The law, which targets the funding of terrorist acts, was passed after 12 hours of heated debate with 32 legislators in favour and 18 against.
The Hong Kong Government argues that it urgently needs to enact the bill to fulfil China's commitments to the UN Security Council resolution against terrorism.
The new law has angered human rights and legal groups who say it was passed in haste and gives the government sweeping powers to brand anyone a suspected terrorist.
Defining terrorism
The law defines a terrorist act as the use or threat of action to influence a government, or to intimidate or endanger the public, to advance a political, religious or ideological cause.
Based on UNSC resolution 1373, it gives the government the power to freeze funds believed to be linked with terrorism and criminalises the act of funding terrorism.
People who provide funds or resources, including weapons, to terrorists face up to 14 years in jail if convicted.
The law also allows the government to confiscate assets believed to be linked to terrorists.
Anyone who has been wrongly accused must prove their innocence in court if they want their property back.
'Affront to freedom'
Security Secretary Regina Ip argued that the bill was essential to prevent Hong Kong becoming the "weakest link" in the global fight against terrorism.
"As a financial hub, we can't rule out the possibility of terrorist funds flowing in," she told legislators.
But legislator and lawyer Margaret Ng told BBC News Online the law rendered individuals extremely vulnerable.
"People fighting for civil liberties can fall into the trap (of being named a terrorist) if the government really wants them to."
Furthermore, as the law then allows the suspect to be deprived of funds, they may then be unable to hire a defence lawyer, she said.
Ms Ng said the law was moreover "contagious" as it prohibited the funding - even unknowingly - of a group or person branded as terrorist.
Johann Wong, principle assistant secretary for security, countered that there was no danger of the law encroaching on human rights, as it was in line with international standards.
He added that the government must go through the courts before acting on their suspicions, "and if you can't trust the courts, who can you trust?".
But civil liberties groups fear that any law passed in Hong Kong could be subject to new interpretation if the government feels under pressure to operate according to the wishes of its sovereign ruler, Beijing.