Beijing has cracked down on dissent in the finance hub since massive democracy protests four years ago, and has mandated that only "patriots" can hold public office.
The previous election for Hong Kong's district councils was held at the height of the demonstrations, and was swept by the city's pro-democracy bloc.
The bill passed Thursday will slash directly elected seats at the councils from more than 90 percent to 20 percent.
"We must plug the institutional loopholes and completely exclude those anti-China and destabilising forces from the (District Council)," city leader John Lee said after the bill's passage.
Lee and his ministers have accused pro-democracy councillors of being obstructionist and of "politicising" an advisory body meant only to handle livelihood issues such as transport routes and hygiene conditions.
The next district council elections are scheduled for November.
Under the new rules, 80 percent of seats will either be filled via official appointment or selected by government proxy groups. Candidates also face strict vetting.
The percentage of elected seats will be lower than when the district councils were created in 1982 under British colonial rule, rolling back decades of democratisation efforts.
A European Union representative blasted the move, saying the new system "severely weakens the ability of the people of Hong Kong to choose representatives overlooking district affairs".
It "goes against the commitment to democratic representation set out in the Hong Kong Basic Law", EU foreign affairs spokesperson Nabila Massrali said, referring to the charter that governs the Chinese city's semi-autonomous status.
Long-time councillor Paul Zimmerman had said in May that the new system "will not only destroy the final bastion of democracy in Hong Kong, it is ultimately a loss for everyone".
- 'Fewer democratic elements' -
Beijing imposed a sweeping national security law on Hong Kong in 2020 after the pro-democracy protests. Critics say it has stifled dissent and curtailed political freedoms.
More than 300 democratically elected district council members have since been unseated or resigned, with some leaving the city.
Hong Kong's legislature was already revamped in 2021 to wipe out the opposition.
Michael Tien, one of the 88 lawmakers who voted in favour of the bill on Thursday, acknowledged that the new system was less democratic.
"Admittedly, this electoral reform proposal has fewer democratic elements," he said in a floor speech.
"But democratic elements are not the goal of local governance."
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