SVA Update Number 20 – Impact on US and PRC Sanctions & Internal Security – 22 January 2021

A round of arrests in January 2021, followed swiftly by US sanctions and Chinese counter-measures, has highlighted not only how internal security has returned to Hong Kong, if at a price – but also how political and regulatory risks are rising. In this context, companies must identify, and respond to, vulnerabilities, or suffer the consequences.

A return to stability

A recent round of police action, including an operation on 6 January 2021 that arrested 53 pan-democrat activists, and another on 14 January 2021 targeting those linked to the flight of 12 people by boat into Chinese waters, have debilitated opposition activism, and highlighted how the government is now setting the agenda. This weakening of the opposition promises greater internal security for Hong Kong.

In response, though, the US State Department on 16 January 2021 sanctioned six more individuals for abetting a reduction in Hong Kong’s autonomy, including Tam Yiu-chung, Hong Kong’s representative to the National People’s Congress (“NPC”), China’s parliament, and You Quan, head of the United Front Work Department.

For its part the Chinese government adopted counter-measures, establishing a system of compensation for companies affected, issuing rules that prohibit compliance with US rules, and imposing its own sanctions on Trump administration officials.

All told, this latest round of strictures has made quite clear how much political risks have risen in Hong Kong, and how an escalatory cycle of tit-for-tat sanctions could harm the business climate.

A fragile stability – Key flash points to look out for

For now, the local political and internal security outlook seems increasingly stable, although any Hong Kong government mishandling of some potential flash-points could yet reignite protest.

Opposition activists (some working in the medical sector) are stoking scepticism as to the safety of Chinese-made vaccines. A botched campaign by the Hong Kong government, perhaps prioritising Chinese products or being seen as incompetent in procurement of foreign vaccines, could easily enrage local people.

Equally, a sudden erosion of judicial standards would stoke anger. Zhang Xiaoming, Vice Chairman of the Hong Kong and Macau Affairs Office, in November 2020 queried the “arcane” nature of Hong Kong’s legal system, and called for reform. Any jarring changes, though, could result in heated protests.

Prominent trials, such as that of media baron Jimmy Lai Chee-ying and barrister Martin Lee, are a further source of potential dissension, particularly if courts impose sentences perceived as unjust. That the chief executive can select judges for such cases will only add to qualms as to the overall system.

Other actions that might provoke future protests include further delays to Legislative Council polls, perhaps coming ahead of broader electoral reforms, or steps to limit the civil rights of British National (Overseas) passports holders, given that as many as three million Hong Kong people are in this category.

Moreover, any return to stability poses its own challenges. After all, desperate radical elements may yet resort to violent attacks, or small scale bombing campaigns, for lack of other options – although the Hong Kong police should be well able to handle any such threat.

A growing burden

Now, Hong Kong’s businesses must not only improvise responses to the impact of the COVID-19, but also adjust to the new restrictions complicating trade.

These sanctions and measures have grown increasingly irksome since 14 July 2020, when Washington ended Hong Kong’s preferential trading access to the US market, and adopted the Hong Kong Autonomy Act, which obliges the imposition of restrictions on those curtailing the city’s separate status.

Since then, the US State Department has imposed sanctions on 11 officials, including Chief Executive Carrie Lam, on 7 August 2020, and on 14 December 2020 on 14 members of the National People’s Congress (“NPC”) involved in the drafting of the National Security Law.

The US government has also hiked tariffs on Chinese goods, and targeted Chinese technology companies, such as Huawei and Tik Tok. The passage of a Holding Companies Account Act is forcing Chinese businesses listed in the US to comply with local audit requirements, prompting a number to delist.

Finally, Washington is seeking to limit US businesses ties to military linked businesses, naming targets in Executive Orders. Amongst those listed are China Railway Construction Corporation, Xiaomi, and China National Offshore Oil Company (“CNOOC”).

For its part, China is starting to respond in kind.

Rising costs of compliance

Such restrictions mark a clear departure from Hong Kong’s tradition of free and easy trading, and are taking their toll. The New York Stock Exchange in early January 2020 announced plans to delist China Mobile, China Telecom and China Unicom.

In response, fund manager State Street sought to comply with US rules, and announced that the Hong Kong Tracker Fund (“TraHK”) would not include those business. Its decision immediately prompted intense criticism, though, forcing a quick reversal.

Goldman Sachs, Morgan Stanley, and JP Morgan, have also stopped offering warrants and derivative products linked to the three mobile companies, thereby halting trade in about 4% of derivatives in Hong Kong. The MSCI, FTSE Russel and S&P Dow Jones indices announced plans to do the same.

Of course, no single measure has a huge impact. Together, though, these developments point to a trend of growing divergence between the Chinese and US economies, and of heightened political and regulatory risks for Hong Kong, emanating from both Washington and Beijing.

International environment

The international outlook is also worrying. Not only has the COVID pandemic stoked uncertainty, but hopes that President Biden will reset links with China seem misplaced – even if the tone of communication improves.

After all, the main differences between China and the US are structural in nature, resulting from irreconcilable political systems, and China’s growing sway. Trump’s measures against China enjoyed bipartisan support, and will likely stay in place.

Worse, the Biden administration will work more effectively than did Trump with regional allies, such as India, Australia, Japan – and even Taiwan. Its doing so, though, will anger Beijing, threatening another spike in tensions, accentuated perhaps by an incident in the South China Sea, or the Taiwan Straits.

What should businesses do?

Hong Kong is changing. A return to stability is welcome, but levels of political risk are rising in a way unknown to Hong Kong for decades. Businesses should immediately take steps to mitigate risks, such as:

  • Adapting to a changing environment in Hong Kong, with attention to political risks, and reduced operational freedoms. Operating procedures should aim to match those in mainland China.
  • Responding to existing sanctions, and considering the impact of further sanctions on Hong Kong institutions on payment systems and banking operations. Businesses must assume that more restrictions will follow.
  • Assessing a business’ unique political exposure, so as to establish whether it might become a target of political pressure, or attacks, by any party.
  • Establishment of sound communications mechanisms, with inbuilt redundancy, so as to issue clear warnings and advice to staff.
  • Taking account of the risk of violent responses by radical protest elements, with preparation, and drilling, of responses (including evacuation measures), in the event of the discovery of an IED, or a bomb threat.
  • Planning for a further deterioration in Sino-American bilateral ties, which could result in restrictions on executives’ movements or business activities, or other constraints, with attention to whether a business is operating in a sensitive sector.

Examining the vulnerability of business to any rise in tensions in the South China Sea or Taiwan Straits, which might affect the movement of goods and suchlike.

SVA is a specialist risk mitigation, corporate intelligence and risk consulting company. The firm serves financial institutions, private equity funds, corporations, high net-worth individuals and insurance companies and underwriters around the world.

SVA has a dedicated crisis management team which, for our retained clients, stands ready to assist companies during crisis situations. Retained clients pay an annual fee for a 24-hour response capability.

We stand ready to support companies faced with these challenges. Our consultants are available to assist, advise and execute as necessary.