Insights and Analysis

U.S. government releases expected report on Hong Kong sanctions

Image
Image

On October 14, 2020, the State Department released an expected report identifying Hong Kong and Chinese persons who the U.S. government considers to have undermined Hong Kong's autonomy and democracy.  These persons are the same as the previous persons sanctioned by the U.S. Department of Treasury’s Office of Foreign Assets Control (“OFAC”) on August 7, 2020. Separately, OFAC published four new FAQs that provide important clarifications regarding the criteria for imposing “secondary” sanctions (i.e., sanctions that apply to foreign persons when there is no U.S. nexus involved in the transaction,  such as U.S. persons, U.S. items or technology, or the U.S. financial system) on foreign financial institutions for conducting "significant" transactions with persons identified in the State Department report.

In the alert below, we summarize the report and FAQs as well as provide options for risk mitigation and next steps for financial institutions and other businesses potentially affected by U.S. sanctions.

Section 5(a) Report

The U.S. Department of State submitted the report required under Section 5(a) (“Section 5(a) Report”) of the Hong Kong Autonomy Act (“HKAA”) to Congress on October 14, 2020. The Section 5(a) Report identifies ten persons whom the Secretary of State, in consultation with the Secretary of Treasury, considers to have materially contributed to the alleged failure of the Chinese Government to meet its obligations under the Joint Declaration or the Basic Law. The Secretary of State was required to release the report within 90 days of passage of the HKAA.

The ten individuals are the same persons sanctioned on August 7, 2020, under the Executive Order on Hong Kong Normalization (“Executive Order”), signalling that the United States is not ratcheting up pressure on new Hong Kong persons at this time. Only the former Commissioner of the Hong Kong Police was named in the August 7 sanctions but not named in today’s report. No reason was given his omission from the Section 5(a) Report, but he is still subject to sanctions under the Executive Order. Further, the U.S. government can still sanction new persons under the Executive Order or HKAA in the future.

The next action that we expect the U.S. government to take is the submission of the report required under Section 5(b) of the HKAA, which requires the Secretary of the Treasury to submit to Congress a list of Foreign Financial Institutions (“FFIs”) that knowingly conduct “significant” transactions with the foreign persons listed in the Section 5(a) Report within 60 days (December 14, 2020). Any FFI identified could face secondary sanctions that could severely affect their business, including becoming a specially-designated national (“SDN”). However, the President will have a year to determine whether to impose sanctions on any FFI identified in the Section 5(b) Report.

Clarifications of Potential Secondary Sanctions on Foreign Financial Institutions

Separately, OFAC released four new FAQs to clarify the HKAA sanctions, especially with regard to FFIs.

In FAQ 848, OFAC clarified that the sanctions imposed on the ten identified individuals in August under the Executive Order were sufficient to satisfy the sanctions required under the HKAA.  Also, and perhaps most notably, it would not consider transactions  by FFIs with persons identified in the Section 5(a) Report that constitute a good-faith wind down as “significant” for purposes of the future Section 5(b) Report, as long as the winddown transactions occurred within 30 days of identification, or November 14.  Further, the FAQ said OFAC would reach out to an identified financial institution to inquire about its conduct before identifying it in the Section 5(b) Report.

In FAQ 849, OFAC clarified that an FFI might be excluded from any future report or removed from a report even if it had “significant” transactions that merited inclusion in the Section 5(b) Report if the transactions (a) do not have a significant and lasting negative effect that contravenes the obligations of China under the Joint Declaration and the Basic Law; (b) are not likely to be repeated in the future; and (c) have been reversed or otherwise mitigated through positive countermeasures taken by that FFI.  Taken together, this gives OFAC considerable discretion as to whether to identify the FFI in the 5(b) Report or exclude it if the FFI has taken mitigating countermeasures.

In FAQ 850, OFAC provides the factors for what it will consider “significant” for purposes of the HKAA.  These factors, which are similar to OFAC's use of the term “significant” in other secondary sanctions programs, are:

  1. the size, number, and frequency of the transaction(s);
  2. the nature of the transaction(s);
  3. the level of awareness of management and whether the transaction(s) are part of a pattern of conduct;
  4. the nexus between the transaction(s) and a foreign person identified in a report submitted by the Secretary of State under section 5(a) of the HKAA or in updates to that report;
  5. the impact of the transaction(s) on statutory objectives, including whether the transaction(s)
    1. have a significant and lasting negative effect that contravenes the obligations of China under the Joint Declaration and the Basic Law,
    2. are likely to be repeated in the future, and
    3. have been reversed or otherwise mitigated through positive countermeasures taken by that FFI;
  6. whether the transaction(s) involve deceptive practices; and
  7. such other factors that the Secretary of the Treasury deems relevant on a case-by-case basis.

Further, for purposes of section 5(b) of HKAA, a transaction will not be considered “significant” if a U.S. person would not require a specific license from OFAC to conduct or participate in the transaction.

Lastly, in FAQ 851, OFAC defines “knowingly” as “with respect to conduct, a circumstance, or a result, means that a person has actual knowledge of the conduct, the circumstance, or the result.” It also confirms that the term “financial institution” has the same broad definition as in 31 U.S. Code 5312, which encompasses,  inter alia, insured banks, private bankers, credit unions, brokers and dealers, investment banks, currency exchanges, credit card operators, insurance companies, pawnbrokers, travel agencies, wire transfer companies, vehicle sales companies, casinos, and other businesses the Secretary of Treasury determines to be related to, or substitute for, these business activities (a full list is available here).

Next steps

Based on the foregoing, FFIs can consider the following steps to mitigate sanctions risks:

  • Carefully assess any ongoing or future transactions with the 11 individuals identified in the August 7 sanctions;
  • To the extent you have a business relationship with the 11 identified persons, wind down any “significant” transactions with the identified persons by November 14, 2020;
  • Provide tailored sanctions training to your company’s compliance and other relevant professionals;
  • Ensure that your company has an effective sanctions compliance policy and procedures; and
  • Conduct risks assessments for politically-exposed persons who may be identified under the sanctions in the future.

To the extent a FFI has identified potentially “significant” transactions with the identified persons, we suggest the following:

  • Conduct an internal review to determine the nature and extent of the transactions;
  • prepare to cooperate with any inquiries from OFAC regarding transactions with identified persons;
  • to the extent necessary, consider self-disclosure of any violations to OFAC; and
  • Consider implementing appropriate remediation, including internal controls and other compliance measures.

If you have specific questions about this Hong Kong Autonomy Act or its impact on you and your business, the Hogan Lovells team welcomes the opportunity to discuss it with you further.

Authored by Anthony Capobianco, Brian Curran, Aleksandar Dukic, Ajay Kuntamukkala, Gregory Lisa, Beth Peters, Stephen Propst, Kelly Ann Shaw, Anne Salladin, Roy Zou, Anne Fisher, and Ben Kostrzewa.

View more insights and analysis

Register now to receive personalized content and more!