Hong Kong update: financial institutions prepare for possible designations under the Hong Kong Autonomy Act in October 2020

The Hong Kong Autonomy Act (HKAA),^[1] enacted on July 14, 2020, authorizes a range of significant sanctions on persons and financial institutions in reaction to the new law on Safeguarding National Security in the Hong Kong Special Administrative Region (the HK National Security Law),^[2] which came into force in Hong Kong on June 30, 2020. A key deadline under the HKAA will occur on October 12, 2020, which is the date by which the US Secretary of State, in consultation with the US Secretary of the Treasury, is required to report to Congress the names of any persons determined to be “materially contributing” to the erosion of Hong Kong’s autonomy as guaranteed in the 1985 Sino-British Joint Declaration and the Basic Law of the Hong Kong Special Administrative Region. Public reports indicate that financial institutions with exposure to Hong Kong have stepped up their US compliance efforts over the past two months in preparation for the October 2020 deadline. Notably, the HKAA authorizes a menu of 10 secondary sanctions on foreign financial institutions that engage in “significant transactions” with any persons that may be designated under the HKAA.

The United States has taken a series of actions this year, including legislative, executive, and administrative action, to tighten US export controls on Hong Kong and impose sanctions on persons and financial institutions that have played or will play a role in the implementation or enforcement of the HK National Security Law. The same day that the HKAA was signed into law, US President Donald Trump issued Executive Order 13936, "The President’s Executive Order on Hong Kong Normalization” (EO 13936),^[3] which immediately authorized sanctions against foreign persons determined to have been involved in various ways (discussed below) with the implementation or enforcement of the HK National Security Law. On August 7, 2020, the Office of Foreign Assets Control (OFAC) of the US Department of the Treasury designated 11 Hong Kong government officials to the Specially Designated Nationals and Blocked Persons List (SDN List) under EO 13936.^[4]

The HKAA and EO 13936 represent largely overlapping authorizations for the imposition of sanctions in connection with Hong Kong. One area in which the two do not overlap is the authorization of secondary sanctions on FFIs; only the HKAA specifically targets FFIs. This post focuses on the risk to financial institutions in connection with the upcoming October 2020 report to Congress under the HKAA.

KEY PROVISIONS OF THE HKAA

The HKAA creates a two-part structure that initially authorizes, and may later mandate, sanctions on certain persons, entities, or foreign financial institutions.

1. Mandatory reports to Congress

Section 5 of the HKAA requires the US Secretaries of State and of the Treasury to submit the following two reports to Congress no later than October and December, 2020, respectively. Persons and FFIs named in the following reports will be “designated” under the HKAA, with the consequences described in Section 1(b), below (including the likely imposition of substantive sanctions if their presence on the relevant reports continues for a specified period).

1. Report on “foreign persons.” Within 90 days of July 14, 2020, i.e., by October 12, 2020, the US Secretary of State, in consultation with the US Secretary of the Treasury, must submit a list of any “foreign person” who “is materially contributing to, has materially contributed to, or attempts to materially contribute to the failure of the Government of China to meet its obligations under the Joint Declaration or the Basic Law” (Designated Persons) in a report to Congress. A “material contribution” is defined under Section 5(g) of the HK Autonomy Act to include any “action that resulted in the inability of the people of Hong Kong—(A) to enjoy freedom of assembly, speech, press, or independent rule of law; or (B) to participate in democratic outcomes;” or any “action that reduces the high degree of autonomy of Hong Kong.”
2. Report on “foreign financial institutions.” Within 30 to 60 days of the US Secretary of State identifying the Foreign Designees to Congress, i.e., no later than December 11, 2020, if the report on “foreign persons” is submitted on October 12, 2020, the US Secretary of the Treasury, in consultation with the US Secretary of State, must submit a report identifying “any foreign financial institution that knowingly conducts a significant transaction with a [Designated Person]” (Designated FFIs) to Congress. The term “knowingly” is defined in the HKAA, “with respect to conduct, a circumstance, or a result,” to mean “that a person has actual knowledge of the conduct, the circumstance, or the result.” HKAA, Section 2(9). The term “significant transaction” is not defined in the HKAA. However, OFAC guidance in respect of other US sanctions programs suggests that OFAC may consider “seven broad factors” in assessing whether a transaction is “significant”: “(1) the size, number, and frequency of the transaction(s); (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.” See OFAC FAQ 542 (referring to Section 5 of the Ukraine Freedom Support Act of 2014 and Section 226 of the Countering America’s Adversaries through Sanctions Act).

2. Sanctions authorized under the HKAA

The sanctions authorized on foreign persons and FFIs under the HKAA are initially discretionary. However, if the persons or FFIs are not removed from the relevant reports after one year (for persons) or two years (for FFIs), then the HKAA mandates the imposition of sanctions.

1. Sanctions on “foreign persons.” Section 6(a) makes sanctions on Designated Persons discretionary within one year of their inclusion in the Secretary of State’s report, and mandatory beginning one year after the date of their inclusion in the report. Under Section 6(b) of the HKAA, natural persons may be subject to visa restrictions or exclusion from the United States. In addition, natural and legal persons may be subject to the imposition of blocking sanctions, i.e., significant financial restrictions that would bar US persons from having any dealings with the foreign person and freeze all of the property and interests in property of the foreign person in the control of US persons. The HKAA’s blocking sanctions would likely result in designation as a Specially Designated National (SDN).
2. Sanctions on FFIs. Section 7(a) mandates the imposition of five out of a menu of 10 authorized sanctions on Designated FFIs within one year of their inclusion in the Secretary of the Treasury’s report. The US President has the discretion to choose which five sanctions measures are initially implemented. Section 7(b) mandates the imposition of all 10 of the 10 authorized sanctions within two years of a Designated FFI’s ongoing inclusion on the Secretary of the Treasury’s report.

The menu of 10 sanctions targeting Designated FFIs are the following:

• (1) Prohibition on making loans or providing credit to the Designated FFI.
• (2) Prohibition on the FFI being designated (or continuing a prior designation) as a primary dealer in US Government debt.
• (3) Prohibition on the FFI serving as agent of the US Government or as a repository for US Government funds.
• (4) Prohibition on any transactions in foreign exchange involving the FFI and subject to US jurisdiction.
• (5) Prohibition on any transfers of credit or payments between financial institutions or by, through, or to any financial institution subject to US jurisdiction and involving the FFI.
• (6) Prohibition on FFIs
  • (A) acquiring, holding, withholding, using, transferring, withdrawing, transporting, importing, or exporting any property that is subject to the jurisdiction of the United States and with respect to which the foreign financial institution has any interest;
  • (B) dealing in or exercising any right, power, or privilege with respect to such property; or
  • (C) conducting any transaction involving such property.
• (7) Prohibition on exports, reexports, and transfers (in-country) of commodities, software, and technology subject to US export controls and destined (directly or indirectly) for the FFI.
• (8) Prohibition on US persons investing in or purchasing significant amounts of equity or debt instruments of the FFI.
• (9) Prohibition on any alien that is determined to be a corporate officer or principal of, or a shareholder with a controlling interest in, the FFI from entering the United States.
• (10) The principal executive officer or officers of the FFI, or on individuals performing similar functions and with similar authorities as such officer or officers may be targeted with sanctions listed at (1) through (8), above.

3. Presidential waiver, removal, and termination authority

The majority of current US sanctions programs have been created through executive order; a minority of sanctions programs are enacted into law by act of Congress. Sanctions and designations imposed on the basis of an executive order, e.g., EO 13936, may be unilaterally lifted at the discretion of the President. By contrast, the mandatory sanctions contemplated by the HKAA may only be lifted in accordance with the HKAA’s procedures for waiver in Section 8 of the HKAA.

1. Waiver. Under Section 8(a) of the HKAA, the President may waive the application of sanctions to a foreign person or FFIs, provided that the President (1) determines that the waiver is in the national security interest of the United States; and (2) submits to the appropriate congressional committees and leadership a report on the determination and the reasons for the determination. However, pursuant to Section 8(e) of the HKAA, the US Congress may reject the President’s proposed waiver by passing a “disapproval resolution.”
2. Removal. Section 5(d) of the HKAA authorizes the President to (i) exclude a foreign person or FFI from the report (or updated report) to Congress described above, or (ii) remove a foreign person or FFI from the report or update prior to the imposition of sanctions, provided that the “material contribution” of the person or FFI for which the person or FFI was designated “(A) does not have a significant and lasting negative effect that contravenes the obligations of China under the Joint Declaration and the Basic Law; (B) is not likely to be repeated in the future; and (C) has been reversed or otherwise mitigated through positive countermeasures” taken by the foreign person or FFI.

NEXT STEPS

As noted above, OFAC has already designated 11 Hong Kong officials under EO 13936. These include a number of individuals with prominent roles in implementing the HK National Security Law. These individuals could conceivably be included in the report due to Congress by October 12, 2020 of “foreign persons” to be designated under the HKAA. To be clear, the US Secretary of State is not required by the HKAA to include the individuals sanctioned under EO 13936 in his report; nor is his report limited to such individuals.

Certain uncertainties remain regarding the HKAA for FFIs. For example, it is not clear how the US Administration will define “significant transactions” for purposes of the HKAA, and whether the same factors will be considered as are considered in other US sanctions programs. Similarly, it is not clear what kind or extent of remedial measures will be considered sufficient to warrant exclusion of a foreign person or FFI from the report to Congress, or to warrant the removal from the report or termination of sanctions with respect to that person or FFI. In any event, given that the President’s waiver, removal, and termination authority is subject to disapproval by Congress, sanctions may be difficult to remove, once imposed.

Once the Secretary of State’s report to Congress is issued, FFIs with exposure to the individuals designated under the HKAA would be well-served to assess their exposure to US secondary sanctions under the HKAA. Appropriate measures may include, but are not limited to:

• Ensuring that your company has an updated, risk-based US sanctions compliance policy in place.
• Evaluating whether your company engages in business with the Designated Persons or the entities or institutions such persons represent.
• Monitoring the situation for developments, given the continued uncertainties regarding the implementation of the HKAA noted above.

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We will continue to monitor the situation. Please reach out to your usual HSF contacts with any questions.

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