New U.S. sanctions add uncertainty for global banks looking to tap China market

Finance

Aerial view of Lujiazui Financial District at dusk, Pudong, Shanghai, China.

Fei Yang | Moment | Getty Images

U.S. sanctions on Hong Kong leader Carrie Lam raises uncertainty for international banks that were looking at a historic opening of the Chinese financial market.

The U.S. Treasury announced Friday sanctions on the semi-autonomous region’s chief executive and 10 other government-related individuals for “undermining Hong Kong’s autonomy” and restricting freedom of expression. The decision generally prohibits the targeted individuals from accessing their U.S. assets and transacting with U.S. persons, including provision of funds.

“It is at the very least awkward for US and foreign banks wanting to take advantage of market opening in China,” Michael Hirson, practice head, China and Northeast Asia, at consulting firm Eurasia Group, said in an email to CNBC on Monday.

He expects that while the Chinese government will not retaliate against the foreign banks, they will fall under greater pressure from the U.S.

“Banks that don’t comply with these sanctions risk losing access to the US financial system, which is of course an existential threat,” Hirson said.

In response, China on Monday sanctioned 11 American citizens including lawmakers such as Senators Ted Cruz, Marco Rubio and Tom Cotton. It was not immediately clear what the sanctions entailed.

The massive U.S. financial system had assets of about $100 trillion as of the end of 2019, according to the International Monetary Fund. About 22% of those assets were in the banking system, the fund said.

It’s not clear how large China’s financial system overall is. However, Chinese banking institutions had assets of 285 trillion yuan ($40.7 trillion) at the end of September 2019, according to state reports.

China’s stock and bond markets are among the largest in the world. But the mainland financial industry is generally in the early stages of development, presenting both risks and significant growth opportunities.

After decades of keeping the mainland financial market relatively closed to foreigners, the central Chinese government began to roll back restrictions on investment and ownership in the last two years. Many European, Japanese and American financial firms have responded with plans to expand in the Chinese market, although some say years of policy restrictions have given local players an unfair advantage.

The U.S. sanctions are intended to force major multinational corporations, foreign banks and U.S. allies to choose between China and the U.S., said Shen Yamei, deputy director and associate research fellow at state-backed think tank China Institute of International Studies’ department for American studies. That’s according to a CNBC translation of her Chinese-language remarks in an email Monday.

Theoretically, major banks’ cooperation with U.S. banks may be cut off, potentially restricting U.S. dollar transactions, she said, noting the sanctions ultimately undermine the fairness of the international business environment.

“(In taking countermeasures), China will not choose the method of sacrificing its own interests and the overall reform and opening up, but will promote reform and opening up, according to its own plan. This is the established policy (direction),” Shen said.

Changes under new security law 

The latest U.S. sanctions come after Beijing enacted a new security law following protests that erupted in Hong Kong last year over a controversial extradition bill turned into violent clashes with local police, all under Lam’s watch.  

“I was surprised that Mrs. Lam was included in the sanctions, and it seems to be intended to be a strong signal,” Kurt Tong, former U.S. consul general to Hong Kong, said in an email Monday. “I imagine that her decision to postpone the Legislative Council election (to next year) was a big part of the decision to include her,” said Tong, now a partner at The Asia Group, a business advisory group.

Hong Kong and Beijing have so far focused their authorities under the national security law on protesters and politicians and have so far demurred on targeting foreign businesses, given the danger of causing an exodus of foreign firms, but may retaliate in softer ways such as loss of business.

Michael Hirson

Eurasia Group

Hong Kong, a former British colony that returned to Chinese rule in 1997, has a separate legal and economic system from the mainland under the “one country, two systems” principle of government. The central government in Beijing strengthened its control of Hong Kong in late June when it passed a national security law that can bypass regional authorities. Local police arrested outspoken media tycoon Jimmy Lai on Monday in the most high-profile implementation of the law to date.

Hong Kong’s national security law contains provisions that seem to make the imposition of such sanctions illegal, placing banks at legal risk within the territory,” Eurasia Group’s Hirson and his team said in a note Friday.

“Hong Kong and Beijing have so far focused their authorities under the national security law on protesters and politicians and have so far demurred on targeting foreign businesses, given the danger of causing an exodus of foreign firms, but may retaliate in softer ways such as loss of business.”  

The Hong Kong Monetary Authority said Saturday that the latest U.S. sanctions had no legal status in the region and there was no obligation for authorized institutions in Hong Kong to comply.

“In any case, ensuring national security is an important matter of principle, with no room for compromise, and no need for concern about the threat of so-called sanctions,” Hong Kong Financial Secretary Paul Chan wrote Sunday in a Chinese-language blog post, according to a CNBC translation.

“(We) only need to be prepared, under the firm support of the country, Hong Kong will certainly become stronger and more competitive,” he said.

Growing U.S.-China rivalry

Hong Kong has attracted businesses from around the world with an operating environment that adheres more closely to international standards than the mainland, while sitting at the entrance to the world’s second-largest economy.

However, Beijing’s tighter control of the region has become one of many points of contention between the U.S. and China as incumbent U.S. President Donald Trump seeks re-election in November.

The latest move by the U.S. only toughens its position against efforts to reduce Hong Kong’s autonomous status, said Scott Kennedy, senior advisor and trustee chair in Chinese Business and Economics, at the Center for Strategic and International Studies in Washington, D.C.

“I wouldn’t be surprised if the US eventually expands similar restrictions to include people outside the Chinese central and Hong Kong government who condone or provide material support to the ending of ‘one country, two systems,'” Kennedy said in an email.

Banks are going to be more cautious in that they’re not going to seek out different kinds of businesses as they were going to before. It’s a pretty clear-cut development that didn’t come out of the blue, so it’s a not big surprise.

John Marrett

The Economist Intelligence Unit

Major international banks UBS and Bank of America had no comments when contacted by CNBC on the implications for business expansion plans in mainland China. J.P. Morgan, Standard Chartered and HSBC did not immediately respond to a request for comment.

Citi said it would not comment on sanctions, but emphasized that the company can draw on its experience of operating in China since 1902 and that its clients in the country include about 70% of the Fortune 500 companies. The bank added it has raised over $10 billion for Chinese clients from global capital markets this year.

Financial institutions in Hong Kong have reportedly already been scrutinizing their operations for potential risks, according to the Financial Times.

“I think a lot of banks … were already seeing this as a risk from what they’ve said already,” John Marrett, Hong Kong-based analyst at The Economist Intelligence Unit, said in a phone interview Monday. “A lot of businesses going back two months or so when they first heard about the actions targeting specifically Hong Kong from the U.S., then they would have thought the biggest risk (was) Carrie Lam.”

“Banks are going to be more cautious in that they’re not going to seek out different kinds of businesses as they were going to before,” he said. “It’s a pretty clear-cut development that didn’t come out of the blue, so it’s a not big surprise.”

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