Strengthening Supply Chains amid Trade Wars
Sanctions and trade restrictions are not new tools in international trade and foreign policy. Correlated with the global shift towards nationalism and protectionism over the past few years, these tools have been pulled out of the toolbox with explosive frequency. They have been used to combat wide ranging concerns including data privacy, cybersecurity, IP theft, trade deficits, human rights, environmental issues and geopolitical issues, such as in Crimea and Hong Kong.
The US–China trade war in particular has been a key point of focus for the global economy throughout the Trump administration, escalating to a feverish pace leading up to the 2020 US presidential election even as companies struggle to address the economic fallout of the covid-19 pandemic. Economic sanctions, export controls and tariffs are ostensibly intended to rebalance the bilateral trade account, but some interpret these moves as a deliberate US led effort to fundamentally decouple the two economies. Proponents of sanctions certainly argue that these influence a desired change of behaviour in the country targeted. While this economic battle intensifies, what steps can companies take to prepare and protect themselves?
Recent developments in the US–China relationship, the 1st and 2nd largest global economies respectively, have a far wider impact on global business growth prospects and supply chains. Couple this with other notable trade restrictions on countries such as North Korea, Myanmar, South Korea and India, doing business in the Asia-Pacific region carries more risk than ever before. In this chapter, we explore how these recent economic policies have altered the supply chain landscape while offering practical guidance to mitigate risk and cut through the complexity.
The growing regional web of sanctions and trade restrictions
While sanctions are a common tool in trade wars, they should also be analysed in the context of other modern legal and economic mechanisms, such as export controls for the full impact on global trade. Under this context, the evolution and shift from military action to trade warfare to effect economic change becomes clear. Owing to the rapid expansion of trade barriers, businesses across all sectors should pay close attention.
The following examples highlight the current challenges faced by companies trading within the Asia-Pacific region.
China, including Hong Kong
In 1989, the European Union imposed an arms embargo on China following the crackdown on the Tiananmen Square protests. Fast-forward to the Trump administration and we have seen a steep rise in sanctions, export controls, trade restrictions and an enforcement initiative involving China. The escalation of tensions is clearly illustrated in the timeline below:
- 2017: Chinese telecoms equipment manufacturer ZTE Corporation pleaded guilty for violating US sanctions by selling US-made goods to Iran and North Korea. This breach threatened to cut off its supply chain, and they also received a fine of US$1.19 billion. A year later, the company was found to be in breach of the sanctions settlement deal and the US slapped ZTE with a seven-year component ban, forbidding American firms from selling parts and software to the company.
- August 2018: the Foreign Investment Risk Review Modernization Act (FIRRMA) was signed into law, overhauling the Committee of Foreign Investments in the US (CFIUS) process and combating theft of sensitive US technology by China. New types of transactions were subject to CFIUS review and, for the first time ever, mandated submissions to CFIUS in certain cases.
- September 2018: the United States imposed sanctions on the Chinese military for buying missile systems and fighter jets from Russia.
- November 2018: the US Department of Justice (DOJ) launched the China Initiative to counter national security threats emanating from the country. The goal of the China Initiative is to identify and prosecute those engaged in economic espionage, trade secret theft, hacking and other economic crimes while protecting critical infrastructure against external threats and combating covert efforts to influence the American public.
- January 2019: the US announced criminal charges against Huawei, a well-known Chinese telecommunications manufacturer, and its CFO Meng Wanzhou (Meng), related to stealing trade secrets, obstructing a criminal investigation and evading sanctions on Iran. Meng, the daughter of the Huawei founder, was detained in Canada a month before the charges were filed.
- May 2019: President Trump signed an executive order, largely focused on Huawei, declaring a national emergency and barring US companies from using telecommunications equipment manufactured by firms that pose a threat to America’s national security. The order was quickly followed by the US Department of Commerce’s Bureau of Industry and Security (BIS) adding Huawei and certain non-US affiliates to the Entity List (with additional affiliates added in August 2019). Entry on the entity list effectively means that US companies cannot sell or transfer technology to Huawei or affiliates without a licence issued by the BIS.
- October 2019: the US added 28 Chinese public securities bureaus and companies, including security camera manufacturer Hangzhou Hikvision Digital Technology Co Ltd, to a US trade blacklist over alleged human rights abuse, predominantly the mistreatment of Uighur Muslims in the Xinjiang Province.
- February 2020: the US added charges to Huawei’s criminal indictment, including additional instances of stealing trade secrets and further sanctions evasion in Iran and North Korea.
- April 2020: the US Trade Representative’s (USTR) section 301 investigation report noted that China ‘directs and unfairly facilitates the systematic investment in, and acquisition of, US companies and assets to generate large-scale technology transfer’.
- May 2020: BIS announced the addition of 33 Chinese companies to the Entity List. Of the 33 new additions, 24 are government and commercial organisations based in China, Hong Kong and the Cayman Islands targeted for ‘supporting procurement of items for military end-use in China’. The remaining nine entities consist of eight commercial entities and China’s Ministry of Public Security’s Institute of Foreign Science for complicity ‘in human rights violations and abuses committed in China’s campaign of repression, mass arbitrary detention, forced labour and high-technology surveillance against Uighurs and minority groups in the Xinjiang Province’.
- June 2020: China passed a sweeping new national security law on Hong Kong, aimed at stamping out opposition to the ruling Communist Party. Conceived in secrecy and passed without serious input from Hong Kong authorities, the law sets up a vast security apparatus in the territory and gives Beijing broad powers to crack down on a variety of political crimes, including separatism and collusion.
- 2 July 2020: the US Congress passed the Hong Kong Autonomy Act (HKAA), imposing sanctions against individuals, entities and financial institutions in response to China’s Hong Kong national security law. The HKAA sought to introduce visa- and property-blocking sanctions on foreign persons who have ‘materially contributed’ to China’s recent actions in Hong Kong (Material Contributors), and a variety of sanctions on foreign financial institutions who ‘knowingly’ conduct significant transactions with such persons.
- 13 July 2020: in response to having four government officials sanctioned for reported human rights abuses, China sanctioned four US government officials, including Republican Senators Marco Rubio and Ted Cruz.
- 14 July 2020: the US Federal Acquisition Regulation (FAR) (rules governing all US government procurements and purchases) was amended to prohibit the purchase from certain Chinese telecommunications companies, such as Huawei, ZTE and Hangzhou Hikvision. The prohibition included banning any contractors that use covered telecommunications equipment or services, even if that use is unrelated to the contractor’s federal business.
- July 2020: the US closure of the Chinese Consulate office in Houston was quickly followed by China’s closure of the US Consulate office in Chengdu. Also, as a follow-on to the alleged human rights abuses in Xinjiang, the US blacklisted the Xinjiang Production and Construction Corps (XPCC), along with Sun Jinlong, the former party secretary of XPCC, and Peng Jiarui, XPCC’s deputy party secretary and commander.
- 6 August 2020: citing data privacy and national security concerns, President Trump signed an executive order against TikTok and WeChat, to take effect after 45 days, banning transactions involving either app within the jurisdiction of the US. TikTok is a popular video app owed by the Chinese company Byte Dance while WeChat is a messaging, social media, and electronic payment application owned by the Chinese company Tencent Holdings Ltd.
- 7 August 2020: following on from the HKAA, the Trump administration imposed sanctions on Hong Kong’s chief executive Carrie Lam and 10 other senior officials in Hong Kong and mainland China over their roles in cracking down on political dissent. 
- 11 August 2020: in the most recent of tit-for-tat moves, China announced it would sanction 11 Americans in retaliation for sanctions imposed by the US, including Senators Marco Rubio, Ted Cruz, Tom Cotton and Pat Toomey; Congressman Chris Smith; Human Rights Watch Executive Director Kenneth Roth; National Endowment for Democracy President Carl Gershman; and Michael Abramowitz, the president of Freedom House. 
To recap, the dizzying pace of trade restrictions between the US and China remains extraordinarily difficult to interpret, with many underlying components left unsettled. From a US perspective, China is quickly moving from a known diversion country, trading directly with sanctioned countries like North Korea and Iran, to a sanctioned country itself, which is a momentous shift. As the US–China relationship continues to spiral downwards, the net of global companies caught in the middle is extremely broad, with significant potential repercussions. Many companies are contemplating difficult strategic decisions around business continuity, including:
•overall investment in China
•revising revenue and growth estimates; and
•de-risking and diversifying supply chains.
Once the dust does settle, there will undoubtedly be additional compliance challenges around sanctions and export controls in China, but for now, strategic business planning is taking precedence.
North Korea is under heavy sanctions imposed by the United Nations, US and EU because of its nuclear and ballistic missile-related activities. The first set of sanctions was imposed in 2006 following its first nuclear test. In 2017, the UN issued further sanctions restricting trade in and out of the country, including export of arms, refined petroleum product and aviation fuel; import of coal and iron; and financial and economic restrictions on North Korean banks. In the last couple of years, there have been reports that North Korea has repeatedly flouted the sanctions regime, including the widely reported shipping of petroleum and coal through a combination of ship-to-ship transfer and direct port calls.
Introduced in July 2020, the United Kingdom’s new ‘Magnitsky’-style sanctions under new global human rights regime, known as the UK Global Human Rights Sanctions Regulations 2020 (2020 Sanctions Regulation), also targets two organisations involved in the forced labour, torture and murder that takes place in North Korea’s gulags.
The EU first imposed sanctions on Myanmar, including an arms embargo, after Myanmar’s then military junta refused to accept the results of the country’s 1990 elections. Unlike North Korea, however, Myanmar has been gradually opening itself to the global economy. There has been an easing of sanctions from western countries as a result. All non-military sanctions were lifted in April 2013 and embargoes on arms and military equipment began to ease more recently in 2019.
However, sanctions are still used to target individuals on the grounds of human rights violations. Both the EU and US imposed targeted sanctions on a number of Burmese military or Border Guard Police commanders in 2018 for their involvement in the ethnic cleansing of Rohingya Muslims. More recently, the UK’s 2020 Sanctions Regulation imposed asset freezes and travel bans on two entities and 47 individuals, which included two commanders of the Myanmar armed forces said to be responsible for serious human rights violations against the Rohingya Muslims.
Sanctions are not limited to those that are imposed by the US, UK and EU. In July 2019, the Japanese government announced its ‘sanctions’ on trade with South Korea, leading to tensions in their bilateral relationship. Japan removed South Korea from the list of ‘white countries’ in its Export Trade Controls Order, hence terminating the preferential treatment allowing for simplified trade procedures that had been applied to South Korea since 2004. South Korea retaliated by boycotting Japanese products and through other forms of political mobilisation.
Other countries in the region that may not be the direct targets of sanctions have voiced concerns over the increasing risk of sanctions enforced. For example, India signed a US$5 billion deal with Russia in 2018 to buy five units of S-400 air defence missile systems, despite warnings from the US that proceeding with the contract may invite sanctions under the Countering America’s Adversaries Through Sanctions Act (CAATSA). While punitive actions have not been enforced at the time of writing, they remain a possibility.
At the same time, India is also creating its own form of trade restrictions for countries seen as unsympathetic to its concerns and core interests. For example, responding to political rows between India and Malaysia, New Delhi announced in late 2019 that it was moving palm oil, a key export commodity from Malaysia, to a restricted category so it could no longer be freely imported. While India’s move is not deemed strictly as ‘sanctions’, India’s palm oil imports will shift away from Malaysia to other exporting countries, such as Indonesia. Most recently, in 2020, India has banned the use of TikTok domestically and mandated the use of local suppliers, instead of Huawei, to upgrade its mobile networks. In response to the latter, Huawei has cut its India revenue target for 2020 by up to 50 per cent and is laying off more than half of its staff in the country. These moves were part of a larger Chinese goods boycott in India as retaliation for the increased Himalayan border violence with China.
Impact on the global supply chain
Listed above are only a few of the many instances of sanctions imposed on Asia-Pacific countries. What impact do all of these various sanction regimes have on the supply chain in the region? Undoubtedly a major one. Asia-Pacific has long played, and continues to play, a significant role in the global supply chain. The region offers cheaper labour and expertise in specific areas, such as technology, all of which was greatly bolstered by globalisation and open market movement seen in the previous two decades prior to the recent pivot towards nationalism. With this pivot, some industries are more in the crosshairs than others in terms of disruption but that list continues to grow now, including food and beverage, fashion, banks, construction and extractive, pharmaceuticals, healthcare and medical equipment, as well as the aviation and defence sectors.
In recent years, there have been heightened risks arising from the supply chain, therefore expanding the list of risk areas that businesses need to consider. These include branding, quality and safety, counterfeiting, bribery and corruption, human rights, environmental impact, third parties and sanctions. We will go into more detail on how to address some of these supply chain risks later, but this discussion would not be complete without further exploration of the Asia-Pacific region’s response to US–China trade war, and most recently, covid-19.
Asia-Pacific’s response to US–China trade tensions
The impact of US–China trade tensions is not limited to the two countries alone. Neighbouring nations with trade relationships with the US, China, or both, are also suffering. While these neighbours may stand to gain from filling in the gap arising from restricted US–China trade flows, they would also be concerned that trading with one country would incur the wrath of the other. Asia-Pacific countries like Malaysia that rely heavily on exports and are closely linked to both markets could be at risk of sanctions enforcement by one major power or the other amid rising protectionism.
With so much uncertainty surrounding trade with both the US and China, a group of 15 Asia-Pacific countries have come together on a wider-reaching pact called the Regional Comprehensive Economic Partnership (RCEP). The initiative aims to boost commerce across the group by lowering tariffs, standardising customs rules and procedures, and widening market access. Launched in 2012 as an initiative by the Association of Southeast Asia Nations to encourage trade among its member states and six other countries, member states are aiming to sign a deal by the end of 2020, with hopes that India will also join.
In January 2020, when China closed its factories and went into widespread business closures, it took many companies, both locally and internationally, by surprise. It created a lot of confusion and anxiety for companies without alternative supply chains.
As the pandemic spread globally and more countries went into various forms of lockdown, it crystallised the need for businesses with cross-border supply chains to adequately de-risk and diversify their risk in today’s fast-changing trade landscape. However, those who were able to act quickly then encountered other challenges, such as procuring from suppliers with which companies had not previously traded, or had not been fully vetted and screened. Rushing into business with disreputable or even restricted parties exposes companies to a whole host of liabilities, including sanction regimes, anti-bribery and corruption regulations, and corporate liability for supplier abuses such as forced labour and human rights violations.
As China and its neighbours responded to the rapidly evolving situation, there was increased pressure on suppliers of certain products, which in turn gave rise to opportunistic behaviour, particularly arbitrage. Prices shot up as a result of scarcity of supplies and soaring global demand, especially for specific products. Antitrust concerns have sprung up worldwide due to these circumstances. The US DOJ’s Antitrust Division, the UK’s Competitions Market Authority, the EU and other relevant enforcement agencies remain focused on anticompetitive behaviour and will take action to investigate and prosecute wrongdoers.
Quality control of healthcare products has been another major area of contention. In late March 2020, as a result of complaints from Turkey, Spain, the UK and the Netherlands, faulty medical equipment and personal protective equipment (PPE) products were returned to source suppliers in China. As a countermeasure, the Chinese government tightened rules governing the export of medical equipment in an attempt to address the concerns of those countries. Thereafter, only accredited and licensed manufacturers could export test kits, PPE such as surgical masks and protective gowns, ventilators and infrared thermometers.
Large amounts of money have been spent by many governments to secure PPE and medical equipment to address the needs of their citizens. Inquiries have been launched in several countries into the processes and controls deficiencies enabling price gouging and poor-quality product procurement especially those equipping frontline medical personnel. Suppliers in Asia-Pacific may not come out of these inquiries unscathed if found to have sold malfunctioning products to other nations.
What can companies do?
The covid-19 pandemic plunged the global economy into a very precarious position. Today, we are in a situation where neither the US nor China, or any of the other Asia-Pacific countries for that matter, can afford the damage a full-blown trade war would inflict. The pandemic has made many businesses vulnerable to external risks. Companies are asking themselves what they can do to emerge stronger and more resilient to the impact of trade wars with no end in sight as well as an enduring global pandemic.
Companies can and should refer to the US Office of Foreign Assets Control’s (OFAC) A Framework for OFAC Compliance Commitments, issued in May 2019, with the aim to provide its perspective of essential components of a sanctions compliance programme. It calls out five essential elements:
- management commitment;
- risk assessment;
- internal controls;
- testing and auditing; and
We attempt to expand on these components with specifics relevant to the management of the supply chain to provide practical guidance companies can follow.
Better understand the business model and conduct a robust risk assessment
Regular and routine risk assessments should be conducted. The importance of periodic reviews cannot be overstated to ensure appropriate consideration is given to a quickly changing global trade and regulatory landscape. Used effectively, a robust risk assessment will allow management to make informed business decisions as well as ensure the implementation of an effective compliance programme.
Regulations have been changing at a speed never previously experienced. Governments have fared poorly thus far in keeping up with the pace of change and lessening uncertainty by issuing practical industry guidance on the application of the voluminous new laws and regulations. Where companies struggle to keep abreast of these developments, law firms, consultancies, specialists (eg, sanctions, export control, anti-corruption) may be a supplemental resource for tailored updates and in-depth analysis. There is a wealth of information readily available for companies to tap into.
On the other hand, businesses with global presence should fully utilise their ‘eyes and ears’ on the ground and lines of defence to help identify key local challenges and concerns, for example local customs or trade challenges, or logistics difficulties. Local personnel can also be key to ensuring effective local internal communication channels so that information is cascaded to all relevant business functions.
Implement a robust compliance programme
Effective and robust compliance programmes must be versatile and focus on risk mitigation. Even the best of compliance programmes will be severely tested and potentially overwhelmed by the unprecedented covid-19 pandemic and global trade disruption. The compliance team should closely evaluate whether the skill and expertise exists within the organisation to be able to address the complex risks within the growing web of sanctions, export controls and embargoes in the Asia-Pacific region. If in-house skills are insufficient, outsourced and external expertise support should be secured as a priority.
Under these dire circumstances, the compliance function should evaluate and prioritise risk areas that are important to the business in the current environment. These may include third-party due diligence, trade and customs due diligence, anti-money laundering, anti-corruption, environmental impact, human rights and antitrust. Regarding the latter, the pandemic’s opportunistic behaviour around price gouging and misrepresented quality could not only lead to public procurement investigations but also severe damage to a company’s reputation and brand.
Last, compliance programmes should not assume that the advent of the new risks explored herein has diverted focus from bribery and corruption scrutiny and investigation. On the contrary, global enforcement agencies continued to be fully staffed and engaged on a full inventory of existing bribery and corruption cases along with an expected surge in illicit payments for preferential and prioritised treatment during the covid-19 crisis.
Conduct thorough third-party due diligence
Third-party due diligence has always been fundamental and the rapidly shifting supply chain landscape only heightens its importance. Basic third-party due diligence is no longer sufficient as it is increasingly important for companies to look thoroughly into its existing third parties. This includes the third parties’ stakeholders, and their connections, key corporate officers and employees, other upstream and downstream providers, and so on. Transactions through intermediaries and agents continues to be a high-risk area across the global supply chain, as is ensuring that products are sourced from regions where labour or other human rights abuses are common.
Furthermore, with new laws introduced and frequent updates made to the prohibition lists, including the US’s BIS Entity List, regular reviews should be performed on third parties to ensure that sanction rules are not breached by trading with sanctioned individuals and entities. Even where the application of laws remains unclear, for example, the implementation of the HKAA, companies may want to proactively review and screen their existing clientele and supply chain to identify those potentially designated as material contributors, even if a precautionary step.
These days, with a wealth of information publicly available, it is no longer acceptable nor defendable at court to claim wilful blindness or ignorance. Regulators increasingly require companies to demonstrate that they have done their utmost to obtain and review relevant information during the third-party due diligence review.
Evaluate, assess and recalibrate (trading) priorities
As the supply chain landscape continues to shift in the coming months and years, companies should ensure that their supply chain and priorities are evaluated and assessed regularly in order to succeed in the new international trading environment.
Businesses should evaluate how recent events have impacted their supply chains, especially those with significant exposure to the Asia-Pacific and realign their priorities to ensure that their supply chains are best placed to withstand the uncertainties current and future events may bring. In some instances, further diversification may be suitable to ensure that the risk exposures are mitigated.
Careful consideration should be given before partially or completely exiting a market and reconfiguring your supply chain. An exit could be disadvantageous and result in assuming more risks owing to potentially steep operational costs or even restrictions on how companies can extract their assets, inventories and cash from a foreign country.
There is no time like the present to pause, evaluate and recalibrate to ensure that supply chains emerge stronger and more resilient to future risks and pressures. Management should consider seeking subject matter experts’ advice to ensure that any company decisions have factored in the relevant risks, costs and advantages.
Review contractual language
Further to the above, close review of contract termination clauses should be included in any contemplated change to the supply chain. While an increased focus has been placed on ensuring third parties are properly screened as part of the due diligence process, a fresh review of contractual language is equally important to ensure the recent changes to international laws and regulations are fully embedded in the standard supplier template and adequately protect the company going forward.
Compliance with data transfer and data privacy requirements
Outside much of the publicised US-driven concerns around IP theft, data privacy and cyberfraud stemming from China, behind-the-scenes regulations around data transfer and data privacy are also evolving, as can be seen of the invalidation of the EU–US Privacy Shield Framework by the European Union’s Court of Justice in July 2020. At the time of writing, companies that rely on the Privacy Shield certification are waiting for further guidance from the enforcement agencies of the respective countries. Companies now more than ever should heed the warning and ensure that proper safeguards and governance exists within all its third parties, including supply chain partners where applicable. Regular reviews should be performed to ensure that the company’s data transfer and data privacy policies are adhered to, and broader network penetration tests should be conducted periodically.
Audit and certification and independent reviews
Teams in the compliance function, internal controls and internal audit functions should reinvigorate audits, monitoring protocols and assurance testing to ensure controls are well designed and operating effectively to mitigate risks. Those controls should be a combination of detective and preventative in nature to safeguard the business.
Where appropriate, companies should consider the value of obtaining certification from external bodies authorised to perform such work, for example product quality assurance certification, provenance-related testing on materials within the supply chain, and sustainability or environmental reviews. The scrutiny faced by global retailers over allegations of human rights abuses in relation to cotton supplies sourced from Xinjiang, China, have renewed the need to audit and certify third parties in supply chains to ensure that they are ethically sourced and do not breach human rights and environmental laws.
Companies should not underestimate the importance of routine and independent sanctions compliance programme review and its automatic screening systems as these have been noted as one of the mitigating factors in the Amazon OFAC settlement in July 2020.
Awareness, communication and training
Compliance risk is dramatically shifting during this period. As such, communication throughout the organisation should be renewed and where required, enhanced awareness training on specific risk areas be rolled out to the parts of the business most exposed. With the ever changing regulatory and sanction landscape, now is the time to evaluate the compliance training content and delivery strategy. Keep in mind companies continue to be expected to demonstrate, through records and key performance indices, how training is rolled out and the effectiveness of those training sessions.
With lockdown occurring in different phases globally, and many companies’ workforces working remotely, one emerging best practice is to over-communicate to ensure alignment of information and avoid misunderstanding. Senior management should also emphasise key messages through formal communication channels and reiterate the company’s commitment towards compliance, integrity and ethical business decision-making.
Countries in the Asia-Pacific region have always had a close and strong trading relationship with one another, supporting the overall supply chain regionally and globally, and contributing to a steady flow of various goods and products to the world. Recent events have placed significant strain on supply chains in the region and have caused countries and companies alike to think hard about how to reposition themselves and pick up from the aftermath of far-reaching trade restrictions and an unexpected global pandemic.
It is near impossible to predict with confidence what the coming year will be in terms of trade wars, sanctions, export controls and their impact on supply chains. However, it is safe to say that international trade flows, together with border constraints and distance imposed, will continue to matter. Countries will continue to battle with the effects of the pandemic, as they have been doing to date in 2020, and re-establish the supply chain network across the region. Companies and their legal counsel will need to be attuned to the complexity of global supply chains and compliance with the rules that govern them, to avoid breaching sanctions and the costly repercussions that could follow.