The End of Hong Kong's "Preferential Treatment": US Imposes Similar Export Controls as on China and Introduces Sanctions

Following China's recent enactment of the "Law on Safeguarding National Security in the Hong Kong Special Administrative Region" (China's National Security Law), which the US identifies as undermining Hong Kong's autonomy, the US government has ended its decades-long preferential US export trade relationship with Hong Kong. Hong Kong now will be subject to similarly stringent US export restrictions and licensing requirements as mainland China. In addition, the US authorized imposing sanctions on foreign persons who materially contribute to undermining Hong Kong's autonomy and democracy and on foreign financial institutions that conduct significant transactions with such foreign persons.

Specifically, on July 14, 2020, President Trump issued Executive Order 13936 (the Executive Order), which states that Hong Kong is no longer sufficiently autonomous to justify differential treatment in relation to China, and which directs US agency heads to commence all appropriate actions to suspend or eliminate different and preferential treatment for Hong Kong within 15 days. As a result, exports or re-exports of US defense and commercial items and technology will have similar export licensing requirements as those currently imposed on China. This will inevitably impact a significant number of US products destined to Hong Kong. Further, President Trump authorized the imposition of sanctions on foreign actors who undermine Hong Kong's autonomy under Executive Order 13936 and the Hong Kong Autonomy Act (HKAA), which he signed into law the same day. US agencies also have taken steps to end Hong Kong's special status, as described below.

The HKAA and the Executive Order mark the culmination of rapidly increasing strains on US-China relations—and the beginning of a much stricter era of trade compliance. Going forward, companies and individuals engaging in trade of US goods and technology with Hong Kong will need to revise their trade practices and export compliance procedures to ensure conformance with the enhanced export restrictions on Hong Kong. Further, foreign persons will need to be cautious about engaging in activities that fall within the broad scope of the HKAA and the Executive Order, in order to avoid potential sanctions imposition—which would result in effectively being cut off from the US economy. Foreign financial institutions and other foreign persons operating within the region also should take care to evaluate whether their business dealings involve parties that may be subject to future sanctions under the HKAA and the Executive Order.

Below, we detail the recent history of the relevant trade regulations and provide further color regarding the new rules.

Elimination of US Export Preferential Treatment

In recognition of Hong Kong's special administrative status in China pursuant to the United States-Hong Kong Policy Act of 1992, the US allowed Hong Kong to receive certain preferential treatment in trade, immigration, and national security matters—until now. Due to the Chinese government's increasing encroachment on Hong Kong's autonomy, including China's National Security Law, the US has suspended application of certain preferential treatment of Hong Kong, including export controls of US defense and commercial items and technology. The Executive Order directs agencies to amend regulations to eliminate such preferential treatment, and US agencies recently have taken steps to end Hong Kong's special status.

On June 29, 2020, the State Department, which is responsible for trade involving defense articles and related technical information, 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." The Executive Order formalized this cessation of differential treatment, including that shipments of defense articles to Hong Kong that were previously authorized under the International Traffic in Arms Regulations (ITAR) are now subject to a presumption of denial for license authorizations. However, despite these steps, recent State Department Frequently Asked Questions (FAQs) provide that "[a]t this time the Department is not taking steps to revoke or rescind previously approved authorizations to export defense articles or services to Hong Kong."

More recently, on July 31, 2020, the Commerce Department's Bureau of Industry and Security (BIS), which oversees trade controls involving "dual use" commercial items under the Export Administration Regulations (EAR), published a final rule suspending the availability of all EAR license exceptions for Hong Kong that provide differential treatment compared to China. Importantly, under the EAR, Hong Kong is treated separately from China and is included in Country Groups A:6 and B, while China is included in Country Groups D:1, D:3-5. BIS's rule falls short of changing the applicable country group and thus does not have the immediate impact of normalizing all of Hong Kong's preferential treatment under the EAR. However, the issuance of the Executive Order should serve as a strong signal that BIS will amend the EAR to remove Hong Kong from Country Groups A:6 and B and to treat Hong Kong in the same manner as China. The eventual removal of Hong Kong from these country groups will have a significant impact on businesses in Asia (in particular, China) that maintain servers and other cyber-assets in Hong Kong to benefit from its A:6 and B group status.

Further, the Executive Order takes additional measures to cease preferential treatment of Hong Kong, including by eliminating preferences for Hong Kong passport holders compared with those of China, incorporating Hong Kong persons into certain US immigration and visa policies for China, terminating the Fulbright exchange program with respect to future exchanges for participants traveling both from and to China or Hong Kong, and reallocating admissions within the refugee ceiling set by the annual Presidential Determination to residents of Hong Kong based on humanitarian concerns. It also directs agencies to give notice of intent to suspend certain US-Hong Kong agreements related to extradition of fugitive offenders and the transfer of sentenced persons. Other countries, including the United Kingdom and Germany, also recently suspended their extradition treaties with Hong Kong in response to recent Chinese encroachment on Hong Kong's autonomy.

Sanctions for Undermining Hong Kong's Autonomy

The newly enacted HKAA provides for the US government to impose sanctions on foreign individuals and entities identified as materially contributing to undermining Hong Kong's autonomy from China, including by taking actions that restrict freedom of assembly, speech, or press, independent rule of law, or democratic processes. Sanctions include the prohibition of transactions subject to US jurisdiction involving property to which the foreign person has any interest, and the denial of visas and exclusion from the United States. Moreover, foreign financial institutions that knowingly conduct a significant transaction with such foreign persons also risk sanctions imposition, including broad restrictions on access to the US financial system. The HKAA does not define "significant transaction," but the parameters of what the US government typically considers to be a "significant transaction" are available at the Treasury Department's FAQ 542.

The HKAA requires the Secretary of State and Secretary of the Treasury to submit reports to Congress identifying such foreign persons and foreign financial institutions. Under the HKAA, the President has discretion to impose sanctions on those initially identified in those reports, but is required to impose sanctions on them if they are still listed in the reports after one year. The President may remove a foreign person or foreign financial institution from an updated report before any sanctions imposition if the material contribution does not have a significant and lasting negative effect, is not likely to be repeated in the future, and has been mitigated through positive countermeasures taken by that foreign person or foreign financial institution. Foreign individuals and entities identified in the reports, therefore, have an opportunity to take certain actions to try to avoid subsequent sanctions imposition. Arnold & Porter's national security and legislative practice groups have significant experience in this area and are well prepared to provide guidance to companies and individuals on US executive and legislative activities regarding these and other US sanctions regimes.

The Executive Order builds on the sanctions authorized under the HKAA by directing the designation to the US Specially Designated Nationals and Blocked Persons (SDN) list any foreign individual or entity determined to be (1) involved, directly or indirectly, in developing, adopting, or implementing China's National Security Law; (2) responsible for or complicit in, directly or indirectly, actions or policies that undermine democratic processes or institutions in Hong Kong, that threaten the peace, security, stability, or autonomy of Hong Kong, or that censor or penalize freedom of expression or assembly by Hong Kong citizens; or (3) a leader or official of an entity, including any government entity, that has engaged in the above activities. The effect of designation to the SDN list is severe: US persons are prohibited generally from engaging in any transactions with SDNs and are required to "block" (i.e., seize) any property or interests in property of SDNs. SDNs designated under the Executive Order and their family members also will be denied entry into the United States.

Conclusion

Given the extensive effort to eliminate preferential trade treatment and to punish actions that undermine Hong Kong's autonomy, the US government's recent measures serve as a stark signal that it no longer views Hong Kong separately from China. As a result, any trade-based, financial, or other business engaged in the region should review carefully its operations in light of the restrictions and possible sanctions under these new laws. The US government, moreover, is likely to take additional actions, the severity of which will depend on the implementation of China's National Security Law and related Chinese conduct vis-à-vis Hong Kong. US-China relations regarding Hong Kong likely will continue to erode, including in light of the Hong Kong police recently issuing an arrest warrant of a US citizen for suspected violations of China's National Security Law. For further guidance on export controls or sanctions regarding Hong Kong, please contact the authors who are part of Arnold & Porter's national security practice group and focus on sanctions and export compliance.

© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This blog post is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.