Before China’s president, Xi Jinping, came to power last year, there was much speculation over what type of leader he would be and how he would tackle the massive task of restructuring the economy. A year into his reign, an unmistakable picture of his modus operandi is emerging. Xi seems to aspire to become a political strongman, of the sort that has led every previous major economic change in China under the Communist Party (CCP). The past year has been marked by his consolidating personal power over the state, the media and the military. This exercise of control is not arbitrary. It is a sort of insurance policy for the change and uncertainty that is bound to be unleashed by the economic transition, to ensure the stability of the country and the continuance of the CCP at its helm. Indeed, two key outcomes of last year’s Third Plenum spell this out: a new government body with a specific mandate to oversee economic change, the Leadership Group, was created simultaneously with a new internal security mechanism, the State Security Commission. Xi will head both entities. Sustained corruption purge This is relevant background to another development that has surprised many China watchers over the past year: the sustained corruption purges of government officials up and down the party hierarchy. Without any fundamental change in the rule of law or the independence of the press, these purges may seem like superficial remedies for China’s deep-seated corruption problems. But they make sense when viewed in the wider context of Xi’s dual strategy – to consolidate control before instigating major change. It is no coincidence that the most significant of the officials embroiled in these purges is Zhou Yongkang, the former security tsar of the country. Not only did Zhou amass considerable power over China’s internal security forces during his time in office, but he also had extensive interests in the oil and gas sector. Xi’s targeting of Zhou, who is now rumoured to be under house arrest, allows him to exert his own control over Zhou’s former security domain. It also sets the scene for later challenges to vested interests in the powerful oil and gas sector; such challenges are seen by most as a critical – and difficult – part of the restructuring. For these reasons, the corruption purge is likely to continue. Internal party discipline, as such campaigns are sometimes called, remains one of the few tools the CCP has to regulate the behaviour of its own members. Moreover, unlike equivalent regulatory action in developed democracies, the CCP’s discipline is often more influenced by opaque and internal political reasons, rather than law. What this means for foreign companies in China, or indeed anyone operating there, is the prospect of prolonged, sustained and unpredictable risk of official and regulatory sanctions for the foreseeable future. While it may be too early to surmise exactly what form these risks will take, some common themes have emerged from the past year of investigations and they are worth highlighting. The “tigers & flies” approach As part of the corruption purges, Chinese officials have vowed to investigate and prosecute both ‘tigers and flies’, meaning both high- and low-ranking officials. This is significant because these investigations have a tendency to spread. Evidence of wrongdoing involving a lower ranking official often leads authorities to their political patrons. Such investigations become high-profile affairs that can embroil many other entities and even whole industries. This was evident in the prosecution of former Chongqing party secretary, Bo Xilai in 2013, which started with controversies surrounding his underling, Wang Lijun. It was repeated in the case of Zhou Yongkang, which has seen many of his less-powerful associates and former protégés investigated first. Current developments suggest that these investigations are spreading out further, and will draw in a wider pool of private sector companies and their principals. The trickle-down effect will mean that the investigations will inevitably spread to associated sectors, including suppliers to, and investment partners of state-owned oil companies. These actions may have an even wider significance. While Chinese authorities focus on domestic officials who receive bribes, they will inevitably try to identify the bribe-payer as well, who is often named in formal records. In our experience, this is often the most direct and concrete evidence of wrongdoing. Nor are due diligence companies the only ones to take note: overseas anti-corruption agencies have stepped up enforcement in relation to operations in China in recent years, and Chinese prosecutions generate some of the best leads for their further investigations. Sector sweeps Over the past few years, the US authorities have begun to use industry sweeps to ferret out corruption across a given sector. The Chinese seem to be following suit. The National Development Reform Commission (NDRC), China’s anti-competition body, which led the probe into the pharmaceutical industry has already declared publicly that it will launch similar investigations into other sectors. They have named telecommunications, banking, automotive, household chemicals and appliances as those on their immediate agenda. Again, these can be linked to the reform agenda and, as such, are likely to be sustained initiatives. As the country moves away from a state-led and investment-heavy development model, the NDRC, which was originally envisaged as a centralised planning agency, faces a reduction in its power and even questions over its relevance. Indeed, the NDRC’s authority is set to be trumped by the newly created Leadership Group. Some analysts believe that the NDRC has reacted by strengthening its role as a regulator, exerting its influence over traditionally commercial domains, such as pricing of consumer goods. This shift also serves another political purpose. It is a highly visible and populist move that bolsters the government’s standing among the Chinese people, which in turn helps to maintain control and stability. The industries currently under scrutiny appear to have been targeted because of a desire to reduce public spending and costs for consumers. Therefore other industries with similar characteristics can expect to be targeted in the future. Practical steps There does not seem to be any end in sight to this sustained enforcement in China and many companies operating there are taking the opportunity to reflect on their approach to compliance. The latest probes highlight a handful of areas where teams should focus their effort. - Control over third parties is one of the biggest issues for legal and compliance teams worldwide. In China, where more third parties are used than elsewhere, and those third parties often rely on a network of their own third parties to deliver services and products, the problem is even more complex. Press articles claim that GlaxoSmithKline alone had as many as 700 different tour companies on its books, some of which acted as conduits for paying bribes. While it can be difficult to drive down this number, efforts to do so are worthwhile. - Conduct background checks on third parties – and update them periodically. This will help to highlight any issues up-front and identify any later changes that might be a cause for concern. Where there is interaction with the government, this is particularly important. Ensure that there is a well-thought out and documented plan if the authorities come knocking. The challenges of conducting investigations in China are widely reported. By Rebecca Palser Director, Head of Hong Kong Office and Nancy Zhang Senior Associate, China Team
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