Top 5 Compliance Risk Trends to Watch Out in China

The risk landscape for foreign companies doing business in China is changing fast due to a dynamic regulatory and economic environment. The following shows the current top 5 compliance risk trends to watch out in China.

Risk 1: Whistle-Blower Allegations, Investigations and CEO/CFO Compliance

Whistle-blower activities are arising worldwide and also in China. The following forces are driving this trend: Foreign companies have rolled-out their whistle-blower systems to their subsidiaries in China, and the Chinese regulator can provide high rewards to whistle-blower. Rewards can usually reach up to RMB 500K (approx. EUR 68K), and under certain requirements even exceed this amount. The rise of whistle-blower allegations will lead to more investigation risks - externally by regulators and internally by the affected company. This will certainly hit the overall liability risk profile of foreign business in China. CEO’s and CFO’s, no matter whether they are running the business in China or abroad, face an increasing level of personal liability risks in conjunction with disclosure, investigation and risk prevention obligations. Foreign business needs to be aware of the regulatory do’s and don’ts in conjunction with the management of whistle-blower allegations, external investigations by regulators, and how to conduct an internal investigation in China.

Risk 2: Attacks by Competitors

Companies are facing aggressive competitors, who don’t comply with the regulations (e.g. in relation to environmental law requirements, product safety, know-how protection, anti-corruption, etc) in order to lower costs and get illegal business advantages. Competitors can also spread deliberately fake news about the quality of products and services in order to damage the brand’s reputation. Unfair marketing practices by competitors will also hit the company’s business. Therefore, it is important to develop robust and realistic legal strategies, which can defend the company against those attacks. The available legal tools for stopping the competitor’s attacks, very much depend on the individual scenario and the affected industry. Some industry sectors have set up their internal blacklisting systems in order to inform each other about wrongdoings. Soft legal tools usually start by alerting the Chief Compliance Officer, Ombudsman or other senior management of the competitor and could end up involving the prosecutor, all of which depends on the individual situation.

Risk 3: Reputation Risks in a Hyper-Connected World

More than 13 millions read the story on the Chinese social network Weibo, that the CEO of a German leading company’s trucks division in China, a German citizen, has made insulting remarks about the Chinese. Many of them asked to boycott this foreign car brand. This story, which spread like wildfire, demonstrates that foreign companies in China need to have strategies in place in order to respond quickly to allegations at social media, which can damage the reputation of their brands. Cyber attacks, which leak confidential information, will damage the company’s reputation too. Social media activities of staff, e.g. at the Chinese WeChat, can lead to reputational risks too. The reaction time to allegations in the hyper-connected world of social media platforms is very limited, so that often a reaction of the affected company is required before internal investigations have been completed. Foreign companies in China need to anticipate these reputational risks, and need to develop china-realistic legal strategies, in order to be well prepared to manage the next reputation crisis.

Risk 4: Restructuring Hit by Hidden Risks

Downsizing business in China can quickly lead to dynamic scenarios, where hidden legal, tax, customs, environmental, product security or other risks could arise, and are getting difficult to manage. The actual risk profile of the company could be unclear given that the previous local management was not interested to mitigate the company’s liability risks, and the headquarter’s management did not realize that certain hidden risks are actually existing. This particularly applies to those foreign investors, who rushed into the Chinese market and had a weak internal control. Hidden risks are usually connected to intransparent procurement and sales practices of the company. Additional typical risk drivers is a high involvement of third parties and a low retention rate. Restructuring plans are getting hit or even failed once hidden risks pop up. These negative scenarios can be avoided by an early risk audit. Risk audits can help to screen first the actual risk profile of the operation in China, and will be then used as a solid basis for the mitigation of the identified risks and the development of a safe restructuring plan, before staff, business partners and authorities will be involved.

Risk 5: Copy Paste Approach Fails in China

It is risky to simply copy and paste the compliance management system from the headquarter abroad and apply to the Chinese subsidiary. This approach will likely fail in practice. Typical examples: The online compliance training, which has been worked out by the headquarter abroad, fails in China due to technical intranet issues. The Global Code of Conduct is not available in Chinese language, or is just not binding due to specific effectiveness requirements under Chinese laws. The internal audit on the China business will be conducted by staff from the headquarter, who are not familiar with the Chinese language and the regulatory environment in China. The company either needs their own qualified internal audit team in China, or must involve external support. Further, the copy paste approach can’t address the operational risks typical in China. It would be ideal to use the headquarter’s compliance management system as the basis, and then to adjust it to the regulatory situation of the subsidiary in China. A solid compliance management system in China will be driven by transparency on the business partners, preventive protection tools and a rapid alert system.