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New Trade Reality: Tightened US Export Controls

By Louis Chan, HKTDK Research

The US President signed into law on 14 July 2020 an amended version of the Hong Kong Autonomy Act (H.R.7440) that expands the range of foreign persons in Hong Kong and mainland China potentially subject to sanctions and allows the President to impose sanctions on foreign financial institutions that knowingly conduct significant transactions with any such persons. Separately, the US Department of Commerce (DOC) has suspended regulations affording preferential treatment to Hong Kong over mainland China, including the availability of licence exceptions for items subject to the Export Administration Regulations (EAR).

The Hong Kong Autonomy Act

The US Congress fast‑tracked an amended version of the Hong Kong Autonomy Act (H.R.7440) that requires the US State Department, in consultation with the US Treasury Department, to submit a report to the relevant congressional committees by 12 October 2020 (i.e. 90 days from enactment) on whether any foreign person is materially contributing to, has materially contributed to, or attempts to materially contribute to the failure of the mainland Chinese government to meet its obligations under the Sino-British Joint Declaration or the Hong Kong Basic Law.

The required report must identify the foreign person and provide a clear explanation for why that person was identified, including a description of the activity that resulted in the identification. A foreign person will be deemed to have materially contributed to the failure of the mainland Chinese government to meet its obligations under the Sino-British Joint Declaration or the Hong Kong Basic Law if that person (i) took action that resulted in the inability of the Hong Kong people to enjoy freedom of assembly, speech, press or independent rule of law, or to participate in democratic outcomes; or (ii) otherwise took action that reduced the high degree of autonomy of Hong Kong.

No later than 60 days after submitting the aforementioned report, the US State Department must identify any foreign financial institutions that knowingly conduct a significant transaction with a foreign person identified in the report. Foreign persons and financial institutions may be excluded or removed from the report in instances where the material contribution by the person or the transaction by the financial institution that merited inclusion do not have a significant and lasting negative effect that contravenes mainland China’s obligations under the Sino-British Joint Declaration and the Basic Law, are not likely to be repeated in the future, and have been reversed or otherwise mitigated through positive countermeasures taken by the foreign person or financial institution.

The legislation requires the President to impose sanctions no later than one year after a foreign person is included in the initial report or an update thereof, although such sanctions may be imposed immediately. These sanctions include prohibiting the identified person from acquiring, holding, withholding, using, transferring, withdrawing, transporting or exporting any property that is subject to the US jurisdiction and with respect to which the foreign person has any interest; dealing in or exercising any right, power or privilege with respect to such property; or conducting any transaction involving such property. Additionally, visas may be denied to such foreign persons and they may be excluded from the US.

In the case of foreign financial institutions identified in the report, the President must impose at least five types of sanctions specified in the legislation within one year after the inclusion of the institution in the report, as well as all ten types of sanctions specified in the legislation within two years. These sanctions include:

  1. Prohibiting any US financial institution from making loans or providing credit to the foreign financial institution;
  1. Barring the foreign financial institution from being designated as a primary dealer in US government debt instruments;
  1. Prohibiting the foreign financial institution from serving as an agent of the US government or a repository for US government funds;
  1. Prohibiting any foreign exchange transactions that are subject to US jurisdiction;
  1. Prohibiting any transfers of credit or payments between financial institutions, or by, through or to any financial institution, to the extent that such transfers or payments are subject to US jurisdiction;
  1. Prohibiting the acquisition, holding, withholding, use, transfer, withdrawal, transport, import or export of property subject to US jurisdiction and to which the foreign financial institution has any interest, as well as dealing in or conducting any transaction with respect to such property;
  1. Restricting or prohibiting exports, re-exports and transfers (in-country) of commodities, software and technology subject to US jurisdiction directly or indirectly to the foreign financial institution;
  1. Barring US persons from investing in or purchasing significant amounts of equity or debt instruments of the foreign financial institution;
  1. Excluding from the US corporate officers, principals or controlling shareholders of the foreign financial institution; and
  1. Imposing sanctions on the principal executive officers of the foreign financial institution.

The legislation specifically provides that it does not include the authority or requirement to impose sanctions on the importation of goods. The President would be able to waive the sanctions above for national security reasons unless Congress enacts a disapproval resolution. The President can exercise all authorities provided under sections 203 and 205 of the International Emergency Economic Powers Act (IEEPA) to the extent necessary to carry out the Hong Kong Autonomy Act.

The Hong Kong Autonomy Act builds upon the Hong Kong Human Rights and Democracy Act of 2019, which amended the United States-Hong Kong Policy Act of 1992 to require the US State Department to annually certify whether Hong Kong is sufficiently autonomous from mainland China as to continue to warrant treatment under US law in the same manner as US laws were applied to Hong Kong before 1 July 1997. Among other things, the Hong Kong Human Rights and Democracy Act of 2019 also allows the US President to impose certain sanctions on foreign persons for undermining fundamental freedoms and autonomy in Hong Kong.

Specifically, it requires the President to submit annual reports to the appropriate congressional committees identifying foreign persons responsible for the extrajudicial rendition, arbitrary detention or torture of any person in Hong Kong, or for other gross violations of internationally recognised human rights in Hong Kong. Sanctions that must be imposed on persons identified in this report include (i) blocking and prohibiting under the authority granted by the IEEPA of all transactions in property and interests in property that are in the US, come within the US, or come within the possession or control of a US person; and (ii) ineligibility for US visas, admission or parole, as well as revocation of any current visas.

The Hong Kong Autonomy Act (i) expands the range of foreign persons potentially subject to sanctions, and (ii) allows the President to impose sanctions on foreign financial institutions. The imposition of broad sanctions on violating foreign financial institutions and the cascading uncertainty could have a negative impact on Hong Kong’s financial system, especially if that authority is used aggressively by the President. At the same time, any attempts to restrict access to the US financial system by Hong Kong, mainland Chinese or other foreign financial institutions would likely hurt many US firms and undermine the US financial system.

Hong Kong Autonomy Act Hong Kong Human Rights and Democracy Act
Foreign persons subject to sanctions Persons materially contributing to the failure of the mainland Chinese government to meet its obligations under the Sino-British Joint Declaration or the Hong Kong Basic Law Persons responsible for the extrajudicial rendition, arbitrary detention or torture of any person in HKSAR, or for other gross violations of internationally recognised human rights in Hong Kong
Sanctions that may be imposed on foreign persons Prohibition on transactions involving property falling under US jurisdiction and ineligibility for US visas/admission
Foreign financial institutions subject to sanctions Yes No
Sanctions that may be imposed on foreign financial institutions Ten types of sanctions Not applicable

Suspension of US Export Licence Exceptions

Effective 30 June 2020, the US DOC suspended regulations affording preferential treatment to Hong Kong over mainland China, including the availability of licence exceptions for items subject to the EAR. As a result, no items subject to the EAR may be exported to Hong Kong, re‑exported to Hong Kong or transferred within Hong Kong based on an authorisation provided by a licence exception, except for transactions that would otherwise be eligible for a licence exception if exported to mainland China. Instead, a licence must be sought and obtained whenever a licence requirement applies for an export to, a re‑export to, or a transfer within Hong Kong.

However, shipments of items that have been removed from eligibility for a licence exception as a result of this action and were on dock for loading, on lighter, laden aboard an exporting or transferring carrier, or en route aboard a carrier to a port of export or re‑export on 30 June 2020 pursuant to actual orders for export to Hong Kong, re‑export to Hong Kong or transfer within Hong Kong may proceed to their destination under the previous licence exception eligibility.

Similarly, deemed export/re‑export transactions involving Hong Kong persons authorised under a licence exception eligibility prior to 30 June 2020 may continue to be authorised under such provision until 28 August 2020, after which such transactions will require a licence. Exporters, re‑exporters or transferors (in‑country) availing themselves of this 60‑day grandfathering clause must maintain documentation demonstrating that the Hong Kong recipient was hired and provided access to technology eligible for Hong Kong under part 740 (the licence exception provision) prior to 30 June 2020.

A licence exception is a general authorisation to export or re‑export certain items without a licence under stated conditions. There are certain limited circumstances in which a licence exception may be available for export to Hong Kong or for re‑export from Hong Kong to mainland China, based on a number of factors, including the Export Control Classification Number (ECCN), the end‑user and the end‑use. As a result of the DOC’s action, the following licence exceptions will no longer be available for exports to Hong Kong.

Technology and Software under Restriction (TSR) It permits exports and re-exports of technology and software where the Commerce Country Chart (Supplement No. 1 to part 738 of the EAR) indicates a licence requirement to the ultimate destination for national security reasons only and identified by “TSR – Yes” in entries on the Commerce Control List (CCL), provided the software or technology is destined to Country Group B. A written assurance is required from the consignee before exporting or re-exporting under this licence exception.
Technology and Software Unrestricted (TSU) It authorises exports and re-exports of operation technology and software, sales technology and software, software updates (bug fixes), “mass market” software subject to the General Software Note, and release of technology and source code in the US by US universities to their bona fide and full-time regular employees. Encryption software subject to the EAR is not subject to the General Software Note.
Computers (APP) It authorises exports, re-exports and transfers (in-country) of computers, including electronic assemblies and specially designed components therefor controlled by ECCN 4A003, exported or re-exported separately or as part of a system for consumption in Computer Tier countries. APP also authorises exports of technology and software controlled by ECCNs 4D001 and 4E001 specially designed or modified for the development, production or use of computers, including electronic assemblies and specially designed components therefor classified in ECCN 4A003 to Computer Tier countries (including Hong Kong).
Encryption Commodities, Software and Technology (ENC) It authorises export, re-export and transfer (in-country) of systems, equipment, commodities and components therefor that are classified under ECCNs 5A002, 5B002, equivalent or related software and technology therefor classified under 5D002 or 5E002, and “cryptanalytic items” classified under ECCNs 5A004, 5D002 or 5E002.
Strategic Trade Authorisation (STA) This licence exception authorises exports, re-exports and transfers (in-country), including releases within a single country of software source code and technology to foreign nationals.

Generally speaking, the types of products that will be affected by this new policy include computer chips, encrypted items and dual‑use technology (i.e., technology that has both civilian and military applications). The new export limitations could have an implication on US semiconductor firms, which will now be barred from sending products or sharing certain high‑tech information with Hong Kong.

Separately, the State Department announced that starting 30 June 2020 it would end exports of US‑origin defence equipment to Hong Kong and take steps toward imposing the same restrictions on exports of US defence and dual‑use technologies to Hong Kong as it does for such exports to mainland China.

Recommendations for Hong Kong Companies

EAR violations may be subject to both criminal and administrative penalties. Under the terms of the Export Control Reform Act (ECRA), penalties can include up to 20 years imprisonment, as well as fines of up to US$1 million for every violation. Administrative monetary penalties can be as high as US$300,000 per violation or twice the value of the transaction, whichever is the greater. The maximum, administrative monetary penalty maximum is also adjusted in line with inflation on an annual basis.

Transgressors may also be subject to denial of export privileges, which prohibits them from any participation in any transaction within the remit of the EAR. Furthermore, it is unlawful for other businesses and individuals to participate in any way in an export transaction subject to the EAR in association with a company or individual whose export privileges have been revoked.

To avoid becoming involved in potential violations, companies should consider focusing on a few key factors when assessing US export controls risks. They should screen transaction partners through a private Restricted Party List (RPL) screening service or the web‑based Consolidated Screening List (CSL).

Companies should also review and understand whether their traded items (commodities, software and technology) are subject to US jurisdiction. The EAR regulations include all items in the US, including if the goods are in a US foreign‑trade zone or moving in transit through the US from one country to another.

Furthermore, foreign‑made commodities that incorporate controlled US‑origin commodities, are “bundled” with controlled US origin software, or are commingled with US origin software or foreign‑made technology that is commingled with controlled US‑origin technology are covered as well. Foreign‑made items that are not made in the US or of US origin (e.g., produced, refurbished, assembled or upgraded in the US) may still be subject to the EAR by nature of the de minimis or direct product rules, while for certain controlled products there is no de minimis level.

A non‑US‑made item, for example, may be subject to the EAR when more than 10% or 25% of its value consists of “controlled” US‑origin content (depending on the classification of the exported product) or when the item has been made from US‑origin technology controlled for national security reasons. Items subject to the EAR may not be transferred to prohibited destinations or prohibited end‑users and are subject to end‑use controls.

Since the rules governing export controls with respect to Hong Kong are evolving as the Trump administration and US Congress may continue to propose new measures, Hong Kong companies having close business ties with the US should better manage the risk through explicit contractual allocation of obligations such as the inclusion of termination and exit rights when a counterparty falls victim of export control violations or sanctions.

Meanwhile, companies shall also consider putting in place a robust compliance programme, including screening of employees, contractors, customers, products and transactions, and implementation of compliance safeguards throughout the export life‑cycle, including for product development, jurisdiction, classification, sales, license decisions, supply chain management, servicing channels and post‑shipment activity.

To minimise compliance gaps, companies, aside from adherence to record‑keeping requirements, should conduct regular compliance monitoring and periodic audits and assessments, while devising contingency plans, especially when making key business decisions such as merger and acquisition.

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