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Developments in U.S. Policy Toward Hong Kong: Analyzing the Hong Kong Autonomy Act and Executive Order on Hong Kong’s Treatment Under U.S. Law

July 16, 2020, Covington Alert

In our client alert of May 29, 2020, we reported on the initial U.S. government reaction to the announced intention of China’s legislature, the National People’s Congress (“NPC”), to unilaterally impose national security legislation on Hong Kong. As expected, on June 30, the NPC unanimously adopted the “Law of the People’s Republic of China on Safeguarding National Security in the Hong Kong Special Administrative Region.

This client alert reports on significant developments since our May 29 alert, and in particular on steps taken by the U.S. government in response to China's adoption of the national security legislation. Among those steps are the passage by Congress and signature into law by President Trump of the Hong Kong Autonomy Act (“HKAA”), President Trump’s issuance of an Executive Order on Hong Kong Normalization, the tightening of U.S. export control restrictions applicable to Hong Kong, and the announcement of visa denial sanctions targeting certain current and former Chinese officials believed to be involved in undermining the autonomy of Hong Kong. We also report below on visa denial and asset-blocking sanctions targeting current and former officials believed to be involved in human rights violations in the Xinjiang Uyghur Autonomous Region ("XUAR").

Hong Kong Autonomy Act (“HKAA”)

On July 14, the HKAA was signed into law by President Trump. This legislation was introduced in the Senate on May 21, passed the Senate by unanimous consent on June 25, passed the House of Representatives with modest changes by unanimous consent on July 1, and passed the Senate a second time on July 2. The speedy and unanimous approval of the legislation by both houses of Congress reflected Congress's profound unhappiness with recent developments in Hong Kong.

The HKAA builds on previous legislation designed to bring pressure to bear on China to continue respecting the autonomy of Hong Kong. The Hong Kong Human Rights and Democracy Act, for example, enacted in November 2019, provided for the imposition of U.S. sanctions (including denial of visas for travel to the United States and blocking of assets subject to U.S. jurisdiction) against foreign persons determined by the President to be responsible for the extrajudicial rendition, arbitrary detention, or torture of any person in Hong Kong, or other gross violations of internationally recognized human rights in Hong Kong.

The HKAA broadens the universe of persons potentially subject to these kinds of U.S. sanctions to include foreign persons who have “materially contributed” to the diminution of Hong Kong’s autonomy. Further, the HKAA contains provisions that threaten U.S. secondary sanctions against any “foreign financial institution” that engages in a “significant transaction” with a foreign person who has been identified under the law as materially contributing to the diminution of Hong Kong’s autonomy. Because the persons who may be identified under this law potentially include some of the most powerful figures in China and Hong Kong, it is conceivable that China may respond to this threat with threats of its own directed against foreign financial institutions should they take actions, or refuse to engage in certain activities, in order to avoid exposure to U.S. secondary sanctions. In this event, those financial institutions could be forced to make difficult choices regarding which country’s laws to respect. China has also threatened to impose its own sanctions in response. A Chinese Foreign Ministry spokesperson said on July 15: “The U.S. attempt to obstruct the implementation of the national security law in Hong Kong will never succeed. In order to safeguard its legitimate interests, China will make necessary response and sanction the relevant individuals and entities of the United States.”

As explained below, the imposition of sanctions pursuant to the HKAA is effectively discretionary. Further, the sanctions framework established under the HKAA largely parallels the one established under the Executive Order issued by President Trump coincident with his signature of the new law. Because any sanctions imposed pursuant to the HKAA are potentially harsh, inflexible, and difficult to modify or remove, to the degree the U.S. Administration chooses to impose sanctions over developments in Hong Kong, it may prefer to act pursuant to the new Executive Order rather than pursuant to the HKAA.

Summary of the HKAA

The HKAA provides that not later than 90 days after its enactment, the Secretary of State is required to submit a report to Congress if, in consultation with the Secretary of the Treasury, the Secretary of State has determined "that a foreign person 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.[1]" Among other things, the Secretary of State’s report must identify the individuals who have been determined to have engaged in these activities, and describe the activities that resulted in them being so identified.

The law clarifies that “a foreign person materially contributes to the failure of the Government of China to meet its obligations under the Joint Declaration or the Basic Law if the person—

1. took 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
2. otherwise took action that reduces the high degree of autonomy of Hong Kong.”

Between 30 and 60 days after such a report has been submitted by the Secretary of State, the Secretary of the Treasury, in consultation with the Secretary of State, is required to submit a report to Congress that “identifies any foreign financial institution that knowingly conducts a significant transaction with a foreign person identified” in the earlier report.

The HKAA further provides that both of these reports “shall be updated in an ongoing manner and, to the extent practicable,” shall be resubmitted with an annual report to Congress required under the United States-Hong Kong Policy Act of 1992.

The HKAA mandates two types of sanctions against persons identified in a report submitted pursuant to the law: (1) the denial of a visa for travel to, and exclusion from, the United States, and (2) the blocking of property subject to U.S. jurisdiction. These sanctions may be imposed beginning on the date that a person is identified in a report submitted pursuant to the law, and shall be imposed beginning not later than one year after the person was so identified.

With respect to foreign financial institutions identified in a report submitted pursuant to the law, the law provides for the imposition of up to ten secondary sanctions. These include prohibitions on:

1. receiving loans from U.S. financial institutions;
2. being designated as a primary dealer in U.S. government debt instruments;
3. serving as a repository for U.S. government funds;
4. participating in foreign exchange transactions subject to U.S. jurisdiction;
5. transfers of credit or payments subject to U.S. jurisdiction by, through, or to the foreign financial institution;
6. conducting any transactions in property subject to U.S. jurisdiction;
7. exports, reexports, and in-country transfers to the foreign financial institution of items subject to U.S. export controls; and
8. purchases of debt or equity instruments of the foreign financial institution by U.S. persons.

In addition,

9. corporate officers and controlling shareholders are subject to exclusion from the United States, and
10. principal executive officers are subject to imposition of any of the sanctions numbered 1 through 8 above, as appropriate.

All ten of these sanctions may be imposed beginning on the date that a foreign financial institution is identified in a report submitted pursuant to the law. Not less than five of the sanctions are required to be imposed not later than one year after the institution is so identified, and all ten of the sanctions are required to be imposed not later than two years after the institution is so identified.

The law provides that the President may exclude a foreign person or a foreign financial institution from a report under the law prior to the imposition of sanctions if the President determines that the actions of that person or financial institution that caused them to be identified—

1. do not have a significant and lasting negative effect that contravenes the obligations of China under the Joint Declaration and the Basic Law;
2. are not likely to be repeated in the future; and
3. have been reversed or otherwise mitigated through positive countermeasures taken by that foreign person or foreign financial institution.

The law also contains a provision permitting the President to terminate sanctions with respect to a person or financial institution after they have been imposed, should the Secretary of State, in consultation with the Secretary of the Treasury, determine that all three criteria above are satisfied.

In addition, the HKAA contains a provision permitting the President to waive the application of sanctions with respect to a foreign person or foreign financial institution if the President “determines that the waiver is in the national security interest of the United States,” and submits a report to Congress outlining the reasons for that determination.

Both the national security waiver and the sanctions termination provision are, however, subject to a Congressional review mechanism that permits both houses of Congress, under expedited procedures, to vote on whether to disapprove the waiver or termination.

The law adopts the definition of "financial institution" set forth in 31 U.S.C. Section 5312(a)(2). That definition is very broad, and includes not only traditional banks, credit unions, and other thrift institutions, but also investment banks, brokers and dealers in securities and commodities, insurance companies, travel agencies, currency exchanges, money transfer companies, dealers in precious metals and jewels, telegraph companies, casinos and other gambling establishments, and businesses involved in the sale of automobiles, airplanes, and boats.

Analysis

It appears that the HKAA provides for the phased-in application of sanctions with respect to both persons and foreign financial institutions in order to afford those persons and institutions an opportunity to alter their conduct before sanctions are actually required to be imposed. However, the standard set forth in the law for avoiding the application of sanctions is so high that it appears very unlikely that the standard could be met in most cases. As outlined above, once a person or financial institution has been identified in a report pursuant to the law, that person or institution is required to be sanctioned at the conclusion of the phase-in period unless the President finds that the actions of the person or institution that caused them to be identified (1) were not that significant to begin with, (2) are unlikely to be repeated, and (3) have been reversed or otherwise mitigated through positive countermeasures, or unless the President exercises the national security waiver.

Any exercise of the national security waiver by the President, or any termination of sanctions by the President after they have been imposed, is subject to the Congressional review mechanism set forth in the law. This mechanism is intended to discourage such action by the President by facilitating floor votes in both the House of Representatives and the Senate on whether to reject the President’s action. Consequently, before taking such action, the President will need to evaluate the level of political support that exists for affording sanctions relief to the individual or financial institution in question, and make a judgment whether it is worth expending the political capital necessary to sustain that action.

In contrast to the types of individuals targeted for U.S. sanctions under the Hong Kong Human Rights and Democracy Act—primarily persons involved in law enforcement or the work of security agencies—the individuals targeted under the HKAA appear to be primarily political officials and other decision-makers and influencers. Such individuals are likely to be powerful members of society, well-positioned to seek Chinese government protection in the event that sanctions under the HKAA affect them in a meaningful way. This would appear to create a risk that the Chinese government may intervene to threaten its own penalties against financial institutions that consider modifying their conduct to avoid exposure to U.S. secondary sanctions. This could force financial institutions operating in China and Hong Kong to make difficult choices.

It remains unclear, however, whether the U.S. Administration will make extensive use of the HKAA. Sanctions under the law effectively are discretionary. The sanctions mechanism of the law is triggered by the submission of a report to Congress by the Secretary of State identifying individuals determined by the Secretary to have materially contributed to undermining the autonomy of Hong Kong. However, no report is required to be submitted if no one is determined to have made such a material contribution, and there is no requirement that the Secretary of State determine that anyone has done so.

There are other authorities available to the U.S. Administration to sanction individuals who are deemed to have undermined the autonomy of Hong Kong, and those authorities are not tied to sanctions frameworks as inflexible as the one established under the HKAA. Most importantly, the Executive Order on Hong Kong Normalization, issued by President Trump coincident with his signature into law of the HKAA and described below, establishes a sanctions framework with respect to Hong Kong that largely parallels the one established under the HKAA. Time will tell whether the HKAA becomes a favored tool of the U.S. Administration, or a rarely-used instrument of U.S. sanctions policy.

Executive Order on Hong Kong Normalization

On July 14, at the same time that he signed the HKAA into law, President Trump issued an Executive Order on Hong Kong Normalization. This Executive Order aimed in the first instance to exercise the President’s authority under the United States-Hong Kong Policy Act of 1992 to direct the termination of preferential treatment of Hong Kong under U.S. law if such treatment was no longer warranted. In light of China’s adoption of national security legislation applicable to Hong Kong, President Trump directed in the Executive Order that Hong Kong henceforward be treated as part of China for purposes of a number of U.S. laws, including provisions of the Immigration and Nationality Act, the Arms Export Control Act, the Defense Production Act, and the Export Control Reform Act. President Trump also directed the suspension of a number of bilateral agreements between the United States and Hong Kong, including the bilateral agreement on extradition. The Executive Order leaves the door open for potential further actions “to end special conditions and preferential treatment for Hong Kong” that are not explicitly included in the Order.

In addition, the Executive Order established a framework for imposing sanctions on any foreign person determined by the Secretary of State, in consultation with the Secretary of the Treasury, or by the Secretary of the Treasury, in consultation with the Secretary of State to, among other things:

1. be or have been involved, directly or indirectly, in developing, adopting or implementing China’s new national security law with respect to Hong Kong;
2. be or have been involved or complicit in undermining democratic processes or institutions in Hong Kong, threatening the peace, security, stability, or autonomy of Hong Kong, limiting freedom of expression or assembly in Hong Kong, 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 abuses in Hong Kong;
3. 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 under the Executive Order; or
4. be a member of the board of directors or a senior executive officer of any person whose property and interests in property are blocked under the Executive Order.

In certain cases, the Executive Order also permits the application of sanctions against individuals who are or were leaders or officials of a governmental entity engaged in sanctionable conduct. Persons and entities designated by the Secretary of State or the Secretary of the Treasury under the Executive Order are subject to property-blocking sanctions. Further, individuals who are so designated, as well as their immediate family members, are excluded from travel to the United States.

The Executive Order obviously provides very broad authority to impose sanctions on individuals and entities with respect to actions in Hong Kong. Notably, the authority under the Executive Order to impose sanctions on persons or entities that “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 under the Order” would appear to extend to, and indeed go beyond, the kinds of activities by foreign financial institutions that could result in the imposition of secondary sanctions under the HKAA.

As with the authority to impose sanctions under the HKAA, sanctions under the Executive Order are discretionary, and therefore will not necessarily be imposed on every individual or entity that potentially could be sanctioned under the Executive Order. Because the sanctions authority provided under the Executive Order is more flexible than the sanctions authority provided under the HKAA, the U.S. Administration may prefer to rely on the Executive Order rather than the HKAA.

Reduction of Favorable Treatment for Hong Kong Under U.S. Export Controls

In addition, the Administration has taken certain initial steps to reduce the more favorable treatment that U.S. export control regulations provide to Hong Kong compared to China, and additional steps will follow to suspend or eliminate the disparity altogether.

Secretary of State Pompeo announced on June 29 that “the United States will today end exports of U.S.-origin defense equipment and will take steps toward imposing the same restrictions on U.S. defense and dual-use technologies to Hong Kong as it does for China.” He stated that “[w]e can no longer distinguish between the export of controlled items to Hong Kong or to mainland China. We cannot risk these items falling into the hands of the People’s Liberation Army, whose primary purpose is to uphold the dictatorship of the CCP by any means necessary.”

With respect to the International Traffic in Arms Regulations (ITAR) administered by the U.S. State Department’s Directorate of Defense Trade Controls (DDTC), DDTC officials have provided guidance that DDTC is not issuing any new ITAR licenses for exports to Hong Kong in light of Secretary Pompeo’s announcement.

With respect to the Export Administration Regulations (EAR) administered by the U.S. Department of Commerce’s Bureau of Industry and Security (BIS), the Commerce Department announced on June 29 that, as part of the “revocation of Hong Kong’s special status,” the “Commerce Department regulations affording preferential treatment to Hong Kong over China, including the availability of export license exceptions, are suspended. Further actions to eliminate differential treatment are also being evaluated.”

BIS subsequently issued an explanatory note on June 30, suspending any license exceptions for exports to Hong Kong, reexports to Hong Kong, and transfers (in-country) within Hong Kong of items subject to the EAR where such license exceptions would not be available for exports, reexports, or transfers (in-country) of such items to China. BIS justified this action based on the heightened risk of diversion of items subject to U.S. export controls jurisdiction to the Chinese People’s Liberation Army or Ministry of State Security or to the U.S.-sanctioned countries of Iran or North Korea.

As a result of this suspension, no items subject to the EAR may be exported or reexported to or transferred within Hong Kong using a license exception, except for transactions that would otherwise be eligible for a license exception if the same transaction involved an export, reexport, or transfer (in-country) of the item to/within China. A BIS license must instead be sought and obtained whenever a license requirement applies for an export to, a reexport to, or a transfer within, Hong Kong. The note includes a “savings clause” with respect to shipments in transit as of June 30 and “deemed export” releases occurring through August 28, 2020.

President Trump’s July 14 Executive Order on Hong Kong Normalization mandated further changes to U.S. export controls applicable to Hong Kong. The Executive Order stated that it is the policy of the United States to suspend or eliminate differential treatment for Hong Kong to the extent permitted by law and in the national security, foreign policy and economic interest of the United States. Accordingly, the Executive Order suspended the application of the United States-Hong Kong Policy Act of 1992 (“HKPA of 1992”) to the Arms Export Control Act and the Export Control Reform Act of 2018, among other statutes. As discussed in our May 29 alert, the HKPA of 1992 provided that following the transfer of sovereignty over Hong Kong from the United Kingdom to China scheduled to occur in 1997, the United States would continue to treat Hong Kong as separate from the rest of China in a variety of political, economic, trade, and other spheres, provided that Hong Kong remained “sufficiently autonomous to justify” such treatment. Specifically the HKPA of 1992 provided that following the handover “the laws of the United States shall continue to apply with respect to Hong Kong, on and after July 1, 1997, in the same manner as the laws of the United States were applied with respect to Hong Kong before such date, unless otherwise expressly provided by law or by Executive order.” Thus, any suspension of Hong Kong’s status—in whole or in part—could only occur through a law or an Executive Order issued by the President.

The Executive Order further directed that within 15 days, the relevant agencies shall initiate various actions to further the purpose of the Executive Order, including with respect to export controls, to amend any regulations providing differential treatment for Hong Kong as compared to China, and to revoke license exceptions for exports to, reexports to, and transfers within Hong Kong that provide differential treatment compared to the license exceptions available for China. This mandate likely will result in further amendments to the ITAR and EAR, and may also include actions affecting existing export licenses.

Following the release of the Executive Order, DDTC posted Frequently Asked Questions (“FAQs”) regarding its policies under the ITAR toward Hong Kong. The FAQs explain that Hong Kong is now considered to be included in the arms embargo on China contained in Section 126.1 of the ITAR, such that there is a presumption of denial for all license requests where Hong Kong is the destination (or is otherwise listed, e.g. as a distribution territory) or where a Hong Kong person is named as an end-user, licensee, or sublicensee. However, the FAQs also provide that license requests to provide defense services to Hong Kong persons who are located outside Hong Kong or the PRC and were authorized to receive defense services prior to July 14, 2020 will be reviewed on a case-by-case basis. Moreover, the FAQs provide that at this time, the Department is not taking steps to revoke existing licenses to export defense articles or defense services to Hong Kong.

Visa Denial and Other Sanctions Imposed on Chinese Officials

On June 26, Secretary of State Pompeo announced that the United States would restrict U.S. visas for current and former members of the Chinese Communist Party (CCP) “who are believed to be responsible for, or complicit in, undermining Hong Kong’s high degree of autonomy, as guaranteed in the 1984 Sino-British Joint Declaration, or undermining human rights and fundamental freedoms in Hong Kong.” Secretary Pompeo indicated that this policy may also extend to family members of those CCP officials. To date, however, no announcements have been made about individual CCP members who have been denied visas pursuant to this policy.

However, the Treasury Department has acted recently to sanction Chinese officials for other reasons. On July 9, the Treasury Department imposed sanctions on one Chinese government entity and four current or former Chinese government officials allegedly involved in serious rights abuses against ethnic minorities in the XUAR. These sanctions were imposed pursuant to Executive Order 13818. The sanctions against these individuals included denial of visas for travel to the United States, and also the blocking of their assets subject to the jurisdiction of the United States.[2]

Further, Executive Order 13818 provides authority to block the property of any persons determined by the Secretary of Treasury, in consultation with the Secretary of State and the Attorney General, 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” Executive Order 13818. This discretionary authority under Executive Order 13818, and analogous authority provided under the newly-issued Executive Order on Hong Kong Normalization, could provide a basis to sanction non-U.S. parties, including non-U.S. financial institutions, that are determined to be providing material assistance or support (including financial support) to persons designated under the new Executive Order.

In coordination with the action by OFAC, the State Department also announced on July 9 visa restrictions against certain of the OFAC-designated individuals and their immediate family members, making them ineligible for entry into the United States. The State Department also announced plans for additional visa restrictions against certain members of the CCP determined to be responsible for, or complicit in, human rights abuses in Xinjiang.

In response to the actions by OFAC and the State Department, the Chinese government announced on July 13 retaliatory actions against Senators Ted Cruz and Marco Rubio, Representative Chris Smith and U.S. Ambassador for Religious Freedom Sam Brownback. The precise elements of these measures were not announced, but they are expected to parallel the U.S. measures.

If you have any questions concerning the material discussed in this client alert, please contact the following members of our International Trade practice.

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[1] The Sino-British Joint Declaration was a treaty signed in 1984 providing for the transfer of sovereignty over Hong Kong from the United Kingdom to the People’s Republic of China on July 1, 1997, under an arrangement providing that Hong Kong would be afforded a high degree of autonomy from China until 2047. The Hong Kong Basic Law was adopted by China’s NPC in 1990 to give effect to the provisions of the Joint Declaration, including its provisions relating to the autonomy of Hong Kong.

[2] Specifically, the Treasury Department’s Office of Foreign Assets Control (OFAC) added the following parties to the List of Specially Designated Nationals and Blocked Persons (SDN List): the Xinjiang Public Security Bureau (XPSB), two current or former officials of the XPSB, and two current or former officials of the XUAR. As a result of these designations, all property and interests in property of the XPSB and the designated individuals (and of any entities that are owned, directly or indirectly, 50 percent or more by them, individually, or with other blocked persons) that are in the United States or in the possession or control of a U.S. person, are blocked and must be reported to OFAC. In addition, unless authorized by a general or specific license issued by OFAC or otherwise exempt from regulation, transactions by or involving a U.S. person that involve any property or interests in property of the designated/blocked persons are prohibited.

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