U.S. Begins Process to Revoke Special Status For Hong Kong

U.S. Begins Process to Revoke Special Status For Hong Kong

Executive Summary

  • On May 29, U.S. President Donald Trump announced that Washington would begin the process of rescinding special privileges granted to Hong Kong in a series of initiatives aimed at punishing China over its tightening grip of the territory. This followed an earlier U.S. State Department certification that Hong Kong was no longer autonomous from China to warrant being treated as a separate territory on economic and trade matters under the U.S.-Hong Kong Policy Act (USHKPA).
  • While specific details have yet to be unveiled, the measures could, if enacted, impact a full range of U.S.-Hong Kong agreements that would include the revocation of preferential treatment for Hong Kong as a separate customs and travel territory from Mainland China, export controls, extradition, and immigration with few exceptions. 
  • Under the U.S.’ current treatment of export controls, Hong Kong is permitted to receive controlled ‘sensitive’ U.S. strategic and dual-use technology sold via direct commercial sales through a U.S. licensing process that Chinese entities are not eligible for. Should the revocation be enacted though, the export of sensitive U.S. technologies to Hong Kong would likely come under greater scrutiny of their dual-use applications by U.S. authorities. 
  • The revocation is expected to result in additional Section 301 U.S. tariffs as well as anti-dumping and countervailing duties imposed on Chinese products being extended to goods produced in Hong Kong. However, the impact is likely be more limited given Hong Kong’s role primarily as a re-exporting hub and a manufacturing sector that makes up only 2 percent of the overall economy. 
  • The measures could also affect Hong Kong’s role as a major re-exporting hub for China particularly within the context of the trade war. Over the past year and a half, companies have increasingly sought to take advantage of a ‘first-sales rule’ in Hong Kong to mitigate the effect of the additional Section 301 tariffs. However, if its special status were to be removed, Chinese exporters may need to search for alternatives as Hong Kong may no longer be treated as a ‘second leg’ for exports to the U.S. which could affect port, shipping, and logistics industries.
  • Washington’s decision could set a precedent for other countries to re-evaluate whether Hong Kong should continue to warrant special treatment separate from Mainland China. The U.K. and Canada have warned Beijing that they could take retaliatory measures (including re-evaluating Hong Kong’s special status), while the E.U. and Australia have both ruled out the possibility of imposing sanctions against Beijing. 

Background

On May 29, U.S. President Donald Trump announced that Washington would begin the process of rescinding special privileges granted to Hong Kong in a series of initiatives aimed at punishing China over its tightening grip of the territory. While the exact details have yet to be unveiled, the measures could, if enacted, impact a full range of U.S.-Hong Kong agreements, which includes the revocation of preferential treatment for Hong Kong as a separate customs and travel territory from China, export controls, extradition, and immigration with few exceptions.


The announcement followed an earlier U.S. State Department certification that Hong Kong was no longer autonomous from Mainland China to warrant being treated as a separate territory in economic and trade matters. Despite a brief respite due to COVID-19 pandemic, mass pro-democracy demonstrations have broken out again in the territory to protest Beijing’s decision to fast-track a national security bill that would suppress subversion, secession, terrorism, and any activities that could be perceived as foreign interference, which critics fear will severely curtail the civil liberties and freedoms granted to Hong Kong under the ‘One Country, Two Systems’ framework. Beijing denies that Hong Kong’s high degree of autonomy will be threatened, and has already vowed to retaliate against Washington in what will likely come about in a tit-for-tat manner.

The revocation is expected to result in additional Section 301 U.S. tariffs as well as anti-dumping and countervailing duties imposed on Mainland Chinese products being extended to goods produced in Hong Kong, although the impact will be more limited given Hong Kong’s role primarily as a re-exporting hub and a manufacturing sector that makes up a marginal portion of the overall economy. However, Hong Kong is likely to be impacted if the U.S. were to modify its export controls for dual-use technologies that could result in tighter restrictions on such U.S. products. Other possible measures include requirements to change the Certificate of Origin (COO) labeling on goods made in Hong Kong, terminating U.S. recognition of COO and other documents issued by Hong Kong authorities, and the status of Hong Kong-flagged ships and aircrafts.

U.S. – Hong Kong Policy Act: What’s at Stake?

Under the U.S.-Hong Kong Policy Act (USHKPA) of 1992, Washington recognizes Hong Kong as a separate territory when it comes to trade and commerce by law that has shielded it from U.S. tariffs on Chinese goods as part of the trade war. However, Hong Kong’s unique status is contingent upon the territory maintaining sufficient autonomy from China as per the ‘One Country, Two Systems’ framework that was established under the Sino-British Joint Declaration of 1984. Should Hong Kong be deemed to have lost its autonomy, the Policy Act enables the U.S. President to unilaterally rescind Hong Kong’s status through an Executive Order. 

Over the past year, Hong Kong’s special status has increasingly come under threat amid city-wide pro-democracy demonstrations and violent clashes with police that triggered frequent severe roadway disruptions as well as mass flight cancellations and delays after the Hong Kong International Airport (HKIA) was forced to shut down for two days in August. In response to growing unrest, U.S. Congress passed the Human Rights and Democracy Act (HKRDA) in 2019 that mandates that the Secretary of State certify annually that Hong Kong is sufficiently autonomous to justify continued special treatment.

From a commercial standpoint, Hong Kong is a major international trading and logistics hub that plays host to more than 1,300 U.S. companies, of which over 800 are either regional offices or headquarters. According to the U.S. Trade Representative (USTR), bilateral trade between the U.S. and Hong Kong reached USD 66.9 billion (EUR 42.7 billion) in 2018 with Washington enjoying a sizeable trade surplus as exports made up USD 50.1 billion (EUR 44.7 billion) and imports at USD 33.4 billion (EUR 29.8 billion). In terms of logistics, Hong Kong remains one of the busiest air cargo by volume, and continues to rank as one of the world’s top five busiest ports by container volume alongside the ports of Shanghai, Ningbo-Zhoushan, and Shenzhen.

EXPORT CONTROLS 

The most significant aspect of Washington’s potential measures is likely to come in the form of export controls, which could considerably impact existing tech and aviation treaties with Hong Kong as well as the extent to which U.S. technology can be exported to Hong Kong without licensing requirements. Under the USHKPA’s current treatment of export controls, Hong Kong is permitted to receive controlled ‘sensitive’ U.S. strategic and dual-use technology sold via direct commercial sales through a U.S. licensing process that Chinese entities are not eligible for. If the revocation were to be enacted, the export of sensitive U.S. technologies to Hong Kong would likely come under greater scrutiny of their strategic and dual-use applications by U.S. authorities.

In particular, the measures are likely to affect the re-export of Chinese origin-goods incorporating U.S. technology via Hong Kong to other non-U.S. locations and could result in more categories of controlled technology being introduced. These potential developments come as U.S. re-export authorization will be required for certain Hong Kong exports after June 29, 2020 following the U.S. Department of Commerce announcement that it would be eliminating License Exception CIV (civil end-users) from its Export Administration Regulations (EAR) that previously allowed products to move freely. 

The potential export controls on U.S. technology could also endanger Hong Kong’s ambitions to position itself as a leading R&D center within Beijing’s Greater Bay Area blueprint for Southern China. U.S. concerns over intellectual property theft were previously highlighted by a group of prominent U.S. senators after appealing to the Trump administration to take appropriate measures to prevent China from abusing Hong Kong’s special status to steal or acquire critical and sensitive U.S. equipment and technologies.

In terms of retaliatory measures, China may elect to retaliate through its much-reported Unreliable Entities List (UEL) that has already threatened to target certain major U.S. businesses as denied parties or other equivalent measures. The potential measures may include investigations and restrictions on leading U.S. companies operating in the China market such as Apple Inc., Cisco Systems Inc., Qualcomm Inc., as well as the suspension of purchases of Boeing Co. planes.

CUSTOMS AND TARIFF TREATMENT 

If Hong Kong’s status as a separate customs territory were to be rescinded, the potential impact of U.S. Section 301 tariffs being extended to Hong Kong-originating goods is expected to be minimal given that around 95 percent of all exports from Hong Kong are already produced elsewhere. The vast majority of Hong Kong’s exports to the U.S. are produced in China and re-exported through Hong Kong, but these goods are already subject to the same high tariffs as Chinese goods exported directly from China to the U.S. The same could also be said for goods from other countries that are re-exported by Hong Kong to the U.S. as the most-favored nation (MFN) duties would still apply if the products were shipped directly to the U.S. themselves. In addition, there is likely not enough material value-adding processing in Hong Kong that would constitute sufficient grounds for changing the COO to Hong Kong. 

Once a leading manufacturer of light industrial goods (including electronics and retail) several decades ago, Hong Kong is now largely a services-driven economy that consists of logistics and financial services. Manufacturing currently accounts for only 2 percent of Hong Kong’s economy, which is largely focused on custom-made industrial materials (such as electrical equipment and machinery) for the construction industry and food processing for local consumption. Top U.S. export categories to Hong Kong in 2018 includes electrical machinery (USD 11 billion; EUR 9.7 billion), agricultural products (USD 4.0 billion; EUR 3.5 billion), while services exports such as the intellectual property and transport sectors reached an estimated 12.8 billion (EUR 11.3 billion).

IMPACT ON HONG KONG AS A RE-EXPORTING CENTRE

Although manufacturing for Hong Kong-originating goods is relatively limited, the revocation could have an impact on Hong Kong’s role as a major re-exporting hub for China particularly within the context of the ongoing trade war. Over the past year and a half, companies have increasingly sought to take advantage of a ‘first-sales rule’ in Hong Kong that has enabled firms to better mitigate the effect of the additional Section 301 tariffs on Chinese imports.

Under the first-sales rule, exports to the U.S. that go through more than one location can be charged duties based on the price of the initial purchase price. In practice, if a Chinese exporter that sells goods to a Hong Kong re-exporter at a lower price, and then the Hong Kong re-exporter (such as a subsidiary of a Mainland Chinese company based in Hong Kong) sells at a higher price to a U.S. importer, the tariff would be based on the first transaction and results in the tariff being lowered when re-exported via Hong Kong. However, if Hong Kong’s special status were to be removed, Chinese exporters may need to search for alternatives as Hong Kong may no longer be treated as a ‘second leg’ for exports to the U.S. which could affect port, shipping, and logistics industries. According to the Hong Kong Trade and Industry Department, around 8 percent of China’s exports and 6 percent of China’s imports from the U.S. went via Hong Kong in 2018.

Outlook

Washington’s historic decision to begin rescinding Hong Kong’s special status could prove to be more significant within the context of U.S. export control than within the broader trade of goods. Although the announcement remained light on specific details, it could nevertheless raise doubts over Hong Kong’s long-term viability as a leading global transport and trading hub. For instance, Hong Kong may continue to experience greater competition from other Mainland cities, such as Shenzhen, Guangzhou, and Shanghai’s Free Trade Zone (FTZs) which includes the newly-established Lingang New Area, as U.S. companies could decide to relocate more of their business operations or re-export their goods via elsewhere if special trading privileges cannot be retained. 

The revocation could also set a precedent for other countries to re-evaluate whether Hong Kong should continue to warrant special treatment separate from Mainland China, with numerous governments having already issued statements outlining their concern regarding the situation. The U.K. and Canada have warned Beijing that they could take retaliatory measures (including re-evaluating Hong Kong’s special status), while the E.U. and Australia have both ruled out the possibility of imposing sanctions against Beijing. 

While the Trump administration’s measures were not as harsh as initially expected, the latest round of actions have further inflamed tensions between Washington and Beijing yet again. In an early retaliatory move over Hong Kong, the Phase One partial trade agreement has come under further doubt after Chinese officials reportedly ordered some state-owned companies to pause imports of some U.S. soybeans – almost certainly ensuring Beijing will come up short on its purchase commitments while Washington remains preoccupied with containing the COVID-19 crisis. If China were to completely abandon efforts to increase U.S. imports under the Phase One deal, the retaliatory tariff waiver, which has been essential for the supply chains of U.S. multinational firms operating in China since March, could also be jeopardized. 

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