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Thursday
Sep052019

China’s Social Credit System applies to companies and impacts compliance

Numerous stories have appeared in the English-language press about China’s social credit system (SCS). Most of these stories focus on SCS’s system of “scoring” individuals in China. But SCS also applies to companies operating in China and, as it develops, may impact how companies approach anti-corruption compliance. 

A full explanation of SCS for companies is beyond the scope of this short blog post; a detailed description can be found in an excellent report issued last week by the European Union Chamber of Commerce in China. 

At a high level, SCS establishes a system by which the Chinese government collects information and rates companies across a wide range of areas (e.g., data transfers, finance/taxes, environment) and then can reward or sanction companies based on that information and rating. Notably, SCS functions as an information-sharing system among government agencies, which means that non-compliance in one area, such as bribery and corruption, will be more quickly reported, publicized, and shared with other government agencies, and, in many cases, with the public. Companies -- and in some cases individuals -- face more immediate and potentially wide-ranging sanctions for violations.

The roll out of SCS began in 2014, and it seems to be on track to be materially complete by late 2019 or 2020. The underlying purpose of SCS is to address a lack of trust in society in China by enhancing the “trustworthiness” of companies and individuals and providing incentives for “trustworthy” behavior and broad-ranging punishments for “untrustworthy” behavior.

As detailed in the EU Chamber report, SCS has substantially enhanced the possible consequences of a company failing to comply with China’s laws and regulations. For example, an administrative violation, such as commercial bribery, that previously was punished by one regulator, typically with a fine, now could have impact across a company’s interactions with a number of government agencies. Once a non-compliant incident is identified, SCS shares information about that incident with more than 20 participating government agencies, including those that may have no oversight over the area of non-compliance. 

This “joint-sanctions” approach can lead to, among other things, higher inspection rates, targeted audits, and difficulties obtaining unrelated administrative approvals, as government agencies view the company as less trustworthy and therefore less willing to grant permits, licenses, or other administrative approvals. Violations can also impact a company’s SCS score, which serves as a reference point when obtaining loans in China and in foreign exchange activities (including getting money out of China). In extreme cases, a violation can lead to a company’s debarment from public procurement in China and can impact the SCS score of the individual serving as the company’s named representative in China.

(Pharmaceutical companies have been subject to provincial-level blacklisting for bribery violations since 2007, and nationwide blacklisting since 2014. Dozens of blacklists for corruption-related violations now exist in multiple sectors and industries. SCS attempts to expand, systematize, and centralize these efforts across industries.)

Foreign companies historically viewed anti-corruption compliance in China through the lens of non-Chinese laws, such as the U.S. FCPA or UK Bribery Act. Since the start of China’s anti-corruption campaign in 2013, which many recognize as the “new normal,” companies have increasingly viewed corruption risk in China equally as a local enforcement matter. SCS will accelerate that trend as companies view compliance issues in China -- corruption and beyond -- not merely as a legal risk but also as a business risk that could have a negative impact on all areas of their operations in China.

Given the disproportionate impact that a negative finding from a government agency or even a negative report in the media could have, it will become increasingly important for companies to take a proactive approach to compliance. Companies will need to understand the requirements under the SCS (which currently numbers approximately 300 and growing, spread out across national and local policies) and assess any potential gaps in its system. In addition, companies may also want to monitor data in publicly available systems and reports in the media, such as potential improper payments, to address any negative or incorrect information.

A company’s SCS score is impacted by the SCS scores of its business partners. On the one hand, the additional transparency and access to presumptively accurate government-provided information about potential business partners may help with due diligence efforts. Indeed, the National Credit Information Sharing Platform, CreditChina, and National Enterprise Credit Information Publicity System have been operational for multiple years and have become a staple of local diligence efforts, along with private consolidators of this public-source information, such as Tianyancha and Qichacha. (All are accessible only in Chinese.)

On the other hand, because a company’s SCS score can be adversely affected by negative SCS scores of its business partners, companies may need to invest compliance bandwidth into regularly monitoring and assessing the scores of its business partners in China, and consider ways to mitigate the risk that a partner’s conduct -- even unrelated to the company -- could impact a company’s SCS score.

Government inspections are a significant input into the SCS database. SCS attempts to reduce corruption among inspectors by randomly assigning inspectors and inspection targets using the “two randoms, one public release” principle (双随机,一公开).  (Of course, government inspectors who know that the result of their inspections could have a direct and immediate impact not only on potential fines but on the company’s broader business could be more inclined to solicit or accept things of value from company employees.)

The SCS scores of key individuals, such as a company’s legal representative or high-ranking management personnel, may affect a company’s SCS score. Companies may need to consider whether and how to monitor the actions of individual employees, and they may find it more difficult to characterize a wrongdoer as a company "outlier.” And, the fact that individuals may be impacted by their company’s SCS score may have a similar impact as the US Department of Justice’s emphasis on prosecuting individuals, as set forth in the Yates Memo.

SCS will significantly impact business operations in China, and companies will need to be more attentive to compliance, including anti-corruption compliance, to mitigate both legal and business risks. Companies have been facing increasing pressure by regulators around the globe to ensure that their compliance systems are comprehensive and effective, so companies that have already made strides to improve their compliance systems may face an advantage over competitors who have not. SCS can be viewed as another thumb on the scale to nudge companies to take a more proactive approach to anti-corruption compliance.

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Eric Carlson, pictured above left, a contributing editor of the FCPA Blog, is a partner, and Helen Hwang, above right, is a special counsel, in Covington & Burling LLP’s Shanghai office. Both are fluent in Mandarin and specialize in anti-corruption compliance and investigations, with a particular focus on China and other regions in Asia.