Identified Financial Institutions

1. Prohibition on receiving loans or obtaining credit from any United States financial institution.
2. Prohibition on designation as a primary dealer in U.S. Government debt instruments.
3. Prohibition on serving as agent of the U.S. Government or serving as a repository for U.S. Government funds.
4. Prohibition on foreign exchange transactions that are subject to the jurisdiction of the United States.
5. Prohibition on transfers of credit or payments between financial institutions or by, through, or to any financial institution, to the extent that such transfers or payments are subject to the jurisdiction of the United States and involve the Identified Financial Institution.
6. Blocking sanctions that would prohibit any person from transacting in any property that is subject to U.S. jurisdiction in which the Identified Financial Institution has any interest.
7. Restrictions or prohibitions on exports, reexports, and transfers (in-country) of commodities, software, and technology subject to the jurisdiction of the United States directly or indirectly to the Identified Financial Institution.
8. Prohibition on U.S. persons investing in or purchasing significant amounts of the Identified Foreign Institution’s equity or debt instruments.
9. Exclusion of the Identified Financial Institution’s corporate officer(s) or principal(s) of, or shareholder(s) with a controlling interest from entering or remaining in the United States, subject only to limited United Nations or other applicable international obligation exceptions.
10. Imposition of any of the sanctions described in 1 through 8 on the Identified Financial Institution’s principal executive officer(s), or individuals performing similar functions.

The HKAA does not define “significant.” But the Treasury Department’s Office of Foreign Assets Control (“OFAC”) has provided guidance on its interpretation of this term in connection with sanctions measures relating to Iran and Russia and issued an Iran-sanctions regulation specifying factors that the Secretary of the Treasury will consider in assessing whether a transaction is significant. In those contexts, OFAC has indicated that it will consider the totality of the facts and circumstances and the following factors: (1) the size, number, and frequency of the transactions; (2) the nature of the transaction(s); (3) the level of awareness of management and whether the transaction(s) are part of a pattern of conduct; (4) the nexus between the transaction(s) and a blocked person; (5) the impact of the transaction(s) on statutory objectives; (6) whether the transaction(s) involve deceptive practices; and (7) such other factors that the Secretary of the Treasury deems relevant on a case-by-case basis. We expect the U.S. government to take a similar approach in evaluating whether one or more transactions are “significant” with respect to the HKAA. 

The HKAA’s Grant of Broad Presidential Discretion for Implementation

The HKAA gives the President flexibility to avoid sanctioning foreign persons and foreign financial institutions that meet the criteria for identification and sanctioning. For the President to exercise his discretionary authority to exclude foreign persons and foreign financial institutions from a report to Congress, the material contribution or significant transaction that merited inclusion in the report must: not have a significant and lasting negative effect that contravenes the obligations of China vis-a-vis Hong Kong; not be likely to be repeated; and be reversed or mitigated through positive countermeasures taken by the person or financial institution. Any exclusion or removal of a foreign person or financial institution from an HKAA report must be appropriately notified to Congress with an explanation. In addition, unless Congress jointly passes a disapproval resolution, the President may waive application of sanctions against an Identified Contributor or Identified Financial Institution if the President determines that the waiver is in the national security interest of the United States and submits to Congress a report on the determination and the reasons for the determination.

Export Control Changes Regarding Hong Kong

For decades, the United States has treated supply of items to Hong Kong far more favorably than supply to the rest of China under export control regulations. This approach has come to an abrupt halt. Moving forward, it appears that U.S. export control treatment of exports and other transfers to Hong Kong will be the same as that of transfers to the balance of China.

Effective June 30, 2020, the Commerce Department’s Bureau of Industry and Security suspended all Export Administration Regulations (“EAR”) license exceptions for exports and reexports to Hong Kong and in-country transfers within Hong Kong to the extent that license exceptions provide treatment that is more favorable than that provided for the rest of China. As a result of this suspension, no items subject to the EAR may be exported to Hong Kong, reexported to Hong Kong, or transferred within Hong Kong based on a license exception, rather than a license, except for transactions that would otherwise be eligible for a license exception if exported to China.

In addition, new EAR provisions expand export, reexport, and transfer restrictions related to military end use and military end users in China, Russia, and Venezuela. These new regulations also remove license exception “Civil End Users” for national security-controlled items that will be exported, reexported or transferred (in-country) to Country Group D:1 (as noted in Supplement No. 1 to Part 740 of the EAR). The U.S. government is expected to apply these restrictions to Hong Kong.

Under the International Traffic in Arms Regulations (“ITAR”), the United States imposes a general embargo on exports of defense articles and defense services to China. On June 29, 2020, the State Department indicated that, in effect, the China ITAR embargo will apply to Hong Kong just as it applies to the rest of China. The State Department is expected soon to amend the ITAR to implement the new policy.

Going Forward

Asian financial institutions and others with substantial business in or relating to Hong Kong would be well served by evaluating their exposure under the HKAA. Depending on the outcomes of such evaluations, it would be useful for firms to establish arrangements to manage HKAA risk. In addition, U.S. and non-U.S. companies that have relied heavily, directly or indirectly, on exports to Hong Kong should assess whether and how U.S. export control changes will affect their sales relationships.

At the same time, the U.S. policy response to the National Security Law may be a moving target. The U.S. government is likely to implement additional requirements, which will probably be targeted and economic in nature. The exact type and scope of any additional retaliatory measures will likely depend on how China implements the National Security Law and the actual impact it has on Hong Kong.

[1] Joint Declaration of the Government of the United Kingdom of Great Britain and Northern Ireland and the Government of the People’s Republic of China on the Question of Hong Kong, done at Beijing on December 19, 1984.
[2] Basic Law of the Hong Kong Special Administrative Region of the People’s Republic of China, effective July 1, 1997.