November 30, 2020
By: Saskia Rietbroek, Executive Director, CSS
U.S. sanctions against China and Hong Kong have been increasing exponentially in recent months. The U.S. is now using economic sanctions and export controls to target certain mainland Chinese companies, including companies with shares listed on major stock exchanges.
Between a variety of Chinese technology companies, including Huawei, being added to Commerce Department’s BIS Entity List and senior members of the Communist Party to Treasury’s SDN list for national security and human rights reasons, doing business with China is becoming an ever-evolving challenge.
As a sanctions professional, it is important to be aware of the four U.S. government agencies that regularly take actions against China with regards to export controls or sanctions against China or Hong Kong, as well as what actions have been taken, and what steps compliance suites can take in order to mitigate exposure to those actions.
The Four U.S. Government Agencies Taking Action
There have been a number of agencies that have taken actions related to China or Hong Kong in recent months.
Department of State
The Directorate of the Defense Trade Controls (DDTC) at the Department of State administers the International Traffic in Arms Regulations (ITAR). Since sanctions as a result of the Tiananmen Square massacre were first imposed in 1990, China is considered a so-called prescribed country under section 126.1 of the ITAR. This means that when it comes to defense articles, China is completely off limits and no U.S. company can export any of these items to China. The EU has similar restrictions.
Department of Commerce
The Bureau of Industry and Security (BIS) within the Department of Commerce administers both the Commerce Control List (CCL), which is a long list of product groups usually requiring a license to export, as well as the Export Administration Regulations’ (EAR) 99 List, which is a list of items not controlled under the U.S. Munitions List or CCL.
BIS also administers the Entity List that contains the names of certain foreign persons – including businesses, research institutions, government and private organizations, individuals, and other types of legal persons – that are subject to specific export license requirements. Under the Trump administration, many Chinese companies – including 150 affiliates of Huawei – were added to the Entity List.
These new beefed up measures against China is a result of the U.S.’ concern of the increased risk of sensitive U.S. items being exported to Hong Kong and then reexported to China, Iran or North Korea. Therefore, in July 2020, BIS issued a final rule amending the EAR, suspending the availability of license exceptions for Hong Kong.
This summer, BIS added further Chinese government entities and companies to the BIS Entity List, for being implicated in human rights abuses in China. Note that the BIS Entity List only prevents U.S. companies from selling components or technologies to Chinese companies without a license, not from purchasing products. In practice, however, major international companies and banks are unlikely to continue doing business with any company named on a BIS List.
Department of Treasury
The Treasury Department houses the Office of Foreign Assets Control (OFAC), which administers several sanctions programs as well as the largest list of designated individuals and entities, namely the SDN list (but also the SSI).
Recently, Treasury has placed multiple individuals and companies on its SDN list, including Carrie Lam, Chief Executive, Hong Kong Special Administrative Region,
for undermining Hong Kong’s autonomy and restricting the freedom of expression or assembly of the citizens of Hong Kong, or in connection with serious rights abuses against ethnic minorities in the Xinjiang region.
Unless authorized by a general or specific license issued by OFAC or otherwise exempt, OFAC’s regulations generally prohibit all transactions by U.S. persons or within (or transiting) the U.S. that involve any property or interests in property of designated or otherwise blocked persons. These prohibitions include the making/receipt of any contribution or provision of funds, goods, or services by, to, or for the benefit of any blocked person.
Department of Homeland Security
Within the Department of Homeland Security sits the U.S. Customs and Border Protection (CBP). This agency enforces the laws at the ports of entry into the U.S. They have jurisdiction to enforce sanctions and EAR-related issues by seizing or detaining goods that are being exported from the U.S. and may be going to a prohibited country. In fact, CBP has staff located in large express couriers and international mail facilities, where they are reviewing shipments that may be ending up in a sanctioned country.
Lately, there has been an increase in so called “withhold release orders” by CBP of goods that are going to or coming from China. These orders allow CBP to detain shipments based on suspicion of forced-labor involvement under U.S. laws to combat human trafficking, child labor and other human rights abuses.
According to CBP, in 2020, customs agents issued an unprecedented 13 Withhold Release Orders, of which eight related to goods from China.
12 Key Developments in relation to China
Recent developments, such as the Xinjiang human rights situation and China’s new national security law for Hong Kong, have caused new U.S. sanctions and restrictions to be imposed on China.
The following provides a timeline and brief overview of these developments.
|May 19, 2020||Additions to the Entity List||Department of Commerce||BIS added Huawei and 114 of its subsidiaries to the Entity List.|
|June 17, 2020||Uyghur Human Rights Policy Act of 2020||Congress||Sanctions, including blocking sanctions and travel ban, on persons, including Chinese government officials responsible for certain human rights violations against Muslim minority groups in China or elsewhere.
|July 1, 2020||Xinjiang Supply Chain Business Advisory||Department of State / Treasury / Commerce / Homeland Security||Guidance on supply chain risks related to suppliers that may engage in human rights abuses, such as the use of forced labor.
|July 14, 2020||Hong Kong Autonomy Act||Congress||Provides for mandatory sanctions against individuals, entities and financial institutions in response to China’s National Security Law for Hong Kong.
|July 14, 2020||EO 13936||President||Authorizes the imposition of blocking sanctions by Treasury against parties that engage in practices that undermine the democracy in Hong Kong.
The EO also requires other agencies, including Department of Commerce to take steps, including revoking of license exceptions for exports to Hong Kong.
|July 20, 2020||Additions to the Entity List||Department of Commerce||BIS adds 11 Chinese companies to the Entity List implicated in human rights violations and abuses.
|July 31, 2020||Additions to the SDN List||Department of Treasury||Xinjiang Production and Construction Corps (XPCC) was added under Magnitsky Program. This blocking program applies only to “U.S. persons”.
|July 31, 2020||Suspension of licensing exceptions for Hong Kong||Department of Commerce||BIS issued a final rule amending the EAR, suspending the availability of license exceptions for Hong Kong.|
|August 7, 2020||Additions to the SDN List||Department of Treasury||11 individuals designated for undermining Hong Kong’s autonomy and restricting the freedom of expression or assembly of the citizens of Hong Kong.
|September 14, 2020||Five Withold Release Orders||Department of Homeland Security||CBP expands a ban on certain imports from the Xinjiang Uyghur Autonomous Region in China|
|October 14, 2020||Release of Hong Kong Autonomy Act Report||Department of State||Report to Congress identifying foreign persons who are materially contributing to, have materially contributed to, or attempt to materially contribute to the failure of the People’s Republic of China (PRC) to meet its obligations under the Sino-British Joint Declaration or Hong Kong’s Basic Law.
Note that the persons on this report were already designated by OFAC under EO 13936.
|October 14, 2020||FAQ updates||Department of Treasury||In FAQ 848, 849, 850 and 851, OFAC explains sanctions implications of Secretary of State’s October 14, 2020 report to Congress pursuant to section 5(a) of the Hong Kong Automony Act
Five Compliance Steps That Can be Taken
In light of the above developments, there are several ways that compliance suites can mitigate the exposure to these new restrictions.
- Assess Your Exposure in the Xinjiang Region
The Xinjiang Advisory provides useful tips on assessing risk within your supply chain and cautions businesses about the risks of transacting with companies that may engage in human rights abuses, including forced labor, within the Xinjiang Uyghur Autonomous Region (Xinjiang) and elsewhere in China.
The Supply Chain Advisory mentions three primary types of supply chain exposure for entities engaged in human rights abuses, including:
- Assisting in developing surveillance tools for the PRC government in Xinjiang.
- Relying on labor or goods sourced in Xinjiang, or from factories elsewhere in China implicated in forced labor.
- Aiding in the construction of facilities used to detain Muslim minority groups, and/or in the construction of manufacturing facilities that are in close proximity to camps operated by businesses accepting subsidies from the Chinese government to subject minority groups to forced labor.
Corporations and financial institutions should consider assessing their exposure to businesses in the Xinjiang area and update their risk assessments accordingly.
- Check the Relevant Lists and Don’t Forget about Beneficial Owners
Following Congress’ enactment of the Hong Kong Autonomy Act, as well as the President’s issuance of E.O. 13936, OFAC, BIS, and DDTC have added a number of individuals and entitles to their Lists. It is imperative that proper checks are done to prevent transacting with the individuals on these lists (and any other relevant lists). This can also sometimes include any companies that own a designated company by 50% or more.
For example, in July 2020, Treasury added Xinjiang Production and Construction Corps (XPCC), a Chinese government entity and four current or former government officials to the SDN List in connection with serious rights abuses against ethnic minorities in the Xinjiang region. This designation of XPCC can create challenges from a due diligence perspective because XPCC Corps has a complex structure with thousands of affiliates. Under OFAC’s 50% Rule, due diligence is key in identifying any entity that is owned 50% or more by XPCC Corps. This may not always be immediately apparent nor easy to determine.
To add to the confusion, BIS does not use the 50% Rule. However, persons that export, reexport or transfer items subject to the EAR should take extra due diligence steps to ensure that the items are not ultimately destined for the listed entity, and also that the affiliate is a separate legal entity (as opposed to a branch or operating division of the listed entity).
Compliance suites should always make sure they know the corporate structure of the entity they are dealing with, on which list the entitiy is designated, and act to mitigate risks accordingly.
- For Name Screening: Convert from Chinese to English and Viceversa
In addition to English, OFAC will sometimes list the names of Chinese companies and persons in Mandarin or other Chinese characters. This can be a challenge to compliance efforts as using tools like Pinion to convert Chinese to English or vice versa it is not always an exact science.
In October 2020, ACSS poll showed that 72% of the participants did not incorporate non-English characters, such as Mandarin at all in their screening programs. This is an essentials step in order to identify key designated individuals/entities in China.
- Adjust Your Compliance Programs Fast
The Hong Kong Autonomy Act, or HKAA, authorized the use of sanctions against individuals, entities, and financial institutions in response to China’s new national security law for Hong Kong.
The HKAA mandates that, within 90 days, the Department of State must provide a Report to Congress identifying ‘foreign persons’ that have materially contributed to the erosion of Hong Kong’s autonomy. The Report was issued in October 2020 and identified 10 persons.
Though all of these persons had all already been designated by OFAC, this Report underscores the need for companies and financial institutions doing business in Hong Kong and China to be able to adjust their compliance programs quickly in order to ensure they can address such rapidly evolving events.
- Foreign financial Institutions: Watch Out for One More HKAA Report to Come by December 10, 2020
The inclusion of individuals in Section 5 of the HKAA Report has direct implications for foreign financial institutions to the extent that they could be identified as engaging in “significant transactions” with such persons.
This is because the HKAA also requires the Secretary of the Treasury, in consultation with the Secretary of State, to submit another report to Congress 30–60 days (so by December 10, 2020) after the Section 5(a) Report. This next report will identify any foreign financial institution (FFI) that knowingly conducts a significant transaction with a foreign person identified in the Section 5(a) Report.
Therefore, any foreign financial institution that knowingly conducts a significant transaction with a foreign person named in the Section 5(a) Report is potentially subject to strict secondary sanctions.
Accordingly, with respect to foreign persons in the Section 5(a) Report that also appear on the SDN List, OFAC has updated the SDN List to include the language, “Secondary sanctions risk: pursuant to the Hong Kong Autonomy Act of 2020 – Public Law 116–149.”