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OFAC sanctions against government officials in Hong Kong spawn compliance ripple effects

Helen Chan  Regulatory Intelligence Expert

Helen Chan  Regulatory Intelligence Expert

Economic sanctions imposed by the U.S. government against senior government officials in Hong Kong could have far-reaching implications for financial institutions in the region.

The names of 11 government officials there, including Hong Kong Chief Executive Carrie Lam, were recently added to the Specially Designated Nationals and Blocked Persons List (SDN List) that is maintained by the U.S. Office of Foreign Assets Control (OFAC). The sanctions are the first to be imposed under a new sanctions regime that was created under President Donald Trump’s Executive Order on Hong Kong Normalization.

U.S. sanctions & enforcement actions

Non-U.S. entities that deal in U.S. instruments of commerce, such as U.S. dollar clearing by banks, could be exposed to secondary sanctions liability for non-compliance with U.S. sanctions laws. Non-U.S. businesses that do not have exposure to U.S. instruments of commerce could still be prosecuted for transacting with sanctioned entities if they conduct business with U.S. companies, employ U.S. citizens, or use goods and services that originate from the United States. As a result, many financial firms — from smaller lenders to private equity firms and international asset managers — have U.S. sanctions compliance programs in place to mitigate secondary sanctions liability.

Banks and investment firms in Hong Kong, along with other businesses, such as online service providers and airlines, potentially have varying degrees of exposure to U.S. sanctions risk.

Indeed, non-U.S. banks are no strangers to prosecution, including:

  • Standard Chartered, which was previously fined US$1.1 billion by U.S. and British authorities for conducting transactions with sanctioned entities and individuals on the SDN List. The bank was accused of illegally moving money on behalf of sanctioned customers through the U.S. financial system. The bank is still under a deferred prosecution agreement with U.S. authorities until 2021.
  • The New York branch of the Bank of China, which was fined US$12.5 million in 2018 for deficiencies in its OFAC compliance requirements. The bank also had to comply with a consent order that imposed ongoing reporting obligations on the firm’s U.S. operations.
  • The Bank of Kunlun, which, in 2012, was barred from access to the U.S. financial system, including clearing U.S. dollars, by the U.S. Treasury Department, for banking with sanctioned Iranian banks. Chinese citizens and companies have also been placed on the SDN List themselves for transacting with sanctioned entities in North Korea.

However, prosecution and imposition of penalties against non-U.S. entities is not always straightforward. Enforcement action can be protracted and costly for both sides. Three Chinese banks have been locked in a lengthy legal battle with the U.S. Department of Justice over allegations that the three banks laundered money for the Foreign Trade Bank in North Korea for many months. Substantial daily fines have been imposed on the banks for failing to comply with subpoenas, but the imposition of the penalties are on hold while the case is on appeal. The ruling is part of a larger sanctions investigation that began in 2017.

Initial guidance from regulators in Hong Kong

Regulators in Hong Kong have issued guidance on the recent sanctions. The Hong Kong Monetary Authority (HKMA) has said that the OFAC sanctions have no legal status in Hong Kong, and there is no obligation, under Hong Kong law, for authorized institutions to comply. The HKMA further reminded authorized institutions of relevant regulatory requirements to treat customers fairly, in the provision of banking services, under Hong Kong law.

Technically, financial institutions in Hong Kong are not exposed to regulatory risk from Hong Kong regulators if they do not comply with OFAC sanctions; however, in practice, many financial firms and businesses are at risk of prosecution by U.S. authorities through links with U.S. entities and instruments of commerce.

Compliance challenges

Further complicating matters is that complying with OFAC sanctions against senior government officials in Hong Kong could prove difficult for businesses.

Technically, asset freezes and other restrictions imposed on SDNs do not apply to their family members. However, compliance scrutiny over SDN designations often does extend to family members and close associates. Banks are required to assess whether an SDN could be the beneficiary of transactions executed by family members, business connections and other close associates. As a result, banks often must decide whether to provide financial services to family members and associates based on an assessment of risk exposure against business value.

Some SDNs in Hong Kong have ties to listed companies that could pose sanctions risks to banks. For example, the spouse of justice secretary Teresa Cheng is the chairman, executive director, and majority shareholder of Analogue Holdings, a listed company in Hong Kong. Earlier this year, Analogue purchased a 51% stake in Transel Elevator & Electric, a New York-based company that describes itself as the largest vertical transportation company serving the New York tristate area.

It is uncertain whether assets affiliated with Cheng, such as investments jointly owned with her spouse through marriage, could be frozen, including bank accounts maintained by Transel, a U.S. company. These restrictions could have additional implications for business operations, ranging from trading in the shares of Analogue to employee payroll functions at Transel. After the sanctions were imposed, Analogue disclosed that it sold shares representing 2% of its interest in Transel to a U.S. citizen who is a substantial shareholder and the current managing partner at Transel. Analogue recently said, in an inside information announcement, that it does not believe that the sanctions imposed on Cheng will “apply” to the group.

Further audits, analysis, and risk assessments over the recently imposed sanctions will likely be carried out by financial institutions and businesses in the region over the next several weeks. In addition to evaluating their exposure to U.S. sanctions risks, firms must also assess potential regulatory risk under a National Security Law that was enacted for Hong Kong in early July.

“Imposing” sanctions on government officials is illegal under the law; however, the text of the legislation is silent on whether complying with regulatory requirements against sanctioned individuals and entities also would fall within the definition of imposition.

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