20 January 2021
On 12 November 2020, the president of the United States issued Executive Order 13959 (the Order), which imposed sanctions on a number of Chinese companies, such as China Mobile, China Unicom and CNOOC, for alleged ties with the People’s Liberation Army.
On 11 January 2021, State Street Global Advisors Asia (State Street), a unit of the Boston-based company and the manager of Tracker Fund (TraHK), which is Hong Kong’s largest exchange-traded fund, announced that it would no longer invest in related stocks, which caused heated discussions in the local and international market. However, State Street recently announced that from 14 January it would resume its investment in the sanctioned shares of Hang Seng Index companies. According to the statements of State Street, as per its interpretation of the Order and its internal policies, TraHK and the company are regarded as ‘non-US entities’ and it will continue to manage TraHK with the goal of tracking the performance of Hang Seng Index and make new investments in all Hang Seng Index constituent stocks. State Street also believed that such investments do not violate the relevant administrative orders, but that TraHK is no longer suitable for US investors.
The above-mentioned case of TraHK is only a prominent phenomenon in the situation of continuous tension between China and the United States. This highlights the increasing commercial uncertainty faced by overseas investors due to political risks in the face of strong US sanctions and China’s booming trade and financial markets.
As it happens, on 9 January 2021, China’s Ministry of Commerce (MOFCOM) promulgated the ‘Rules on Counteracting Unjustified Extra-territorial Application of Foreign Legislation and Other Measures’ (hereinafter the ‘Measures’). As the Measures were announced, commentators regarded the formation of this legislation as the legal basis of the Chinese government’s counter-measures against the United States, which has frequently imposed trade sanctions and export restrictions on Chinese enterprises in recent years. This is also the latest move taken by the Chinese government to deal with a series of foreign sanctions or restrictive measures after the MOFCOM announced the Provisions on Unreliable Entity List in September 2020, and the Measures for the Security Review of Foreign Investment jointly issued by the National Development and Reform Commission and the MOFCOM in December last year.
In this article, we will go through the major terms of the Measures and set out some initial comments on the potential implications of the Measures.
1. Background and legislative purpose of the Measures
According to the legal system of US trade control and sanctions, non-US entities with significant transactions in violation of US trade sanctions can still be imposed with additional sanctions, even if there is no US connection point in the relevant transactions, forcing the relevant non-US entities to make a choice between the sanctioned national market and the US market and supply chain services. This is called ‘secondary sanctions’. Since 2018, on the alleged grounds of national security, the US government had imposed several restrictions on Huawei, blocking Huawei’s channel to acquire key technology components from overseas and threatening to weaken Huawei’s competitiveness in the global 5G field. In December 2020, the US government further blacklisted 60 Chinese enterprises, including SMIC International and DJI, prohibiting non-US entities from trading with these enterprises.
Therefore, Article 1 of the Measures stipulates its legislative purpose: ‘to counteract the impact on China caused by unjustified extra-territorial application of foreign legislation and other measures, safeguarding national sovereignty, security and development interests, and protecting the legitimate rights and interests of citizens, legal persons and other organizations of China’.
2. Scope of application
According to Article 2 of the Measures, these ‘secondary sanctions’ are ‘in violation of international law and the basic principles of international relations, unjustifiably prohibits or restricts the citizens, legal persons or other organizations of China from engaging in normal economic, trade and related activities with a third State (or region) or its citizens, legal persons or other organizations’.
It should be noted that ‘Chinese citizens, legal persons or other organizations’ (hereinafter referred to as ‘Chinese entities’) are not defined in the Measures. For example, the wholly-owned companies, representative offices and offices established by foreign companies in China should be in line with the scope of Chinese entities under the Measures.
However, since the Measures only involve ‘third State (or region) or its citizens, legal persons or other organizations’, it means that if the US law prohibits the sale of products to Chinese companies, the Measures will only target non-US companies. For example, the US government has banned high-tech companies from selling chips to China. In such case, as a US company, Qualcomm may not be subject to recourse or punishment for complying with US sanctions. However, once non-US companies such as Sony or TSMC interrupt their transactions with Huawei, Huawei has the obligation to report, and MOFCOM may issue a ban or other measures against, these non-US companies.
3. Reporting obligation and evaluation mechanism
Article 4 of the Measures stipulates the working mechanism for dealing with the unjustified extraterritorial application of foreign laws and measures. The working mechanism is clearly led by the MOFCOM of the State Council, together with the National Development and Reform Commission and other relevant departments. Since the MOFCOM is also responsible for the working mechanism under the provisions on the list of unreliable entities, it can be reasonably foreseen that the interdiction method and the list of unreliable entities may be applied in an interactive manner.
According to Article 5 of the Measures, when Chinese entities encounter foreign laws or measures that prohibit or restrict their normal economic and trade activities, they shall report the relevant situation to the competent department of commerce of the State Council truthfully within 30 days. The relevant reports shall be kept confidential. At the same time, Article 13 of the Measures stipulates that those who fail to report the relevant information truthfully in accordance with the Measures may face the consequences of punishment such as warning, rectification order within a specified time limit and fine. Therefore, when it is uncertain whether the relevant foreign laws or measures prohibit or restrict the normal economic and trade activities, it is safer for the relevant individuals or enterprises to report as soon as possible and submit it to the working mechanism for evaluation and confirmation, so as to avoid punishment due to their own wrong judgment.
Article 6 of the Measures stipulates that the working mechanism shall take the following factors into overall account when assessing and determining whether the reports received involve unjustified extra-territorial application of foreign legislation and other measures: (1) whether international law or the basic principles of international relations are violated; (2) potential impact on China’s national sovereignty, security and development interests; (3) potential impact on the legitimate rights and interests of the citizens, legal persons or other organisations of China; and (4) other factors that shall be taken into account. These provisions are relatively general and should be analysed in specific cases in practice. However, it can be inferred that once the assessment confirms the existence of unjustified extraterritorial application, the relevant foreign laws and measures will generally violate all the above-listed factors.
4. Issue, compliance and exemption of prohibition
Article 7 of the Measures stipulates that where the working mechanism, upon assessment, confirms the existence of unjustified extra-territorial application of foreign legislation and other measures, MOFCOM will issue a prohibition order against recognition, enforcement and compliance with relevant foreign laws and measures. Subject to the actual situation, the working mechanism has the discretion to suspend or withdraw the prohibition order.
Once the prohibition order is issued, it will be enforced immediately. Article 9 of the Measures stipulates that if the parties concerned breach the prohibition order and causes losses to a Chinese citizen, legal person or other organisation, the parties in breach may be liable for civil compensation by Chinese entities whose legitimate rights and interests have been infringed.
At the same time, Article 13 of the Measures also stipulates that MOFCOM or the relevant authority may give a warning, order them to rectify within a specified period of time, and may concurrently impose a fine according to the severity of the circumstances.
According to Article 8 of the Measures, a citizen, legal person or other organisation of China may apply to MOFCOM for exemption from compliance with a prohibition order. The applicant shall submit a written application stating the reasons and scope of the application for exemption. MOFCOM should make a decision on whether to approve or not within 30 days from the date of acceptance of the application, and make timely decisions in case of emergency.
5. Civil recovery and state support
According to Article 9 of the Measures, if the legitimate rights and interests of Chinese entities are infringed due to the party's compliance with foreign laws and measures within the scope of the prohibition order, or the judgment or ruling made according to foreign laws within the scope of the injunction, the party concerned may file a lawsuit to the Chinese court to require the relevant parties to compensate for the losses.
At the same time, Articles 11 and 12 of the Measures also provide protections from the national level, including (1) the Chinese government can provide relevant support to Chinese entities that suffer significant losses due to non-compliance with the relevant foreign laws and measures, in adherence to the prohibition order; and (2) the Chinese government may take necessary counter-measures based on actual circumstances and needs.
The Measures did not clarify what the so-called ‘relevant supports’ specifically include. Based on previous experience when Chinese enterprises were subject to the US’s sanctions and bans, the supports from the Chinese government mainly included fiscal and tax policies, industrial support, expanding import and export channels and financial support.
6. Conclusion
Article 3 of the Measures stipulates that the Chinese government pursues an independent foreign policy, adheres to the basic principles of international relations, including mutual respect for sovereignty, non-interference in each other’s internal affairs, and equality and mutual benefit, abides by the international treaties and agreements to which China is a party, and fulfils its international obligations. Article 15 further clearly states that these Measures shall not apply to the extraterritorial application of foreign laws and measures stipulated in international treaties and agreements concluded or acceded to by China. These provisions are in line with China’s public commitment to maintain the international economic and trade order.
The purposes of the Measures are, as per Articles 1 and 2 of the Measures, only to counteract the improper extraterritorial application of foreign laws and measures and effectively protect the legitimate rights and interests of Chinese entities. However, whether the measures can effectively resist the supervision and sanctions of the United States or other countries on Chinese entities has yet to be tested.
Our expert team in Hill Dickinson Hong Kong is well placed to work with clients to help them understand local challenges, navigate through complexity, and to find commercial solutions that deliver a competitive advantage for the clients. Please reach out to us if you require any guidance.
For further information, please contact:
Edward Liu , Legal Director, Hill Dickinson Hong Kong
