What is the Hong Kong Autonomy Act?
On July 14, 2020, President Trump signed into law the Hong Kong Autonomy Act (the "HKAA"), unanimously passed by the U.S. House of Representatives on July 1, 2020 and by the U.S. Senate on July 2, 2020.
Section 5 of the HKAA requires that the U.S. Secretary of State submit a report within 90 days1 of the bill’s passage on persons and entities that materially contribute to the contravention of China’s obligations to Hong Kong under the Joint Declaration and the Basic Law. The report should also include “a clear explanation for why the foreign person was identified and a description of the activity that resulted in the identification.” These persons/entities, however, do not need to be included in the report if their actions do not have a significant and lasting negative effect that contravenes those obligations, their actions are not likely to be repeated in the future, and their actions have been reversed or otherwise mitigated through positive countermeasures taken by themselves.
By virtue of the HKAA and executive order issued by the U.S. president on July 14, 2020 (the “Executive Order”), the U.S. president has the ability to impose sanctions on individuals and entities who assist China in the implementation of the HK Security Law (defined below). In addition to requiring sanctions on foreign persons directly involved in repressing Hong Kong’s autonomy, the HKAA also requires the U.S. president to impose sanctions on foreign financial institutions engaging in significant transactions with such foreign persons.
What led to the introduction of the HKAA?
The HKAA was introduced in response to the implementation of the “The Law of the People’s Republic of China on Safeguarding National Security in the Hong Kong Special Administrative Region” (the “HK Security Law”) on June 30, 2020. To understand what the HKAA is trying to address, we therefore have to undertake a short recap of some of the historical milestones in Hong Kong's political development.
Hong Kong has been, and continues to be, a territory of another sovereign state. It has never been a country. Save for a short period during the Japanese Occupation during World War II, Hong Kong had been a colony of Britain for more than a century from 1841 to 1997. During that time, as with the state of some colonies, business thrived but there was no democracy. The 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 (the “PRC” or “China”) on the Question of Hong Kong (the “Joint Declaration”) was signed on December 19, 1984. The Joint Declaration sets out, among other things and subject to the provisions therein, the basic policies of China regarding Hong Kong. Under the principle of "One Country, Two Systems", the socialist system and policies shall not be practised in Hong Kong and Hong Kong's previous capitalist system and life-style shall remain unchanged for 50 years (i.e. until 2047). The Joint Declaration provides that these basic policies shall be stipulated in a Basic Law of Hong Kong. The Basic Law was adopted on April 4, 1990 by the Seventh National People's Congress of China and it came into effect on July 1, 1997. From that time, Hong Kong has reverted to Chinese sovereignty but is a “special administrative region” with, among other things, the rule of law (as it has evolved under the British common law) enshrined in its Basic Law.
Article 23 of the Basic Law (in its existing form since the Basic Law came into effect in 1997) stipulates that Hong Kong “shall enact laws on its own to prohibit any act of treason, secession, sedition, subversion against the Central People’s Government, or theft of state secrets, to prohibit foreign political organizations or bodies from conducting political activities in the Region, and to prohibit political organizations or bodies of the Region from establishing ties with foreign political organizations or bodies.” The Government of Hong Kong did try to pass implementing regulations for Article 23 in 2002 but the attempt resulted in protests which led to the Government of Hong Kong abandoning such proposal.
The widely reported protests in Hong Kong in 2019 were sparked by a legislative proposal in early 2019 from the Government of Hong Kong which would have permitted the extradition of persons to jurisdictions with which Hong Kong did not have extradition agreements, including China and Taiwan. This led to concerns that Hong Kong residents and visitors would become subject to the legal system of China through their extradition, thereby undermining Hong Kong’s autonomy and infringing civil liberties. Notwithstanding the withdrawal by the Government of Hong Kong of the proposed legislation in September 2019, the protests continued and calls for the independence of Hong Kong began to increase. The Hong Kong government’s reaction and the concern from Chinese authorities evolved as well in response.
On May 21, 2020 and following demonstrations and protests for almost a year, China’s state media announced that the Government of China would begin drafting a new law that covers "secession, foreign interference, terrorism and subversion against the central government" into the Annex III of the Basic Law. This meant that the law would come into effect through promulgation and bypass the local legislative council of Hong Kong. The HK Security Law came into effect at 11pm (Hong Kong time) on June 30, 2020.
As stated in the Executive Order, the U.S. interprets the HK Security Law as:
“…a series of actions that have increasingly denied autonomy and freedoms that China promised to the people of Hong Kong under the 1984 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 (Joint Declaration). As a result, on May 27, 2020, the Secretary of State announced that the PRC had fundamentally undermined Hong Kong’s autonomy …and that Hong Kong no longer warrants treatment under United States law in the same manner as United States laws were applied to Hong Kong before July 1, 1997.”
Hong Kong will now be treated like China – what does this mean? The Executive Order released just over 24 hours ago implements several of the steps President Trump outlined in a recent press conference. The changes outlined in the Executive Order include:
- Ending preferential treatment for Hong Kong passport holders as compared to PRC passport holders;
- Treating Hong Kong as part of China under the Arms Export Control Act (22 U.S.C. 275 et seq.);
- Requiring reporting of the situation with respect to Hong Kong’s autonomy (declared a national emergency in the Executive Order) to Congress;
- Covering Hong Kong under the Export Control Reform Act of 2018, meaning heightened controls of certain emerging and foundational technologies;
- Suspending extradition treaties;
- Terminating US cooperation with a treaty covering reciprocal exemption with respect to taxation of shipping;
- Ending cooperation on provision of training to Hong Kong law enforcement.
What are the effects of being subject to the HKAA?
Persons subject to sanctions cannot engage in property transactions in the U.S. and may be subject to U.S. visa restrictions - The sanctions that would be imposed under the HKAA are prohibitions on U.S. property transactions (which in certain scenarios can result in being put on the Specially Designated Nationals and Blocked Persons List (“SDN List”)) and visa restrictions. As a sign of things which may come, in the last 48 hours, the Secretary of State (utilising other legislative authority) also imposed visa restrictions on certain employees of Chinese technology companies, including Huawei, that provide material support to regimes engaging in human rights abuses globally. So if a person is “put on the list”, such person and any person who may have “materially assisted” the person, constitute persons who will face significant difficulties in (i) getting visas for their employees to travel to the U.S., (ii) doing business in the U.S. or with US persons, (iii) receiving finance (both debt and equity) from financial institutions who have legitimate business interests in the U.S. or have vested interests in being able to deal in US Dollars, among other things.
What about trade tariffs against Hong Kong? Although President Trump signed the Executive Order revoking Hong Kong’s preferential trade status, President Trump notably did not equalise tariff rates between Hong Kong and China.
Who is likely to “make the list”?
The HKAA authorizes sanctions on foreign persons that “materially contribute” to the failure of the Government of China to meet its obligations to Hong Kong under the Joint Declaration or the Basic Law. The HKAA states that a foreign person materially contributes to the failure of the Government of China to meet its obligations if the person takes an action that results in the inability of the people of Hong Kong to enjoy freedom of assembly, speech, press, or independent rule of law; or to participate in democratic outcomes. Actions that reduce the high degree of autonomy of Hong Kong can also constitute a material contribution.
Specifically, as shown in the text from the Executive Order, the type of person that is a candidate to be put on such a sanctions list includes those who are determined:
(i) to be or have been involved, directly or indirectly, in the coercing, arresting, detaining, or imprisoning of individuals under the authority of, or to be or have been responsible for or involved in developing, adopting, or implementing, the Hong Kong Security Law;
(ii) to be responsible for or complicit in, or to have engaged in, directly or indirectly, any of the following:
(a) actions or policies that undermine democratic processes or institutions in Hong Kong;
(b) actions or policies that threaten the peace, security, stability, or autonomy of Hong Kong;
(c) censorship or other activities with respect to Hong Kong that prohibit, limit, or penalize the exercise of freedom of expression or assembly by citizens of Hong Kong, or that limit access to free and independent print, online or broadcast media; or
(d) the extrajudicial rendition, arbitrary detention, or torture of any person in Hong Kong or other gross violations of internationally recognized human rights or serious human rights abuse in Hong Kong;
(iii) to be or have been a leader or official of an entity, including any government entity, that has engaged in, or whose members have engaged in, any of the activities (except (ii)(d)) described above;
(iv) to have materially assisted, sponsored, or provided financial, material, or technological support for, or goods or services to or in support of, any person whose property and interests in property are blocked pursuant to the Executive Order;
(v) to be owned or controlled by, or to have acted or purported to act for or on behalf of, directly or indirectly, any person whose property and interests in property are blocked pursuant to the Executive Order; or
(vi) to be a member of the board of directors or a senior executive officer of any person whose property and interests in property are blocked pursuant to the Executive Order.
A person may be the subject to these sanctions even if they do not have any ties to the United States. The new Executive Order allows the U.S. government to impose sanctions on those who “materially assist” any person (including non-U.S. persons) who is designated under this legislation.
No list currently exists but we can extrapolate from similar sanctions by the U.S. against countries like Russia and Venezuela. Based on that, we believe that persons who might be sanctioned include a Hong Kong Police unit enforcing the HK Security Law, low and mid-level Chinese Community Party officials responsible for imposing the HK Security Law, and entities tied to supplying equipment that may have been used by the Hong Kong Police such as riot gear and tear gas. Executive leadership such as Carrie Lam or Xi Jinping are unlikely to be targeted due to the significant political risk that such an action would present. The sanctions that may be imposed under the HKAA could potentially impact transactions in Hong Kong to the extent that there are transactions with a person who is, or at some point in the future, becomes the subject of sanctions under the HKAA.
Who will enforce the sanctions and what is their principal effect?
The imposition and enforcement of these sanctions will be tasked to the U.S. Department of Treasury’s Office of Foreign Assets Control (“OFAC”) which has broad authority to enforce and promulgate U.S. sanctions. Depending on the way in which OFAC implements and imposes these sanctions, targeted foreign persons could find themselves on the SDN List, the result of which is that U.S. persons are barred from engaging in virtually all transactions with those persons and all property belonging to the sanctioned person that is within U.S. jurisdiction must be blocked and cannot be transferred without authorization from OFAC2.
How does the HKAA affect your business?
- Business/Contract counterparty risk - This is not unlike how everyone currently navigates current sanctions imposed by the U.S. or any other country. What we would recommend is enhanced Know-Your-Client checking to ensure we are not dealing with a person/entity from a sanctioned territory or sanctioned person/entity. When the relevant lists are available, they should be checked against for compliance purposes. Know-Your-Client procedures are familiar to financial institutions and professional service providers – it is basically a system of checks to ensure that you understand the ultimate beneficial owners of entities you are doing business with and whether such ultimate owners and their affiliates are the subject of sanction lists.
- Assess your business risk in light of what the HKAA intends to address – are you and your customers engaged in activity that could materially contribute to the contravention of China’s obligations to Hong Kong under the Joint Declaration and the Basic Law? The current heightened concern is due to the lack of guidance on the term “materially contribute”, whether or not there will be wind down periods (typically, such sanctions by the U.S. are not intended to harm innocent third parties and in other similar sanctions there have been periods during which certain transactions would be permitted to unwind) and whether the selection of parties or entities could be rather arbitrary under the current U.S. administration given that China/U.S. relations are at an all-time low. However, some businesses will be more obviously at risk than others. Does your business, for example, deal with police chiefs directing policemen to arrest Hong Kong protestors, companies supplying equipment used by the police to suppress protests (e.g. tear gas, water cannons, and other crowd control tools), Hong Kong court officials involved in trying and sentencing Hong Kong protestors or Chinese Communist Party officials administering the HK Security Law?
- What do you do if you have an entity which does business in Hong Kong? The Executive Order signed by President Trump contains what is commonly referred to as a ‘’material support’’ provision which would create a risk to persons who provide the sanctioned person with “material support or assistance“. So the sanctions could extend to group companies who are providing material support (financially, technologically or otherwise) to a person or entity in Hong Kong which is found to be in breach of the HKAA. This may lead to some businesses establishing business operations (or at least contingency plans for business operations) in other parts of Asia for their Asian coverage. There will, inevitably, be businesses who have to remain in Hong Kong for other business or regulatory reasons. The mitigant here is to familiarise yourself with the HK Security Law and continually assess whether there would develop basis for your business to run afoul of that law. Social media platforms which serve as a forum for all sort of comments and opinions potentially run a materially higher risk. Other data processors which have control about what is published and attributed to them as a business would run a lower risk.Foreign financial institutions (FFIs) will have deeper concerns. In an effort to further combat China’s alleged violations of Hong Kong’s autonomy and the extension of Chinese authoritarian practices to Hong Kong, the HKAA also authorizes the U.S president to impose sanctions on FFIs conducting “significant transactions” with anyone included in the Secretary of State’s mandated report on foreign persons who are materially contributing to China’s failure to meet its obligations to Hong Kong. The term “significant transaction” is undefined, so the U.S. government will have broad discretion to target conduct by these organizations.
These FFIs will be included in a report produced by the Secretary of State within 60 days of the report on foreign persons. If an FFI is included in that report one year after the initial report, the president will be required to impose no fewer than five of the sanctions listed below. If the FFI is still included in the report two years after the initial report, the president will be required to impose all of the sanctions listed below. If the FFI’s activity does not have a significant and long-lasting negative effect, is not likely to be repeated, and has been reversed or otherwise mitigated through positive countermeasures by the FFI, the FFI can be removed from the report.
The following is the “menu” of sanctions that can be imposed on FFIs under the HKAA:
- Prohibition on obtaining loans or credits from U.S. financial institutions
- Prohibition on designation as a primary dealer for U.S. government debt instruments
- Prohibition on serving as a repository for U.S. government funds
- Prohibition on foreign exchange transactions subject to U.S. jurisdiction
- Prohibition on transfers of credit or payments between financial institutions subject to U.S. jurisdiction
- Prohibition on property transactions subject to U.S. jurisdiction
- Prohibition on exports, re-exports, and in-country transfers of commodities, software, and technology subject to U.S. jurisdiction to a financial institution
- Prohibition on obtaining equity or debt investment from any U.S. person
- Prohibition on the entry into the U.S. of corporate officers, principals, or controlling shareholders of the FFI
- Sanctions on principal executive officers of the FFI (being any of the above sanctions which may be imposed on FFIs)
Contractual comfort and “get out” clauses – do you have clauses in your contracts where the counterparty represents and warrants that it is not a sanctioned person or engaging in activities which could be the subject of sanctions? Even if they are not so designated at the start of your contract with them, time changes everything. Do you have a contractual clause which would entitle you to suspend the performance of your obligations without liability in the event that a person you are contracting with becomes subject to such sanctions?
Seek updated legal advice – much is changing rapidly. Today it is the HKAA. The UK and EU are thinking of something similar although media reports indicate that the EU is seeking another tack of suspending Hong Kong as a territory to which they would allow extradition to and allow more asylum applications. It is not clear as of today what the UK is considering over and above the published announcements of allowing certain Hong Kong people rights to stay and work in the UK as a path to eventual citizenship. The UK also considering potential sanctions similar to those that may be imposed by the United States under the HKAA.
- Although the language of the HKAA requires that the report be submitted within 90 days, similar reports due under other sanctions programs (e.g., PEESA) are routinely delayed for significant periods of time.
- U.S. person is defined throughout OFAC’s regulations to mean U.S. citizens and permanent residents, persons physically located in the United States, and entities organized under the laws of the United States and their foreign branches. The parent entity of an organization does not become a U.S. person for purposes of sanctions just because it has a single entity in the United States or because it does U.S.-related business.
Client Alert 2020-448
