United States – China Trade Conflict Escalates Following Hong Kong Unrest

Key Takeaways

• The U.S. government has responded to recent events with a new slate of sanctions and revocation of Hong Kong’s special trade status, most recently with the enactment of the Hong Kong Autonomy Act signed by President Trump on July 14, 2020, immediately followed by the President’s Executive Order on Hong Kong Normalization the same day.  
  
  
• China also has announced its own unspecified sanctions targeting certain U.S. officials and companies.  
  
  
• While many of the recent escalations have mostly symbolic impact or remain in a threatened or pending status now, certain export control developments have immediate impact for companies dealing in U.S. origin goods, software, and technology.  
  
  
• Non-U.S. financial institutions also must be aware of new sanctions risks raised by the Hong Kong Autonomy Act.  
   

The U.S.-China trade war continues to escalate, most recently fueled by U.S. concerns over China’s assertion of increasing authority over Hong Kong. The U.S. and Chinese governments have exchanged jabs through the use of economic sanctions measures, travel bans and other trade measures, some of which are largely symbolic, but some of which have significant practical impact.

U.S. Determination that Hong Kong Is No Longer Autonomous

Following the 1997 transition of Hong Kong from British rule to the authority of mainland China, the United States has accorded special trade status to Hong Kong, in recognition of China’s commitment to maintain the territory’s economic and administrative independence. The U.S. State Department is required by the Hong Kong Policy Act of 1992¹ to assess the autonomy of the territory, as a condition of the special trade status. Following China’s response to unrest in Hong Kong, on May 27, 2020 U.S. Secretary of State Pompeo certified to Congress that: “Hong Kong does not continue to warrant treatment under United States laws in the same manner as U.S. laws were applied to Hong Kong before July 1997.”² Days later, President Trump instructed his administration to “revoke Hong Kong’s preferential treatment as a separate customs and travel territory from the rest of China.”³

On June 30, 2020, China released new national security legislation, making it easier to monitor and punish Hong Kong dissidents and reducing the region’s autonomy. The “Law of the People’s Republic of China on Safeguarding National Security in the Hong Kong Special Administrative Region”⁴ amends the Basic Law governing Hong Kong since 1997. The law imposes severe criminal penalties (including life imprisonment) on acts of secession, subversion, terrorism, and collusion with foreign or external forces. Article 38 of the new law applies to offenses committed “from outside the Region by a person who is not a permanent resident of the Region,” which could potentially reach acts committed by individuals residing in the United States.

Additional Sanctions under the Hong Kong Autonomy Act

In response to China’s enactment of new national security legislation in Hong Kong, on July 14, President Trump signed the Hong Kong Autonomy Act into law.⁵ The Act, which passed both houses of Congress by unanimous support in early July, authorizes sanctions to be imposed on two categories of persons:

1. Non-U.S. individuals or entities determined by the U.S. Government to be contributing to China’s failure to preserve Hong Kong autonomy, including by taking action that results in the inability of the people of Hong Kong to enjoy freedom of assembly, speech, or press or participating in democratic outcomes.

• Within 90 days from enactment of the law, the State Department and Treasury Department are required to submit a report to Congress identifying any non-U.S. individuals or entities that fall into this category.
  
  
• The Act authorizes – but does not require – sanctions to be imposed on such persons immediately. If a person remains included in this report for one year, however, the President is required to add the person to the U.S. List of Specially Designated Nationals (“SDN List”), meaning U.S. persons will be prohibited from transacting with them and are required to block their property. Sanctioned individuals also could be barred from entry into the United States.

2. Non-U.S. financial institutions that knowingly conduct significant⁶ transactions with such individuals or entities; 

• Within 90 days after the State Department has produced the report described above, the Treasury Department must submit an additional report to Congress that identifies any non-U.S. financial institution that knowingly conducts a significant transaction with a person identified in the State Department report. 
  
  
• These institutions would not be at immediate risk of being sanctioned. However, if a financial institution has been identified in the Treasury report for at least a year, the President is required to impose at least five sanctions out of a menu of ten options.⁷ If a financial institution remains on the list for two years, the President must impose all ten sanctions.
   

The President nonetheless has significant discretion to waive sanctions in certain circumstances. The Act also creates a path for removal of sanctions on non-U.S. financial institutions and individuals. In order to secure sanctions relief, the non-U.S. financial institution must clearly show that it has undertaken remedial actions to prevent ongoing suppression of Hong Kong’s autonomy and that the underlying activity that led to designation will not reoccur in the future. The burden will be on the targeted financial institution – elevating the importance of customer due diligence. 

The President’s Executive Order on Hong Kong Normalization

Immediately following his signature on the Hong Kong Autonomy Act, the President issued an Executive Order on Hong Kong Normalization (“Order”).⁸ The Order gives effect to his prior policy directive for federal agencies to revoke Hong Kong’s preferential status compared to China. The Order suspends application of section 201(a) of the Hong Kong Policy Act  (the authority for preferential treatment) with respect to immigration laws, defense trade controls, dual-use/commercial export controls, foreign investment review, and country of origin and marking under the customs rules.⁹ Federal agencies have 15 days following the Order (until July 29) to amend their regulations accordingly. The Order also provides the basis for OFAC sanctions and travel bans on non-U.S. persons determined to be involved in human rights abuses, undermining the democracy and autonomy of Hong Kong and related activities.

U.S. Revocation of Export License Exceptions for Hong Kong

In immediate response to the Hong Kong national security law, the U.S. Department of Commerce, Bureau of Industry and Security (“BIS”) issued a significant export licensing policy change for Hong Kong effective June 30, 2020. BIS suspended all export control license exceptions for transactions with Hong Kong involving items subject to the Export Administration Regulations (“EAR”),¹⁰ if the exception provides differential treatment from mainland China. Similarly, the State Department, which regulates defense articles subject to the International Traffic in Arms Regulations (“ITAR”),¹¹ also announced that it will “end exports of US-origin defense equipment and will take steps toward imposing the same restrictions on US defense and dual-use technologies to Hong Kong as it does for China.”¹² China is subject to a U.S. arms embargo.

Historically, pursuant to the special trade status under the Hong Kong Policy Act, the United States has treated Hong Kong independently of China for export control purposes. It has listed Hong Kong in more favorable country groups¹³ and has made available preferential license exceptions reserved for the United States’ closest allies. Far fewer transactions have required specific licenses for Hong Kong than for China. Under the new policy, items subject to the EAR may not be exported, reexported, or transferred to or within Hong Kong using a license exception, unless if the exception is also available to China. Otherwise, a specific license must be obtained from BIS whenever a license requirement applies to Hong Kong. Similarly, deemed export/reexport transactions involving Hong Kong nationals continue to be authorized under license exceptions until August 28, 2020, at which time such technology transfers will require a license (unless a license exception is available to China). 

The new policy will, for example, impact semiconductor, computing, telecom, and sensor equipment subject to national security controls that require authorization for export to Hong Kong, which previously were eligible for a number of license exceptions that did not apply to China. On the other hand, certain items eligible for the encryption license exception under the EAR will remain authorized for Hong Kong as that exception also applies to China. With the recent elimination of the CIV license exception for exports to civilian end users in China (among other countries),¹⁴ license exception options for Hong Kong will be significantly limited.

As discussed above, modifications to regulatory authorities under the EAR and ITAR are expected soon, pursuant to the Order.

Additional Acts of Escalation

While this update focuses on the Hong Kong Autonomy Act and the change in Hong Kong export licensing policy, these developments have occurred in the context of several other recent escalations between the U.S. and China. The U.S. government has issued a series of sanctions designations and export control prohibitions on several Chinese parties,¹⁵ as well as travel bans on several Chinese senior officials.¹⁶

On July 13, 2020, China announced retaliatory sanctions against three Members of Congress, the U.S. Ambassador at Large for International Religious Freedom, and the U.S. Congressional-Executive Commission on China. China has not yet specified the details of its sanctions, such as whether they would restrict access to China’s financial system or involve visa travel bans. On July 14, China announced plans to impose unspecified sanctions against a U.S. defense contractor over a Taiwan arms transaction. In the meantime, China has yet to officially designate any companies on its threatened “Unreliable Entities” list, which China first announced in 2019 as a retaliatory tool against the BIS Entity List restrictions on Chinese companies.

Potential Areas for Continuing Escalation

Companies engaged in trade with China and Hong Kong might continue watching for potential escalations in the following areas:

• Tariffs. Phase 1 of the China trade deal froze the tariff war, and the U.S. government has not since then imposed new tariffs on China under Section 301 of the Trade Act of 1974. Recent press reports indicate that President Trump does not at this time foresee entry into a second more substantive trade deal phase that might lift or scale back tariffs. Imports from Hong Kong thus far have been exempt from the Section 301 tariffs against China. However, a next step could involve extension of those tariffs to Hong Kong on the basis of changes to the Customs marking and country of origin rules under the Executive Order, treating Hong Kong as part of China.
  
  
• Export Controls. BIS has room to take its policy shift further, imposing further restrictions on Hong Kong.  Right now, the new license exception policy has yet to be codified in the regulations. Pursuant to the Executive Order, BIS may move Hong Kong to the same restrictive country groups as China and expand the license requirements for Hong Kong in the EAR Country Chart. The State Department may take similar actions by formally extending the China arms embargo to Hong Kong.
  
  
• Restrictions on Access to Technology. The U.S. government has a panoply of tools to prevent Hong Kong from accessing the U.S. tech sector, including export controls and increased scrutiny by the Committee on Foreign Investment in the United States (“CFIUS”). Under the Executive Order, CFIUS may be directed to treat Hong Kong investors categorically as Chinese, and China has been subject to heightened scrutiny in the CFIUS process in recent years. Many U.S. tech companies voluntarily are exiting Hong Kong and refusing to cooperate with government requests there in light of recent protests, and it will be interesting to see whether the U.S. government considers other measures to nudge that withdrawal further.

Footnotes

1) Hong Kong Policy Act of 1992 (Public Law 102–383), codified at 22 U.S.C. §5701 et seq.

2) See U.S. Secretary of State Press Statement, “P.R.C. National People’s Congress Proposal on Hong Kong National Security Legislation” (May 27, 2020).

3) See “Remarks by President Trump on Actions Against China” (May 29, 2020).

4) Available at http://www.xinhuanet.com/english/2020-07/01/c_139178753.html.

5) Hong Kong Autonomy Act, H.R. 7440, available at https://www.congress.gov/116/bills/hr7440/BILLS-116hr7440enr.pdf.

6) The Act does not define what is considered to be a “significant” transaction that could lead to sanctions against a non-U.S. financial institution. Based on prior guidance from the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) in other secondary sanctions contexts, OFAC has broad discretion in determining what is “significant”, including the volume of transactions, the level of awareness of management, and the impact of the transactions on statutory objectives. See, e.g., OFAC Frequently Asked Question No. 154.

7) See sec. 7 of the Act. These measures, which are similar to sanctions options available in other U.S. secondary sanctions legislation regarding Iran and Russia, vary greatly in potential impact but include very significant potential penalties such as prohibiting the financial institution from conducting transactions involving U.S. property, U.S. foreign exchange transactions, and other U.S. financial transactions.

8) Not yet numbered, available at: https://www.whitehouse.gov/presidential-actions/presidents-executive-order-hong-kong-normalization/.

9) Impacted laws include section 103 of the Immigration Act of 1990 (8 U.S.C. 1152 note); sections 203(c), 212(l), and 221(c) of the Immigration and Nationality Act of 1952, as amended (8 U.S.C. 1153(c), 1182(l), and 1201(c), respectively); the Arms Export Control Act (22 U.S.C. 2751 et seq.); section 721(m) of the Defense Production Act of 1950, as amended (50 U.S.C. 4565(m)); the Export Control Reform Act of 2018 (50 U.S.C. 4801 et seq.); and section 1304 of title 19, United States Code.

10) 15 C.F.R. Parts 730-774.

11) 22 C.F.R. Parts 120 et seq.

12) U.S. Secretary of State Press Statement, “U.S. Government Ending Controlled Exports to Hong Kong,” (June 29, 2020).

13) 15 C.F.R. Part 740, Supplement No. 1. Hong Kong presently is listed in Country Groups A:6 and B. In contrast, China is in Country Groups D:1, D:3, D:4, and D:5 (restricted for reasons of national security, chemical and biological weapons proliferation, missile technology, and U.S. arms embargo policies).

14) See Dechert’s April 28 OnPoint on tightened export restrictions on China, Russia and Venezuela.

15) Most recently, on July 9, OFAC added the Xinjiang Public Security Bureau, along with two current and two former officials in the region, to its Specially Designated Nationals and Blocked Persons (“SDN”) List on grounds of human rights abuses against ethnic minorities in the Xinjiang Uyghur Autonomous Region.

16) The State Department complemented the sanctions designations on July 9 with an announcement of travel bans on three senior officials of the Chinese Communist Party and visa restrictions on unnamed current and former Chinese Communist Party officials “who are believed to be responsible for, or complicit in, undermining Hong Kong’s high degree of autonomy.”