New Guidance for Hong Kong Banks on Dual-use Goods

Introduction

Banks internationally face increasing expectations to ensure that their services do not facilitate the proliferation of weapons of mass destruction (WMDs) and that they understand whether their customers may be involved in military-related activities.

However, this is no easy task.  “Dual-use goods” remain one of the toughest areas for banks to navigate, as they are products and materials that can have both civilian and military applications.  Differentiating between these applications (and their legitimacy) can be exceptionally challenging.

Against this backdrop, the Hong Kong Monetary Authority (HKMA) has published updated Frequently Asked Questions (FAQs) in relation to Anti-Money Laundering and Counter-Financing of Terrorism (AML/CFT).  The FAQs were developed by the Hong Kong Association of Banks (HKAB).  The updated FAQs supersede the previous version issued in October 2022, and provide further guidance on dual-use goods in a new Appendix 2 (HKAB Dual-Use Goods Guidance). 

This alert provides:

• A primer on the FAQs and what has changed
• A short explainer on dual-use goods
• A synopsis of the HKAB Dual-Use Goods Guidance
• A summary of the key next steps

The HKAB Dual-Use Goods Guidance is the most granular guidance specifically for banks that we are aware of internationally.  As such, we expect it may be useful not only to Hong Kong-licensed banks, but those also abroad. 

There is no transitional window for the HKAB Dual-Use Goods Guidance, so banks will need to check and update their controls expeditiously to remain compliant.  KWM has supported on the development of Hong Kong’s AML/CFT framework since 2011.   Please contact us if you have any questions.

A primer on the FAQs

The FAQs are non-statutory guidance issued to assist “authorized institutions” (AIs) regulated by the HKMA to understand relevant AML/CFT requirements.  In addition to dual-use goods, the FAQs cover various topics including: 

HKAB also publishes the Guidance Paper on Trade-Based Money Laundering (TBML Guidance Paper), which is also relevant to dual-use goods and provides controls to support banks involved in trade more broadly.

The FAQs are not law, but compliance is expected by both HKAB and the HKMA in practice.  AIs are also expected to implement the controls having regard to their particular circumstances and the money laundering, terrorist financing (ML/TF), proliferation financing and sanctions risks (Relevant Risks) to which they are exposed.  Flexibility is possible, but only if justifiable and appropriately documented.  A noteworthy area of flexibility is whether (and which) technology is used to mitigate Relevant Risks.

What has changed?

The FAQs are updated periodically.  On this occasion, the changes are relatively modest and primarily involve streamlining or lightly adjusting content to reflect updates made to the HKMA’s Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (For Authorized Institutions) (AML/CFT Guideline).

A key exception is the addition of a new FAQ 56 in relation to former non-Hong Kong politically exposed persons (PEPs).  In summary, this confirms that:

• an AI does not need to obtain senior management approval if it decides not to apply, or not to continue to apply the enhanced due diligence (EDD) measures to a former non-Hong Kong PEP who no longer presents a high risk of ML/TF after stepping down;

however:

• it must still conduct an appropriate assessment on the ML/TF risk associated with the previous PEP status taking into account various risk factors, including those set out in the FAQ (which generally relate to any ongoing influence, their seniority as a PEP and any link between their prior and current functions).

The FAQs also provide further guidance to AIs regarding law enforcement and crime-related intelligence requests under FAQs 72 and 73, which was not previously covered by the FAQs.

As the FAQs are not generally released in mark-up, we suggest AIs maintain all versions of the FAQs and compare new iterations when released to ensure any changes are appropriately addressed. 

Guidance on dual-use goods

What are dual-use goods?

Dual-use goods involve products and materials that can have both legitimate commercial applications, as well as military or proliferation applications. 

A dual-use good may include the components of a weapon, and even the items used in the manufacture of a component of a weapon.  Common examples of dual-use goods include radio navigation systems, nuclear power technologies, certain chemicals, biotechnology, computing technology, drone or aerospace technologies, telecommunications equipment, robotics, and other products and materials.

The very nature of dual-use goods makes regulation and policy difficult to formulate.  They have the ability to promote technological, human development and strengthen economic ties, yet they also pose a potential risk to international security objectives and the promote proliferation of weapons of mass destruction.  Chlorine for example, is a cheap, commercial solvent with a wide variety of industrial applications.  However, when used for military purposes, it can become a devastating chemical weapon.

Why are dual-use goods relevant to AIs?   

Hong Kong has stringent laws that prohibit services being provided that may facilitate the proliferation of WMDs under the Weapons of Mass Destruction Ordinance (Cap. 526), as well as a broad array of adjacent rules, including a sanctions regime implementing the United Nations Security Council sanctions.  In a banking context, “services” can take multiple forms – from deposit and lending services, through to more complex trade finance facilities and other transactions.

Certain AIs can face elevated Relevant Risks due to their involvement in trade-related financial services and/or their exposure to various international touchpoints as part of their customer relationships and their customer’s own supply chains, relationships and transactions.  This includes transactions involving dual-use goods, which can carry heightened Relevant Risks.

Summary of the new HKAB Dual-Use Goods Guidance

The HKAB Dual-Use Goods Guidance sets out direction for AIs in handling customers whose business or transactions may involve dual-use goods.  Specifically, it summarises good practices that AIs may consider implementing, having regard to the nature, size and complexity of their business and the Relevant Risks to which they are exposed.  

We have summarised some of the key messages in the table below. 

Some key points to bear in mind:

• This area requires a whole-of-lifecycle approach.  That is, dual-use goods need to be factored into institutional risk assessments, customer risk assessments, diligence, other controls and ongoing review.  In this respect, this is a new process as such, but the deepening of existing controls to ensure they are appropriately dual-use goods-sensitive.

• Some AIs may need to go beyond these good practices. The HKAB Dual-Use Goods Guidance is only intended to support the development of AIs’ own controls and not as a prescriptive minimum or maximum standard.  AIs will need to consider the good practices on a risk-based approach (RBA), having regard to their own circumstances and their assessment of Relevant Risks.  In practice, this means higher risk exposure = more sophisticated controls. 

• What really matters?  The crux of several good practices is to ensure that the AI:

“has enough information on hand to assess…

o    the potential extent of involvement of dual-use goods; and

o    whether any potential dual-use goods are used for ML/TF, sanctioned activities or proliferation financing purposes.”

Please refer to the full HKAB Dual-Use Goods Guidance for further details.

AIs are also required to document their approach on dual-use goods and maintain appropriate records in accordance with Chapter 8 of the of the AML/CFT Guideline.

Why does HKAB Dual-Use Goods Guidance matter?

The TBML Guidance Paper establishes the need to address dual-use goods-related risks.  The HKAB Dual-Use Goods Guidance now provides far more detailed guidance that publicises and advances good practices.  As noted above, it is the most granular guidance specifically for AIs that we are aware of internationally.[1]  Another key reference point for AIs is “Dual-use Goods List” maintained under the Import and Export (Strategic Commodities) Regulations (Cap. 60G).  See the Strategic Commodities Control List of HKSAR.

Strengthening compliance principles (and complexity) internationally

Dual-use goods and import / export controls generally are an area of burgeoning compliance complexity.  For example, developments in Australia (as we summarised in our KWM alert on "Strengthening the AUKUS partnership: what are your obligations under new export controls?") and in Mainland China (as we reported in our KWM alert on Mainland China's export controls and dual-use items and our KWM alert on Mainland China compliance) make it increasingly important for banks to implement sophisticated controls, particularly (but not exclusively) if they have customers involved in trade.

We also see the ongoing impact of international sanctions on our international financial sector clients on their investments, divestments and other transactions and relationships.  Some examples include the following:

• (Contracts and compliance) For multiple entities, sanctions can have broad-ranging impacts, including the need to renegotiate agreements, reconsider choice of law, implement heightened diligence and monitoring, obtain permits where available, and deal with the immediate and downstream effects of frozen assets. 
• (Navigating conflicting regimes) Some institutions are also concerned that complying with the sanctions of one jurisdiction (say, the United States) may result in a breach of the requirements in another (for example, China’s Anti-Foreign Sanctions Law regime).  As such, there is tension in navigating – sometimes picking between - differing sanctions laws for banks and other corporate groups with operations in multiple jurisdictions.
• (Individuals) There is also a need to consider compliance at entity versus individual level.  For example, a United States bank at an entity level will always endeavour to comply with United States sanctions, but:

o    will that compliance cause any individuals (such as Mainland Chinese citizens) to breach offshore countering laws and regulations; or

o    how does the employment of a United States citizen within a Mainland Chinese bank impact the practices and approach of that bank?  Similar issues in relation to individuals also arise when complying with other areas of law such as anti-bribery and corruption.

While these matters do not always involve dual-use goods or import/export controls generally, there can frequently be areas of overlap.

Next steps

Banks will need to move swiftly to implement the HKAB Dual-Use Goods Guidance and other updates to the FAQs – or the controls they have selected – as there is no formal transitional window as such.

Please contact us if you have any questions about the HKAB Dual-Use Goods Guidance, FAQs or AML/CFT, sanctions or trade matters generally. 

We would be delighted to assist you.

*In this article, “Hong Kong” or “HK” means the “Hong Kong Special Administrative Region of the People’s Republic of China”, and “PRC” or “China Mainland” means the People’s Republic of China, excluding Hong Kong, Macao Special Administrative Region and Taiwan.