Foreign investors in China often face a dual challenge: Accomplishing turnover expectations in a competitive and volatile environment and keeping clean in a market where fraud and corruption are key business risks for foreigners.
Foreign companies that do not comply with Chinese regulations against fraud, corruption, and kickbacks face the risk of penalties, imprisonment, and loss of reputation. Recent cases show that the establishment and enforcement of robust compliance structures in China have become essential for foreign companies.
Compliance Risks in China
The 2011 Corruption Perceptions Index, released by Transparency International, shows that corruption is a substantial risk for foreign investors in China. The same applies to fraud, kickbacks, and other malfeasances. There are several reasons why many foreign companies face higher compliance risks in China than in their domestic markets.
Foreign companies that struggle to meet their turnover targets in China face the risk of paying less attention to their compliance policies as they perceive compliance to be a disadvantage. Local sales teams under turnover pressure then continue to make illegal payments to business partners to secure sales and save their jobs.
However, there are also successful and fast-growing foreign companies that have a poor internal compliance infrastructure as they do not have the right people or enough time to implement compliance tools that maybe already work well abroad and in the Chinese headquarters, but not in the new operations in second and third-tier cities. Foreign companies that are affected by fraud, corruption, and other malfeasances usually have poor compliance structures, which results in weak internal controls and training, and insufficient screening of staff and third parties, like agents, suppliers, local accountants, or other relevant key people.
The lack of solid compliance tools may lead to higher risks in China than in other countries, as foreign managers perceive the country to be a market where a lack of transparency combines with an aggressive business culture. Moreover, the way of doing business locally is often linked to personal connections (guanxi), which can lead to a culture of offering inappropriate gifts (like the cash-stuffed “hongbao” envelopes) and an excessive client entertainment culture.
Foreign companies and their management teams that do not comply with Chinese regulations, especially with those against fraud and corruption, can face liability risks which may trigger high penalties, imprisonment, and damage the reputation of the firm and its people. Non-compliance may also have a negative impact on future coordination with Chinese authorities when the foreign company applies for approvals, licenses, and registrations – these are required in China to do business and can take time to receive even under the best of circumstances.
Chinese regulators show a high interest in combating fraud, corruption, and other malfeasances – which is reflected in a number of regulations in the Criminal Law, Company Law, and in other areas of Chinese laws.
In 2010, the Chinese Central Commission for Discipline Inspection released a set of rules containing a list of prohibited activities for public officials, mostly in the area of corruption. In 2011, the Criminal Law was amended so that for the first time the bribery of foreign public officials or officials of international public organizations was criminalized. The bribery of Chinese government officials was already subject to Criminal Law and can trigger generally higher sanctions than the bribery of foreign public officials. There are still uncertainties with regard to the precise scope of application of this amended regulation.
The Company Law contains a precise catalog of forbidden activities for the directors, supervisors, and senior managers of a company, including the misappropriation of company funds, kickbacks, bribes, or other illegal income. In addition to the sanctions listed under the Criminal Law, directors, supervisors, and senior managers who do not comply with these duties may face liability compensation if their misbehavior causes damages to the company and further requirements have been fulfilled.
Given that certain liability risks are barely insurable under Chinese laws, it is essential for foreign investors to work out appropriate strategies for the mitigation of these risks.