Source: Morgan Lewis
Published on: July 28, 2020
President Donald Trump issued Executive Order 13936 on July 14 titled “The President’s Executive Order on Hong Kong Normalization” (the Executive Order or EO 13936). On the same day, the Hong Kong Autonomy Act (HR 7440) was signed into law (the Act). Together, the Executive Order and the Act represent the US government’s response to the recently enacted Law of the People’s Republic of China on Safeguarding National Security in the Hong Kong Administrative Region (the National Security Law) in China, which outlined China’s jurisdiction over Hong Kong.
The Act allows the Secretary of State, in consultation with the Secretary of the Treasury, to sanction any foreign individual or entity that is “materially contributing” or “attempts to materially contribute” to Chinese government actions taken pursuant to the National Security Law. The Act also outlines an extensive list of mandatory sanctions against foreign financial institutions (FFIs) that “knowingly conduct a significant transaction” with an individual or entity sanctioned under the Act. The Executive Order both implements essential authorities under the Act and arguably extends further by declaring a national emergency with respect to the “unusual and extraordinary threat” to US national security posed by China’s passage of the National Security Law.
EO 13936 includes two significant components:
- It directs all agencies with relevant authorities (i.e., the Department of Commerce, the Immigration and Customs Enforcement agency, etc.) to take all necessary steps to eliminate Hong Kong’s special and preferential treatment under specific US law and regulations, including, for example, the elimination of trade, export, and customs preferences; and
- It empowers the Secretaries of State and Treasury to block US property and interests in property of individuals or entities integrally involved in implementing the new National Security Law
ELIMINATING HONG KONG’S PREFERENTIAL STATUS
Within 15 days of the date of the Executive Order (or before July 29, 2020), the relevant US government agencies must commence “all appropriate actions” to terminate Hong Kong’s preferential treatment under various US laws, including the following:
- Amending regulations implementing the order to eliminate or suspend preferential treatment of Hong Kong under laws related to immigration, export controls, national security, foreign investment and customs and under the International Emergency Economic Powers Act (IEEPA);
- Revoking license exceptions that provide different treatment of Hong Kong compared to China for exports and reexports to Hong Kong and in-country transfers within Hong Kong of controlled items;
- Terminating export licensing suspensions under the Foreign Relations Authorization Act that apply to exports of defense articles to Hong Kong individuals or entities physically located outside of Hong Kong and China and who are authorized to receive defense articles before the date of the Executive Order;
- Ending training to members of the Hong Kong police or other Hong Kong security services at the State Department’s International Law Enforcement Academies;
- Terminating the Fulbright exchange program with respect to future exchanges for participants traveling both from and to China or Hong Kong;
- Eliminating the preference for Hong Kong passport holders as compared to Chinese passport holders and reallocating admissions within the refugee ceiling to Hong Kong residents based on humanitarian concerns;
- Issuing required notices of the intent to suspend or terminate specific agreements between the US and Hong Kong related to law enforcement, including extradition, reciprocal tax exemption, and scientific and technical cooperation; and
- Proposing any further actions deemed necessary and prudent to end special conditions and preferential treatment of Hong Kong under US law. §2, the Executive Order.
The Executive Order thus implements the policy announced in June to continue the process of recasting the US relationship with Hong Kong. These steps are designed to extend to Hong Kong the same policies and regulations that currently apply to China. While this is expected to significantly impact certain aspects of trade with and in Hong Kong, it is not designed to sever all ties with Hong Kong, except to the extent that parties relied on technology transfers in their dealings with specific Hong Kong entities. It is also expected to impact individuals operating in Hong Kong, to the extent that they were provided preferential immigration and related statuses. In short, the EO accelerates the US policy shifts by 25 years that recognize the turnover of Hong Kong to China.
SANCTIONS RELATING TO HONG KONG
Potentially more significant than the change in trading status is the section of EO 13936 that authorizes broad sanctions against various persons and entities relating to actions taken under the National Security Law. Section 4 of the Executive Order authorizes the president to impose sanctions against any person who:
- Has been involved, directly or indirectly, in 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, China’s new National Security Law;
- Is responsible for or complicit in, or to have engaged in, directly or indirectly, in one or more of the following:
- actions or policies that undermine democratic processes or institutions in Hong Kong;
- actions or policies that threaten the peace, security, stability, or autonomy of Hong Kong;
- 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
- 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;
- Is or has been a leader or official of an entity, including any government entity, that has engaged in, or whose members have engaged in, the above activities, or an entity sanctioned under the Executive Order;
- Has materially assisted, sponsored, or provided financial, material, or technological support for, or goods or services to or in support of, any person sanctioned under the Executive Order.
The Executive Order also allows the US government to sanction persons “owned or controlled by,” or who “acted or purported to act for or on behalf of,” any sanctioned person, as well as directors and senior executive officers of a sanctioned entity.
Persons sanctioned under EO 13936 will become Specially Designated Nationals (SDNs), or the equivalent. This designation generally prohibits US persons and entities from any dealings with these persons without authorization from Treasury’s Office of Foreign Assets Control (OFAC). As with other SDNs, Treasury rarely grants licenses and authorizations for most activities. Although OFAC may allow for “wind down” licenses, which provide individuals and companies the opportunity to withdraw from or terminate transactions with sanctioned individuals or entities or divest ownership of the blocked asset, absent compelling US interests for such wind downs, such licenses are not guaranteed and may not be available.
Persons subject to the EO also are likely to be prohibited from entering the US, including having existing visas revoked. The EO also allows such entry restrictions to be applied to “immediate family members,” which generally includes spouses and children of any age. For sanctioned entities, entry may also be restricted for any foreign citizens and nationals employed by, or acting as an agent of, the sanctioned entity.
Consistent with other sanctions-related executive orders, EO 13936 does not require prior notice of any determination to impose sanctions under the Executive Order. In this respect, the EO fills an important gap in the requirements and processes envisioned by the Act, which requires first the identification of entities and foreign financial institutions in reports to Congress. Although the Act allows for sanctions immediately following the submission of the reports to Congress, EO 13936 authorizes action while those reports are still in progress. Moreover, the EO allows for a more traditional approach to sanctions.
The EO also adds important levels of flexibility to the policy determinations available to OFAC and/or the Department of State because it does not require that an individual or entity be “materially contributing” to or “attempt[ing] to materially contribute” to the Chinese government’s actions in the same manner as the Act does. On the other hand, EO 13936 does not single out FFIs for specific sanctions like the Act. In combination, however, the Act and the EO continue the Administration’s trend toward a more holistic approach to actions in certain foreign policy realms, and particularly with respect to those relating to China.
Together, the Act and the EO present new compliance challenges for investors, multinational companies, financial institutions and others with business dealings and interests in Hong Kong. These developments counsel that those operating in this new environment exercise caution in their transactions and investments. For example, dealings with persons or entities in Hong Kong will require enhanced due diligence and more detailed examination of individuals and entities (including those associated with investment funds, portfolio companies, shareholders, directors, officers, managers and advisors), and of assets (including securities, commodities and currencies, and derivatives instruments related thereto) involved in transactions. This additional analytical rigor can help entities or individuals identify information gaps that can raise concerns under the Act or EO as well as highlight circumstances where enhanced risks merit discussions with the US government or the need for authorizations.
The more detailed diligence can also be instrumental in the development of commercial documentation, decisions on transaction structure, financing requirements, and future engagement with parties subject to either sanctions or other limitations under the Act or EO. Given the depth and complexity of financial dealings in Hong Kong, parties operating in the city will need to understand even more than previously whether their dealings involve parties who are or could be subject to these sanctions, which can impact virtually all transactions, including securities trades, equity or debt investments, loans and financings, foreign exchange, and other banking activities. Deal or fund structure and the terms and conditions of the transaction or investment will also need to consider these sanctions. Some deal terms, such as withdrawal and termination rights, may now carry greater weight in the negotiation process.
THE BIGGER PICTURE
Continuing engagement with Hong Kong now requires consideration of the likelihood that these sanctions will be aggressively implemented, and the likely targets for these actions. As the geopolitical situation changes, exit strategies will likely be viewed as key elements of the overall business engagement with entities or individuals from Hong Kong. Among the factors parties may need to consider is the likelihood that China will take its own actions in response to any sanctions or, in some instances, as part of its own initiative to address what it may see as changed political or economic circumstances. China’s policy options include but are not limited to, its own sanctions, blocking actions or more affirmative steps. This is expected to contribute to the complexity and uncertainties related to commercial dealings in Hong Kong.
Questions regarding the US government’s resolve to pursue these actions should consider at least two important factors: bipartisan support and the importance of human rights. In particular:
- The US actions have unusual bipartisan support. The Act passed both houses of Congress unanimously and with consistent focus on the challenges both political parties outlined as reasons for the Act. Thus, Congress is expected to remain supportive of, and may seek to press, definitive actions under the Executive Order.
- The sanctions imposed against Chinese officials and companies based on the situation in the Xinjiang Uyghur Autonomous Region demonstrate the administration’s willingness to use sanctions, especially where human rights are involved. In addition to sanctioning 37 persons and entities previously in October 2019 and June 2020, the Commerce Department recently sanctioned 11 Chinese companies after accusing them of human rights violations against the Uighur people in China. More recently, the US sanctioned three senior officials of the Communist Party, including a high-ranking member of the politburo for actions related to the Uighurs.
Based on the bipartisan actions taken by the administration and Congress, the passage of the Hong Kong Autonomy Act and the issuance of EO 13963 highlight the need for additional focus on due diligence and risk assessments related to continuing business in Hong Kong. While manageable at this point, the likelihood of additional US government or congressional action would not be unexpected and parties should consider evaluating their current commercial and deal documentation to ensure that relative risks are adequately addressed. This can assist with both deal certainty and risk management.
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