This article was written by Martyn Huckerby and Intan Eow.
Over the last 12 months a number of Australian corporates have suffered unexpected business disruption in China. For some affected entities, this has caused serious crisis at home, including the risk of class action alleging failure to adequately disclose risk and changing circumstances to the investment community. These developments have highlighted the importance of directors of Australian corporates with extensive business in China in understanding emerging regulatory and political issues in China and monitoring risks.
Key regulatory and political risks
While "reading the tea leaves" may not have enabled the former CEO of one high-profile Australian company to avoid business issues with inventory and declining market share, companies operating in China do need to be able to prepare for the future in a scientific way. One thing is for sure, the volatility in the past year will continue in 2017:
- Continued regulatory action and law enforcement – China has continued to crackdown on violations of PRC law, including against foreign firms involved in the violations or close to persons who are involved. Laws and regulations in China are constantly changing as is local enforcement priorities and practices. Sectors such as pharmaceutical, infant formula, automobiles, gambling and securities market have been affected in turn. We can discern some themes below:
- Competition law and anti-corruption – While unannounced inspections (ie "dawn raids") of companies accused of breaching China's Anti-Monopoly Law and arrests of wayward Government officials and executives of state owned enterprises (SOEs) are attracting fewer headlines, enforcement activity is continuing. Foreign firms that work with third party intermediaries, government officials or SOEs are particularly at risk.
- Food safety – Advertisement and food safety and labelling requirements are being strictly enforced resulting in substantial fines. Additional registration requirements are imposed on infant formula products exported to China.
- Cyber security – With new Cyber Security Laws coming into effect on 1 June 2017, cyber security will be regulated as a matter of national security in response to the growing Big Data trend, requiring personal information and data to be stored in China.
- Tax collection and reform – The Chinese tax bureau, one of the world's most aggressive tax collectors, is expected to focus on the collection of enterprise income tax (including withholding tax) on the transfer of taxable Chinese assets which have no reasonable business purpose and transfer pricing, particularly on intercompany cross-border remittance of service fees, royalties and cost-sharing payments.
- Travel bans (China's, not Trump's) –Travel bans (or worse) have been imposed on directors or senior executives after they have travelled to China, where their company is being investigated for breaches of PRC laws (such as the above) or where they have close ties to an individual who is being investigated. Travel bans were even used in commercial disputes or bankruptcy proceedings. Directors can be held personally liable and even where they are not travel bans could create pressure to settle disputes on unfavourable terms.
- Tighter capital controls – At the end of 2016, it was widely rumoured that the Chinese government will be tightening capital controls, to slow down the significant capital outflow and currency devaluation. Whilst much of these have not been confirmed:
- Repatriation of profits - The State Administration of Foreign Exchange (SAFE) now requires Beijing-level approval for transfers over USD 5 million and companies are being encouraged to delay repatriating profits offshore.
- Restrictions on outbound investment transfers – Applications for outbound investment transfers approval are subject to uncertainty and intense scrutiny, causing prolonged delays.
- Geopolitical tensions – Geopolitical developments may cause ripples for foreign companies operating in China. For example a trade complaint overseas or any Trump-inspired tariffs affecting Chinese exports may affect the ease of doing business in China.
What should directors do?
Directors will be well served considering and asking the following questions:
- Evidence-based decision making – is your company's China strategy based on evidence and data? Has your company done its homework?
- Regular briefings – how often are you briefed on your company's China activities, strategy and risks?
- Systematic risk management – does your company have a system in place to assess risks? Are risks elevated to and considered by the board in a timely manner? Is risk management part of your company's DNA?
- Assess the impact of regulatory change – when did you last receive an update and how susceptible are your Australian revenues to regulatory developments in China?
- Take compliance seriously – does your company have clear compliance policies relating to your China business that all relevant staff have been trained on? "Everyone else does it" is not a defence.
- Due diligence on counterparties - before consummating a deal, hiring a new employee, or taking on a new Chinese supplier does your company routinely check government records, consider litigation history, and undertaken social media searches to understand the business practices of the Chinese company or individual you are dealing with?
- Disclosure policy – does your company have a disclosure policy which includes regular and timely disclosure of material information relating to its China business? What communication should be made publicly when facing imperfect information and data?
- Crisis and public relations management – does your company have a crisis management plan in place and a robust public and investor relations strategy that can be called upon when unexpected business disruption in China occurs?
- Travel – do executives routinely check if there are risks in travelling to China before doing so, such as unresolved disputes with large Chinese companies? When facing these circumstances should executives defer any non-essential travel or consider meeting offshore, for example in Singapore, Thailand or Japan (which Chinese individuals can easily travel to)?
- Funds transfer strategy – when did your company last review its inter-company agreements and strategy for funding its China business or repatriation of Chinese profits?
While business practices, culture and customs in China are very different from those in more developed economies (and China is growing more international rather than more western), many of the problems companies and their directors face can be identified early by practices that are not that different from those they are familiar with at home.