How Will OFAC Change In The Biden Administration With Respect To China-Related Sanctions

As the Biden administration begins, global companies are assessing whether they should shift compliance objectives in the short or long term based on the priorities of a new team. This analysis makes sense, as every administration seeks to put its own stamp on foreign policy issues, and the new Biden administration may try to separate itself from the Trump team in every way.

With respect to China, the final year of the Trump administration was characterized by increased confrontation with China and broad deployment of tools to pursue its policy objectives. Looking forward, the rhetoric may soften and the tweets may cease, but many things will stay the same: the Biden administration will continue to deploy sanctions and export control authorities to compete with China. The effect of these actions could be even greater though, as the new administration will seek to build multilateral support for sanctions and diplomatic initiatives.  

The Biden administration will attempt to reinforce alliances and partners around the world through American soft power. A cornerstone of this strategy will seek to differentiate the United States’ commitment to the rule of law and human rights and will more than likely focus extensively on China’s human rights record in Hong Kong, Xinjiang, and Tibet’s autonomous regions. This also means that sanctions and export controls may be targeted more precisely to consider the interest of U.S. alliance partners.

Reversing sanctions is harder than implementing them and there is bi-partisan support for America to compete with China. As such, at least in the short term, the new administration will continue to use many of the tools and practices implemented during the Trump administration, even if more judiciously. And, because it is always much harder to get off a list than get on, initial designations may linger. It takes more political and administrative capital to roll-back a sanctions program than to implement one.

Although the Biden China strategy will likely involve a broad range of sanctions, involving not only the Office of Foreign Assets Control (OFAC) but also the Department of Commerce’s Bureau of Industry and Security (BIS) and the Defense Department, among others, this column focuses principally on the OFAC sanctions and framework.  

The Biden Administration’s Increased Focus on Human Rights

One area that will likely be expanded in the Biden administration is the focus on human rights. The Trump administration issued some sanctions involving the perpetrators of human rights abuses in Xinjiang and Hong Kong but has chiefly prioritized sanctions against China’s technology and economic sectors. President Biden will certainly make human rights a central part of his strategy to confront China and will likely use the authorities under the Global Magnitsky Act and other congressional legislation to expand designations of Chinese entities. The heightened focus on human rights is apparent through many of his announced appointments and organizational changes, including President Biden’s recent move to elevate the National Security Council position on human rights.

There are several areas in which the Biden administration will or may continue to focus on promoting human rights through sanctions (and other diplomacy initiatives):

·     First, they will almost certainly focus on abuses in Xinjiang and the increasing abuses in Tibet, the latter of which has not been as widely reported in recent months.

·     Second, they will continue to pressure China on its anti-democratic activity in Hong Kong, including the arrest of over 50 lawmakers on January 6, 2021.

·     Finally, there is some possibility that the administration may tie the facilitation of human rights abuses to certain Chinese technology companies and possibly into projects from China’s Belt and Road initiative.  

Human rights-related sanctions will be most effective if they undercut the economic activity that benefits from these abuses. The groundwork has already been laid for this approach – starting in July of 2020, the U.S. government issued an advisory highlighting the potential human rights abuses in Xinjiang. This advisory detailed supply chain risks from Xinjiang and OFAC later designated Xinjiang Production and Construction Corps (XPCC), a Chinese state-owned entity (SOE) that contributes significantly to Xinjiang’s economy and produces up to a tenth of the world’s cotton.

Many experts would not be surprised to see more designations (XPCC has at least 13 publicly traded subsidiaries that are not on an OFAC list at present) and enforcement actions related to companies entangled in these supply chains as a method to raise awareness of these risks. This strategy would be an effective way to generate multilateral support for sanctions against China and the Biden administration is almost certain to capitalize on this opportunity. If firms haven’t already, they should consider their exposure to these regions including whether their supplier’s supplier sources raw materials from Xinjiang.

We also expect that there will be additional sanctions related to Hong Kong, but these may follow the same trend as previous designations – targeted towards certain persons to freeze their assets. Targeted designations present a complex set of challenges for businesses operating locally in Hong Kong, but not a significant risk to businesses elsewhere in the world. However, the Hong Kong Human Rights and Democracy Act (and follow-up legislation) holds open the door that the Biden administration may target Chinese state-owned actors who facilitate human rights abuses in Hong Kong.

Designating Chinese Networks in Support of Other Sanctions Programs

In addition to a focus on human rights, we are likely to see continued sets of sanctions on Chinese networks facilitating Iranian and North Korean trade. For example, OFAC has recently designated large networks of Chinese and Chinese-run offshore companies that have imported Iranian oil and petrochemicals to China. OFAC also designated (although, later de-listed) Cosco Dalian Shipping, a subsidiary of the Chinese SOE Cosco Shipping, for importing Iranian oil.

While these designations were in support of the Iran sanction programs, they mark a newfound willingness by OFAC to designate Chinese entities across different sanctions programs that will likely continue under President Biden. OFAC has previously designated Chinese entities for their direct support of Iranian and North Korean nuclear weapons programs, but OFAC previously avoided placing sanctions against Chinese firms that were openly supporting non-nuclear sanctions activity. These networks have been under-reported but are not new to trading with Iran and North Korea. They may also be expanded by the new administration as OFAC discovers new parties and trade routes.

Financial institutions may also come under pressure from regulators such as the Office of the Comptroller of the Currency (OCC) or the Federal Reserve Board (FRB) to consider the geographic and industry risk of these jurisdictions with respect to customers and other business operations. Not specific to financial institutions, you and your company may have to exercise increased due diligence when dealing with offshore companies – particularly those incorporated in Hong Kong. Despite the administration change, OFAC will certainly begin focusing on these supply networks more intensely and may conduct enforcement actions related to these designations against an array of industries including the maritime, insurance, and financial industries.

Whether by design or discovery, OFAC’s designation of firms in the global supply chain such as Rusal and Cosco have caused major impacts to multiple industries across the globe. With an active interest in doing business with the world’s second-largest economy though, firms should be prepared for more of these designations. For example, if a major commodity trader was designated by OFAC because it trades with Iran or North Korea, is your firm prepared to navigate the complexities of such a designation or the fallout? Furthermore, is your firm implementing controls currently to ensure that your business does not involve an undiscovered sanctions nexus?

How to Prepare for OFAC’s Changes in the New Administration

In ensuring that your compliance program is prepared to address OFAC changes in the Biden administration, it is important to consider several factors:

·     Review your current KYC and due diligence practices to ensure that they are able to accurately assess the ownership of your clients, buyers, and suppliers, as well as provide adequate evidence of research as to whether the person conducts business in a sanctioned jurisdiction. Based upon prior designation activity, Chinese companies operating in the maritime and commodity trading industries present increased levels of risk, as well as general trading companies located in Hong Kong.

·     Jurisdictional (or geographic) and industry risks will change with the addition of many Chinese networks to sanctions and export control lists, as well as sanctions programs targeted specifically towards China. As the world’s second-largest economy, companies may not have the luxury to treat China as a monolithic risk. Instead, they may need to bucket risks based on a typology, province, or line of business. Global companies should begin planning their next risk assessments by considering these risks.

·     Chinese “countermeasures” such as the new China blocking statute must be carefully evaluated and considered.

·     Chinese SOEs will present a source of possible sanctions risks, and firms should make contingency plans if a major client, supplier, or buyer is designated. This can occur for many reasons, and your risk assessments should incorporate an understanding of how much your firm relies on its relationship with the designee and what actions you can take if the entity was designated.

As you prepare for the changes in OFAC leadership and priorities, it is important to continue to evaluate your compliance program overall. Export controls, sanctions, corporate social responsibility (e.g., human rights and countering slave labor), and data privacy practices will continue to converge. This makes sanctions compliance more complex and highlights the need for holistic compliance programs that can juggle and understand these competing interests. Risks in one area may define the risks in another. The next generation of compliance officers should be well-versed in each area to meet the requirements imposed by the Biden administration and protect their companies.