Trump Administration Set to Sanction Foreign Financial Institutions Over Hong Kong

The HKAA, first introduced in the Senate on May 21, passed both houses of Congress unanimously with astonishing speed before being sent to the president on July 2. The law is the latest U.S. response to the ongoing political turmoil in Hong Kong. Since June 2019, the city has been engulfed in anti-government protests, culminating in the national security law imposed by Beijing on the special administrative region on June 30. In November 2019, the U.S. enacted the Hong Kong Human Rights and Democracy Act, which stipulated sanctions against foreign individuals and entities deemed responsible for human rights violations in Hong Kong.

The definition of "financial institution" in the HKAA is very broad. All kinds of institutions in the financial sector could be subject to secondary sanctions, from traditional banks to insurance companies to currency exchanges. Even though the law specifies "foreign" institutions as being the targets, large U.S. multinationals themselves such as JPMorgan and Citi are also implicated by dint of their foreign subsidiaries. They will also be tasked with enforcing blocking sanctions against identified foreign individuals and entities.

"The law does not list any particular financial institutions that would be targeted and in fact, the way the law is written, it would not necessarily be limited to a Hong Kong or China-based financial institution, so the application is potentially broad," said Nick Turner, of counsel at Steptoe & Johnson in Hong Kong.

Financial institutions that have ordinary day-to-day transactions with a person who might be sanctioned probably are not of the utmost concern

Under Section 5 of the HKAA, the Secretary of State has up to 90 days following the law coming into force to identify foreign individuals and entities for sanctions, should there be any that meet the criteria. These are the primary targets of the law. Then, the Secretary of the Treasury will have up to 60 days to identify those foreign financial institutions that have "significant transactions" with those individuals and entities – the secondary targets. The list of these institutions will be continually updated by the Treasury.

The law does not specify what constitutes "significant transactions." However, foreign financial institutions can refer to other U.S. sanctions programs to consider their exposure to potential sanctions under the HKAA, Turner says. He points to the U.S. sanctions programs against Iran as well as Russia, where the U.S. Office of Foreign Assets Control has used a standard definition based on seven factors. These include the size and frequency of a transaction, as well as the "nexus" between the transaction and a sanctioned person. There is also a catch-all provision that gives the Secretary of the Treasury discretion to judge on a case-by-case basis.

"For the purposes of this law, financial institutions that have ordinary day-to-day transactions with a person who might be sanctioned probably are not of the utmost concern, but it's still not clear what a significant transaction might be. So this is an area we'll be watching closely." Turner said.

Once a foreign financial institution is identified, the HKAA clearly lists out the sanctions that would be imposed on them. Section 7 provides a menu of 10 specific sanctions, including prohibitions on receiving loans from U.S. financial institutions, participating in foreign exchange transactions subject to U.S. jurisdiction, and importing commodities and technology subject to U.S. jurisdiction.

A clear timeline for the imposition of the sanctions is also provided. Within a year of a financial institution being identified, the president shall impose at least five of the 10 available sanctions. Within two years, all of those sanctions must be imposed. Nonetheless, all 10 of the sanctions could be imposed immediately after a financial institution is identified.

In addition to the HKAA, Trump also signed an executive order that enhanced various key components of the proposed sanctions regime. The executive order introduces potential blocking sanctions on primary targets for the first time. It also introduces a new provision to sanction entities that have "materially assisted, sponsored, or provided financial, material, or technological support for" targeted individuals and entities.

For financial institutions operating in China and Hong Kong, the potential danger is that they could be forced to choose between complying with U.S. laws or Chinese laws

This material assistance provision seems to cast a wider net in terms of subjecting more foreign financial institutions to secondary sanctions than the criteria set out in the HKAA, according to a recent client alert written by Covington & Burling lawyers. Nonetheless, as the executive order does not explicitly mention foreign financial institutions, the sections of the HKAA that deal specifically with foreign financial institutions should still be in effect, says Turner.

The HKAA also provides a way for foreign financial institutions, which have been identified by the Treasury Department, to avoid sanctions. Under Section 8, which deals with waivers and exceptions, foreign financial institutions may avoid sanctions if the president determines that its actions, or those of the individual or entity that it does business with, do not have a "significant and lasting negative effect" on Hong Kong's autonomy. Moreover, the president has to determine that these actions are unlikely to be repeated, and that the financial institution has "reversed or mitigated through positive countermeasures."

For financial institutions operating in China and Hong Kong, the potential danger is that they could be forced to choose between complying with U.S. laws or Chinese laws. On July 15, a Chinese Foreign Ministry spokesperson said that China will sanction relevant U.S. individuals and entities in response. The Hong Kong government has also said that it will cooperate with Beijing's countermeasures. One potential basis for these could be Article 29 of the new Hong Kong National Security Law, which prohibits receiving "instructions, control, funding or other kinds of support from a foreign country" to enforce sanctions against Hong Kong or China.

"[I]t 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," Covington lawyers wrote.

Foreign companies in China are already struggling with this dilemma, most notably in the area of U.S. export controls. China has said that it will blacklist any U.S. companies that cut-off supplies to Chinese customers through an Unreliable Entity List. The newly-launched cybersecurity review also threatens to punish foreign suppliers of network products and services that interrupt supply.

U.S. suppliers argue that they are merely complying with the export control rules of their home country. In addition to strengthening potential sanctions over Hong Kong, President Trump's executive order directed various government agencies to begin treating Hong Kong the same as China in export controls and other areas.

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