Background

The latest development in relation to 11 senior Hong Kong and Chinese officials being added to the Specially Designated Nationals And Blocked Persons List (the “SDN List”) as published by the U.S. Office of Foreign Assets Control (the “OFAC”) by the U.S. Department of Treasury has turned the clash of conflicting regimes between local Hong Kong national security-related laws and foreign legislations on Hong Kong-related sanctions from a looming possibility to an immediate timed-bomb for banks and financial institutions with operations in Hong Kong. The wide scope of application of foreign legislations on Hong Kong-related sanctions (most notably, the Hong Kong Autonomy Act 2020 (the “Autonomy Act”) as enacted by the U.S Congress in July 2020), as well as Hong Kong’s own law on national security (most notably, the Law of the People's Republic of China on Safeguarding National Security in the Hong Kong Special Administrative Region (the “National Security Law”)) means that in complying with the provisions of one set of these legislations, banks and financial institutions are likely to be in the jeopardy of breaching the other. Against this background, this article takes the Autonomy Act and the National Security Law as examples  to point out the technical difficulties in meeting the national security requirements of both the Chinese and foreign governments, while providing ways to mitigate the operational and legal risks faced by banks and financial institutions with operations in Hong Kong.

Brief outline of the Autonomy Act and the National Security Law

Autonomy Act

On 2 July 2020, the U.S. Congress passed the Autonomy Act providing for mandatory sanctions against individuals, entities and financial institutions who have materially contributed to China’s failure to comply with the Sino-British Joint Declaration or the Basic Law of Hong Kong. The thorn in the flesh for the financial sector is the possibility of sanctions against banks or financial institutions entering into significant transactions with these individuals and/or entities.

National Security Law

It is an offence under Article 29(4) for any person or organisation to receive instructions from a foreign institution or individual to impose sanctions or blockade on, or engage in other hostile activities against Hong Kong and China. This would suggest that when banks and financial institutions implement sanctions imposed by foreign legislations and governments against these individuals or entities, they might contravene the National Security Law.

Another concern is the prospect of banks and financial institutions being compelled to disclose information concerning their clients by law enforcement bodies of both Hong Kong and other foreign jurisdictions. Generally, banks and financial institutions would not breach their customer confidentiality obligations if any disclosure is required by a valid court order or warrant, such as one under the Securities and Futures Ordinance (Cap. 571). It should be noted that such a power is also found in the Implementation Rules for Article 43 of the National Security Law (the “Implementation Rules”), which supplements the National Security Law in terms of the power by law enforcement bodies in Hong Kong (including the Hong Kong Police Force and the Office for Safeguarding National Security as established by the Central People’s Government of China) to, inter alia, freeze properties and require information to be furnished under the National Security Law. In this relation, just as a bank or financial institution would be required to when faced with a warrant otherwise issued under existing Hong Kong laws and regulations, they would also have no choice but to co-operate when there is a request or court order issued under the Implementation Rules. On the other hand, Article 29 provides that it is an offence to steal, obtain with payment or unlawfully provide state secrets or national security intelligence to a foreign country, foreign entity or individual outside China. This means that where the Hong Kong branch of a global bank or financial institution is compelled by foreign authorities to provide client information which somehow is deemed to be “state secrets” or “national security intelligence” under the National Security Law, it might have committed an offence under Article 29 as well.

Mitigation measures

Demerger

One possible way to mitigate such risks would be to split up the business into different entities based on their geographical location. Consideration should be given to the option of spinning off the Hong Kong retail banking and wealth management divisions into a separate entity, transforming it into a vehicle dedicated to Hong Kong-based clients and severing ties with its headquarters in terms of ownership. Profits and resources sharing then might have to be arranged by way of contracts and memorandum of understandings between the Hong Kong branch and the branches in the rest of the global network of the bank or financial institution. Of course, where the Hong Kong branch fails to implement sanctions imposed by the U.S. government, the U.S. Treasury Department could potentially limit or suspend the Hong Kong branch of the bank from handling U.S. Dollar-denominated transactions, but through this structure the rest of the branches elsewhere could remain unaffected.

Offshoring

Another possible way is to set up the bank in a different country to operate the bank outside its registered jurisdiction and/or the location of its ultimate ownership. The bank can have the company headquartered in an offshore jurisdiction that is politically and economically stable while not subject to the sanctions imposed by foreign legislations and governments or the National Security Law. This keeps the company’s assets away from potential legal issues and maintains privacy in conducting business, although as mentioned above, the U.S. Treasury Department could still potentially limit or suspend the bank’s ability to handling U.S. Dollar-denominated transactions where the bank fails to implement sanctions imposed by the U.S. government.  

Relocation of personnel

While corporate structures can be “ring-fenced”, employees cannot. For bank staff situated within Hong Kong, they could also be at risk of breaching the National Security Law where they, in the course of their employment, take steps to implement sanctions imposed by foreign legislations and governments against, for instance, Hong Kong high officials. It would be hard to expect all employees to take on such a risk. Against this background, where the Hong Kong branch has not yet spun off out of the larger global group of the bank or the financial institutions, it might be prudent to either hire employees outside Hong Kong to handle procedures relating to sanctions imposed by foreign legislations and governments, or relocate key staff responsible for implementing the sanctions to outside Hong Kong.

Account closures

A more minimalist and realistic approach would be closing the accounts of the relevant individuals without freezing funds and assets contained inside. After identifying individuals and/or entities that are at risk of being subject to sanctions imposed by foreign legislations and governments, it is prudent for internal control and compliance departments to:

1.        keep track of the SDN List and other lists outlining individuals designated to be subject to sanctions imposed by foreign legislations and governments, and consideration should also be given to closing bank accounts of those that the bank or financial institution deems to be at risk of being added to the SDN List and other similar list of designated individuals;

2.        consider the general principle of treating all customers equitably, honestly and fairly as set out and required, for example, by the Code of Banking Practice (issued by the Hong Kong Monetary Authority) and identify whether the bank or financial institution should and has a contractual right to close the account or terminate the transaction without penalty; and

3.        review the types of transactions that the bank or financial institution has entered into with the client. While the assets in simple savings account or securities account can be returned to the client within a short timeframe, more complicated transactions such as mortgages or insurance products may have to be handled at an early stage to ensure that the client relationship is terminated properly within the shortest possible time.

Conclusion

Rising geo-political risks have prompted banks and financial institutions with operations in Hong Kong to prepare for the worst. With the mitigation measures suggested above, it is hoped that banks and financial institutions with operations in Hong Kong are able to minimise the impact of the conflicts between foreign legislations on Hong Kong-related sanctions and the National Security Law.