04 March, 2021
Ever since it was first announced, China’s Social Credit System (SCS) has been expanded and further developed. Following signing of the EU-China Comprehensive Agreement on Investment in December 2020, foreign investors doing business in China should pay particular attention to the ongoing implementation of the SCS and the implications it could have for their operations.
Since 2007, the Chinese government has been developing a national system to standardize the assessment of individuals’ and companies’ economic and social reputation (“social credit”). The system is intended to track and evaluate the economic and non-economic behavior of people and organizations, thereby enabling the government to better regulate markets and business in China. The SCS applies to both individual citizens and corporations. This article focuses mainly on corporations.
The SCS is mainly comprised of three interconnected components:
To better understand how the SCS works, let’s consider a real-life example. An international company operating in China was punished by the local environmental authority for its non-compliant behavior in the area of environmental protection. The company then submitted a bid for a government project, but was rejected by the local government in accordance with the interministerial memo that called for joint measures to be taken against the company and that deemed it a distrusted enterprise in the area of environmental protection.
Here is a summary of the regulatory areas in which the relevant governmental institutions may enforce compliance:
Generally, all business entities registered in China are covered by the SCS, including subsidiaries, branches, joint ventures and other operations. Each government authority lays out its own measures (e.g. punishment) to be taken against companies which engage in non-compliant activities. It can lower their credit scores in the respective regulatory areas, or even put them on a blacklist, which could trigger joint punishment by other regulatory authorities. Similarly, businesses with favorable credit scores (i.e. those on a redlist) may receive beneficial treatment from the authorities for their operations, such as fewer government inspections and faster approval processes (e.g. for obtaining a business license or establishing a joint venture).
Since each government level (state, province, city) and different regions can lay out their own regulations and policies regarding the SCS, the possibility exists that government information on multinational corporations (MNCs) may be incomplete and discrepancies could exist across the regions implementing the SCS, making it difficult for MNCs to be fully compliant with it. What adds to the complexity is that the credit scores of various entities could also be affected by the personal credit ratings of top-level management such as board members and the credit scores of business partners such as suppliers.
At the same time, many uncertainties about the SCS must still be clarified. A few examples:
The SCS clearly introduces a range of challenges that companies must address. However, it also offers an opportunity for them to review and refresh their internal and external compliance policies. Here are a few tips on how to proactively prepare and successfully enhance any changes that must be made: