“No More Special Treatment”: The Likely Legal Effects of Hong Kong’s Loss of Preferred Trading Status with the United States

On May 29, standing in the White House Rose Garden, President Trump announced plans to withdraw certain U.S. “policy exemptions that give Hong Kong different and special treatment.” One month later, on June 30, as expected, the People’s Republic of China (“PRC”) National People’s Congress unanimously passed national security legislation designed to suppress subversion, secession, terrorism, and other acts that purport to threaten Hong Kong’s security. Both announcements were scarce on details, but the new PRC national security law and the U.S. response to it could dramatically impact the legal terms of the U.S.-Hong Kong relationship.

Three potential changes stand out: (1) Termination of the U.S.-HK extradition treaty; (2) Extension to Hong Kong of a broad range of U.S. export controls previously reserved for the PRC; and (3) Emergence of trade and commercial disputes arising from rescission of Hong Kong’s preferential status. Hong Kong-based companies and individuals with regular commercial connections to the U.S. should brace themselves for a significantly altered legal landscape. No longer treated as distinct from their PRC-based counterparts, Hong Kong-based entities will be increasingly subject to the effects of U.S.-China political developments, especially U.S. regulatory and enforcement responses. Much like PRC-based entities, Hong Kong-based operations must learn to anticipate, prepare, and pivot to satisfy both U.S. and PRC legal requirements.

Potential Termination of U.S.-HK Extradition Treaty

In December 1996, the U.S. and Hong Kong signed the Agreement for the Surrender of Fugitive Offenders (Treaty Document 105-3), which obligates both signatories to turn over fugitives upon a request from the other (Article 1). Although the laws of the two often differ on the elements of a particular crime, the treaty calls for handover when the alleged conduct is generally considered to be criminal in both jurisdictions (Article 2). However, the treaty exempts PRC nationals from extradition where “[t]he requested surrender relates to the defence, foreign affairs or essential public interest or policy” of the PRC (Article 3).

The 1996 Agreement reflects the historically close working relationship between Hong Kong and the U.S. on extradition issues. And these favourable terms extend to other areas of bilateral law enforcement cooperation. For example, the U.S. Department of State’s 2003 U.S.-Hong Kong Policy Act Report noted that “[l]aw enforcement cooperation remained a central pillar of U.S.-Hong Kong relations” and that agreements on extradition, prisoner transfer, and mutual legal assistance “all continued to function smoothly in most instances.” The 2015 and 2016 reports described the U.S.-HK law enforcement relationship as “robust” and “on par with many of our closest allies.” Nonetheless, more recent reports also include comments about Hong Kong’s slowly eroding autonomy in matters of mutual legal assistance. Most notably, the legal requirement for the PRC’s “sovereign assent” has “hindered” cooperation or even led to outright “denial” in some instances. The 2015 report, for instance, stated that while U.S.-HK bilateral agreements “have generally functioned very well,” Hong Kong “effectively suspended the transfer of American prisoners to the U.S. since November 2012, stating it needed more time to review cases.”

A close review of these reports reveals a marked shift in language, pointing to a slowly deteriorating relationship in bilateral law enforcement cooperation between the two governments. Most significantly, after a ten-month effort to extradite computer hacker and Macau resident Iat Hong failed in October 2017, the State Department indicated in its 2018 Hong Kong Policy Act Report that this proceeding was the first instance where Hong Kong denied an extradition request. The State Department claimed that the refusal came “at the behest of the [PRC] Central Government” and added that Hong was later released into PRC custody on the basis of a separate PRC criminal action. Since this denial, U.S.-HK law enforcement relations have been on increasingly precarious footing, despite the report’s statement that “Hong Kong generally remains a good partner for fugitive surrender and sharing of evidence in criminal cases.” The latest 2019 report included similar lukewarm language but noted that Hong Kong assisted during the previous year with two fugitives sent to the U.S. for prosecution. 

Now the slow deterioration seems primed to accelerate. In response to the new PRC national security law for Hong Kong, President Trump’s announcement indicated that the U.S. would “begin the process” of revoking 20 years of extradition cooperation between the U.S. and Hong Kong. The implications of this slippage in relations – from “a central pillar” to merely “robust,” then to “generally a good partner,” and now possibly a complete revocation – are dramatic.

First, it shrinks the threat of extradition from Hong Kong to the U.S. for crimes like fraud, international money laundering, transport of stolen property, and a variety of trade and customs law violations, amongst many others. This change could potentially lead certain types of fugitives sought by the U.S. to view Hong Kong as a safe haven free from the reach of U.S. criminal laws and government authorities.

Second, the deterioration may eliminate future cross-border law enforcement cooperation, including MLAT (mutual legal assistance treaty) requests. For example, the treaty on Mutual Legal Assistance in Criminal Matters could very well be revoked or significantly modified, potentially mirroring the changes to the extradition treaty that are now expected. Consequently, not only is the threat of extradition reduced, but the U.S. ability to investigate transnational crime is also likely to be significantly diminished.

Third, as a secondary effect of treaty rescission, companies and individuals operating in Hong Kong may experience a lack of regulatory clarity as well as communication due to predicted reductions in information sharing between the Hong Kong and the U.S. authorities. These entities will face difficulties in understanding what laws they could be exposed to, and in some situations might even be reduced to guessing.

Another potential implication of treaty rescission is the increased use of Hong Kong by PRC officials and executives as a favourable, currently, control-free jurisdiction for parking assets and building operations outside the reach of the U.S. Granted, PRC officials and executives already frequently use Hong Kong for these purposes; however, if the potential for extradition comes off the table, then these individuals may be even more emboldened to partake in activities that the U.S. deems unfavourable to its interests.

Weakened U.S. law enforcement and investigation strength in Hong Kong has great geopolitical consequence not only for Hong Kong, but across the Asia-Pacific region, given Hong Kong’s role as a hub for regional businesses, banking transactions, international commerce, and information technology service providers. For example, recently Google, Facebook, Twitter, and other technology companies reported that they will no longer comply with data extraction requests from Hong Kong law enforcement authorities. Severing this significant tie to with Hong Kong may appear to be a natural and instinctive U.S. response to the new PRC-imposed Hong Kong national security law, but it will diminish U.S. influence in the region and ironically is likely to be viewed favourably by the PRC government. Moreover, Hong Kong will likely find its Western base of allies reduced as well: On July 3, Canada became the first country to suspend its extradition treaty with Hong Kong. If trends continue as projected, Hong Kong will find itself even more isolated from the Western countries that its system of governance was designed to emulate, and increasingly subject to PRC influences and PRC-directed outcomes.

Extension of Export Controls on “Dual-Use” Technologies

The U.S. Commerce Department’s Bureau of Industry and Security (“BIS”) regulates the international trade of U.S.-origin goods, software, and technology through the Export Administration Regulations, including shipments from the U.S. (exports), between foreign countries (re-exports), and within a foreign country (transfers). BIS’s powers are far-reaching:  “U.S.-origin” items are controlled even when sold and re-sold overseas, and include all foreign-made goods with “de minimis” U.S. content (25% or more in most cases), cross-border electronic transmissions (e.g., e-mail and data uploads), samples of products, donations, and lectures/seminars. And it includes exchanges of ideas and information as well, passed along, for example, in seminars for foreign audiences. Generally, the U.S. Department of State controls strictly military/defence items under the International Trafficking in Arms Regulations (“ITAR”), while BIS controls dual-use items (those with both military and civilian applications) under its Commerce Control List (“CCL”). Purely non-military consumer, industrial, and commercial goods are categorized as EAR99 items, and are subject to less stringent control than CCL and ITAR items. Every U.S.-origin product is categorized along these lines, and accordingly assigned certain export controls, restrictions, and licensing requirements based on what it is, where it is sent, who will use it, and how it will be used.

Hong Kong has until recently enjoyed preferential trade treatment and not been subject to the relatively strict export controls in place for the PRC as to sensitive and dual-use technologies.  Similarly, Hong Kong, unlike the PRC, had been eligible to receive ITAR-controlled U.S. defence articles. That is now all changing. In his May 29 announcement on Hong Kong, President Trump forecast potential new regulations for Hong Kong as to exports of CCL dual-use technologies. And on June 29, the State Department announced the end of exports to Hong Kong of U.S.-origin defence equipment. The State Department also noted that the U.S. plans to impose on Hong Kong the same restrictions on U.S. defence and dual-use technologies as in the PRC. In addition, BIS announced the suspension of license exceptions and preferential treatment for exports to Hong Kong, effective June 30. In addition to a broad range of new controls expected for Hong Kong, preferential treatment for export licenses will also likely disappear, and Hong Kong license applications will likely face the much more stringent “presumption of denial”, a standard commonly applied to PRC-related license applications. 

The policy changes go a long way to eliminating the long-standing “differential treatment” that Hong Kong previously enjoyed, placing it nearly on par with the PRC in terms of U.S. export control policies. As a result, Hong Kong seems to be experiencing a dramatic shift from being a seldom scrutinized export control destination to one that will face the historically and increasingly stringent control standards applied to the PRC. Companies that have CCL or ITAR items in supply chains that touch the PRC—and now Hong Kong as well—must be ever-vigilant to these changes.

This re-alignment comes right as the U.S. further tightens and restricts the controls it applies to the PRC—and now likely for Hong Kong as well—for certain products (especially technology) and for select entities (especially those affiliated with the PRC defence establishment).  But while tougher regulations seem certain, Hong Kong may also face the same stepped-up enforcement actions that the U.S. has used to target PRC entities in recent years. For example, BIS has added numerous PRC companies to the Entity List (mandating no receipt of U.S.-origin goods), the Denied Persons List (no export privileges for senders), and the Unverified List (extra safeguards required). Many of these actions effectively cripple the global operations of the targeted company, and prominent recent examples include use of the Entity List in preventing PRC telecommunications giants ZTE Corp. and Huawei Technologies Co., Ltd. from accessing critical U.S. components. And the U.S. is continuously expanding its enforcement scope, for example, by adding PRC-based companies such as Dahua Technology, Hikvision, and other companies to the Entity List for alleged human rights violations.  The question is, will Hong Kong entities now face the same aggressive pace of U.S. enforcement?

With these radical U.S. regulatory changes and the prospect of a new U.S. enforcement approach to Hong Kong, combined with BIS’s far-reaching and broad discretionary powers, entities doing business in and with Hong Kong should carefully monitor these developments and prepare for this new era in U.S.-Hong Kong trading relationships.

Emergence of Increased Trade and Commercial Disputes

Historically, the U.S. has viewed Hong Kong as a separate commercial and customs hub within the Greater China region. Businesses on both sides of the Pacific have gained much from visa-free travel, Hong Kong’s close proximity to mainland China, as well as the relative ease with which capital and investment can flow across borders (compared with the PRC’s strict capital controls). Moreover, the U.S.-HK relationship currently benefits from a preferential lower tariff rate for exports to the U.S. and a zero tariff rate for imports of U.S. goods. Hong Kong remains exempt from the tariffs that the U.S. imposed on the PRC in 2018, although this exemption has been in a precarious state since President Trump’s recent announcement on Hong Kong. With Hong Kong’s status as a commercial and financial capital in Asia, both the U.S. and Hong Kong have much to lose should subsequent policies threaten their current mutually beneficial relationship.

According to the U.S. Census Bureau, in 2019 the U.S. maintained a $26 billion goods trade surplus with Hong Kong ($31 billion goods surplus in 2018), exporting over $30 billion in goods to Hong Kong. These figures do not include the tremendous two-way volume of financial, travel, and other services benefitting both parties’ economic prosperity (totaling $23.3 billion in 2018, with a U.S. services surplus of $2.3 billion). The U.S. Office of the Trade Representative reported that in 2018, U.S. goods and services trade with Hong Kong totalled $67 billion, with a US $33.4 billion goods and services trade surplus for the U.S. Moreover, with two-way foreign direct investment totalling almost $100 billion, hundreds of businesses and corresponding commercial transactions could experience a significant disruption in the form of legal disputes. The more than 1,300 U.S. companies operating in Hong Kong may consider renegotiating certain material contractual terms; delay or re-adjust potential merger or acquisition plans; or altogether decide to cease operations in Hong Kong and move elsewhere. Some of the hundreds of billions of dollars in assets under management by major U.S. financial firms could feel the impact of the disrupted business environment. Breach of contract disputes and company dissolution/insolvency considerations may potentially emerge in the wake of these policy shifts. Rescission of Hong Kong’s preferential status may disrupt many of these financial outflows while creating an environment ripe for litigation and arbitration due to legal uncertainties and complexities.

Conclusion

If the U.S. decides to completely rescind Hong Kong’s preferential status and effectively treat Hong Kong the same way as it does the PRC, then businesses and individuals operating out of Hong Kong must surely prepare for a significant shift in the legal and regulatory landscape. While formal channels of communication through MLAT and extradition requests may recede, the U.S. possesses numerous tools, including export controls, to impact operators in Hong Kong, even if they are no longer within the reach of U.S. criminal or civil actions. Risks posed by this shift are not just regulatory, but also include the rise of private, commercial disputes that will likely increase the cost of doing business in Hong Kong.

To prepare for these potential changes, entities in Hong Kong should perform a comprehensive review of business practices and assets from a U.S. regulatory perspective. Businesses should get ahead of regulatory issues by developing/refining compliance programs, determining what, if any, products could be subject to BIS Export Administration Regulations and other far-reaching rules, and ensuring that business partners remain compliant with U.S. regulations. High-risk businesses, such as those dealing with military supplies, dual-use items, or “emerging or foundational technologies,” should formulate robust contingency plans that include how to comply with potential license requirements; how to respond to BIS inquiries about existing practices; and how to diversify their supplier base.

Should the U.S. government impose export controls or other stringent sanctions, businesses must retain experienced outside counsel immediately to avoid the crippling effects of these legal actions, which can last for extended periods of time, and sometimes threaten the ongoing viability of business altogether. Regarding private, commercial implications, operators in Hong Kong should anticipate how commercial dealings (contracts, merger discussions, joint venture agreements, etc.) might be affected as well as what legal risks might most affect their bottom lines. Again, to avoid drawn-out disruptions to business, quick action and experienced outside counsel should be at top of mind.

Regardless of the specific consequences of the U.S. government’s policy shift, there is little doubt that we are entering a new – and more stringent – chapter for trade relations between the “Fragrant Harbor” and the U.S.

Partner, Kobre & Kim

A former U.S. Department of Justice (DOJ) prosecutor, Wade Weems counsels corporations and individuals with Asia ties in cross-border criminal cases and internal investigations stemming from U.S. government enforcement actions, particularly those alleging bribery or Foreign Corrupt Practices Act violations, theft, fraud and money laundering. Mr. Weems also advocates for clients affected by export control restrictions and sanctions issued by the U.S. Department of Treasury’s Office of Foreign Assets Control (OFAC) and the U.S. Department of Commerce.

Before joining Kobre & Kim, Mr. Weems was a prosecutor and trial lawyer with the DOJ in the National Security Division in the Counterintelligence and Export Control Section, where he handled highly sensitive national security cases involving economic espionage and trade secret theft, export control violations and violations of U.S. economic sanctions regimes.

Partner, Kobre & Kim 

John Han is admitted as a Solicitor Advocate in Hong Kong, in the United States, and in the Dubai International Financial Centre Courts. He is an accomplished litigator and advocate who helps clients achieve business objectives in matters involving Greater China, the U.S., and English common law jurisdictions including the British Virgin Islands. Clients rely on his deep regional business knowledge and bilingual language capabilities.

Mr. Han has acted as lead counsel in a wide range of cross-border disputes involving monetization and demonetization of US $100M+ judgments and arbitration awards both against and on behalf of governments, state-owned enterprises, and multinational corporations. The matters often involve fraud or misconduct. He regularly leads large-scale cross-border matters to monetize substantial defaulted PRC loan and guarantee portfolios where assets are concealed through complex offshore structures, trusts, and foundations, and where debtors and decision-makers are found in Europe, EMEA, and the U.S

Kobre & Kim

Tsering Jan Van der Kuijp is a Summer Associate at Kobre & Kim and a law student at Harvard Law School.