In response to the national security law introduced in Hong Kong on June 30, 2020, the US Congress passed the Hong Kong Autonomy Act (Act) on July 2, 2020. The Act, which may be signed into law by President Trump as early as this week, would introduce property- and visa-blocking sanctions on foreign persons who have “materially contributed” to China’s recent actions in Hong Kong (Material Contributors), as well as a variety of sanctions on foreign financial institutions who “knowingly conduct significant transactions” with such persons.
We explain the entities targeted by the Act and its impact in further detail below.
The impact on Material Contributors
The Act requires the Secretary of State, in consultation with the Secretary of the Treasury, to submit a report to Congress identifying foreign individuals and entities who have “materially contributed to the failure of the Government of China to meet its obligations under the Joint Declaration or the Basic Law”. While this appears intended to target the Chinese officials behind Hong Kong’s new national security law, many other individuals and entities could also be considered to be Material Contributors, as the Act defines material contribution generally as any action that reduces the autonomy of Hong Kong or prevents the people of Hong Kong from enjoying certain rights and democratic processes.
Persons who are identified in the report will be subject to mandatory sanctions, such as asset freezes and travel and visa restrictions, which must be imposed within a year of identification. The first report must be submitted within 90 days of the enactment of the Act, and must be updated in an ongoing manner and resubmitted annually.
The impact on financial institutions
The Act is also designed to target financial institutions assisting Material Contributors. Although the accompanying political rhetoric suggested that the Act would primarily target Chinese state-owned banks, the reach of the Act is potentially much wider, as it requires the Secretary of State, in consultation with the Secretary of the Treasury, to submit a separate report to Congress identifying any foreign financial institution that “knowingly conducts a significant transaction” with a Material Contributor.
This wording enables OFAC to target a wide range of financial institutions, not least because the term “significant transaction” is not defined in the Act. It is anticipated that, in this regard, OFAC will adopt the same approach used under the Countering America’s Adversaries Through Sanctions Act (in relation to Russia), namely that a “transaction” will include any transfer of value, and its “significance” will be judged using a multi-factor test, taking into account, among other things, the transaction’s size, nature and impact on the Act’s statutory objectives. Additionally, the term “financial institution” is defined unusually broadly and extends beyond commercial and investment banks to insurance companies, currency exchanges and even travel agencies and car dealers.
Furthermore, there is no requirement that the financial institution have knowledge of the fact that the counterparty has been identified as a Material Contributor, as the term “knowingly” refers only to actual knowledge of the conduct of the transaction. And while it is likely that the “significant transaction” must take place after the counterparty has been identified as a Material Contributor, the text of the Act is not entirely clear in this respect.
Any foreign financial institution so identified (Identified Institution) would be subject to a menu of 10 mandatory sanctions (Menu), including prohibitions on US financial institutions making loans to the Identified Institution, prohibitions on transfers or payments between financial institutions involving the Identified Institution and a “US Nexus” (e.g. the US Dollar), as well as asset freezes. The Act requires the Menu to be phased in over time—within a year of identification, the President is required to impose at least five of the 10 mandatory sanctions on the Identified Institution and, within two years of identification, the entire Menu.
Even though the Act has yet to be signed into law, it has sparked considerable controversy within the financial industry in Hong Kong, particularly because it introduces a potential dilemma. Compliance with the Act may be illegal under Hong Kong’s broadly-worded national security law, which prohibits receiving “instructions, control, funding or other kinds of support from a foreign country”
to impose sanctions against Hong Kong or China. As a result, companies may have to choose between breaching the national security law and falling foul of US sanctions. Several banks have sought clarification in this regard, however guidance from Hong Kong or Chinese authorities has not yet been received.
If enacted, and depending on the number and identity of the Material Contributors identified. the Act may have a significant impact on the many financial institutions that have dealings in the Chinese market and with Chinese entities. To mitigate risk with respect to the Act, such financial institutions should ensure that they continuously monitor the reports released by the Secretary of State, and have robust sanctions policies in place to prevent any dealings with Material Contributors. As a proactive step, they may also want to review their existing clientele to identify those at risk of being designated as Material Contributors—indeed, some financial institutions with significant operations in Hong Kong have already done so.
We will continue to monitor the progress of the Act, as well as its interaction with Hong Kong’s national security law, and issue additional briefings.
If you have any questions regarding the Act, or US sanctions on China, please do not hesitate to contact Katie McDougall
(London), Kim Caine
(Washington, DC) or David Harris