WE ARE NOT ALONE It is common knowledge that doing business in China is challenging… but somehow these challenges can also make the average businessperson feel isolated, like they are the only ones struggling. Yet sometimes it’s good to be reminded that misery loves company and you are not alone. This is one reason business surveys are so popular in challenging markets like China – insight into what others are facing and how they are dealing with it can be extremely valuable. Since 2011, Control Risks has worked with the American Chamber of Commerce in Shanghai to produce their annual China Business Climate Survey, one of the longest running and largest surveys of multinational businesses in China (full survey here). One main purpose of the survey is to gauge multinational business performance and challenges in China, especially over time, as they change with the business and political environment. Another important purpose is to gauge the changing risk environment, with results pertaining to corruption risk, regulatory investigations and compliance. This year’s results are particularly interesting, given the especially piqued rate of change in China’s business environment in recent years. Overall, we found that MNCs are still struggling with the challenges of fraud and corruption in China but that China’s “new normal” is, in some ways, making things even more difficult. The survey also reveals that, while companies are taking compliance very seriously, they may be missing some of the key mitigation strategies to even further protect them in this challenging market. A PERFECT STORM China today is very different from what it was even a few years ago. We are now under what Chinese leaders are calling the “new normal,” which started in early 2013 when President Xi Jinping let it be known that his Administration was not going to be business as usual. In a relatively short period of time, we have seen a series of sector investigations – in electronic consumer goods, dairy products, pharmaceuticals, automotive, computer software – and deep-dive probes into the Party to identify “disciplinary issues”. High-profile trials have ensued, resulting in Figure 1: Do you feel that you, as an MNC, are more likely to be targeted by regulators this year? Source: 2014-2015 China Business Climate Survey conducted in partnership between Control Risks and the American Chamber of Commerce in Shanghai since 2011. RISKY BUSINESS: SURVEY FROM CONTROL RISKS AND AMCHAM SHANGHAI SHOWS CONTINUED CONCERNS OVER CHINA BUSINESS CHALLENGES 10% 20% 30% 40% 50% 60% 70% 80% HEALTHCARE IT & TELECOMS AUTOS ALL RESPONDENTS ENERGY CONSUMER GOODS CHEMICALS ELECTRONICS MANUFACTURING SERVICE RETAIL 62.5% 60.0% 56.1% 52.0% 51.9% 51.0% 47.2% 45.2% 55.3% 47.6% 47.1% judgments with massive fines and lengthy jail sentences. When asked if this is just another campaign soon to abate, President Xi and others throughout the Administration have consistently indicated this is the new normal (新常态). Businesses now find themselves in the midst of a perfect storm of aggressive regulatory enforcement, a slowing economy and a still-maturing business environment where fraud and corruption are still quite common, as our survey strongly indicates. LET’S GO TO THE NUMBERS… Many facets of the new normal in China are reflected in our survey. On an economic level (Figure 2), rising costs were the #1 challenge for MNCs in China in 2014, as they have been for several years in a row, while domestic competition was named the #3 challenge. China is now becoming a “normal” economy, in which cost advantage is limited or gone, “blue ocean” opportunities are rare, and where increasingly, market gains must come from taking back shares from one’s domestic competitors, many of whom have moved up the value chain. Nevertheless, China still faces many of the integrity risks of an emerging market: corruption risk was the #4 challenge for foreign firms in China in 2014, up from #5 in 2013. In more developed markets, internal compliance practices generally keep up with a maturing economy, but in this respect China is still behind the curve. To make matters worse, the policy enforcement landscape has shifted since 2013 with the Xi Administration’s anti-corruption and anti-monopoly campaign. This has added greatly to corporate anxiety, with fully 52% of MNCs in China saying they feel more likely to be targeted by Chinese regulators this year than at any time in the past (Figure 1). 0% 20% 40% 60% 80% 100% RISING COSTS HR CONSTRAINTS DOMESTIC COMPETITION CORRUPTION/FRAUD FOREIGN COMPETITION IPR INFRINGEMENTS UNFAIR PROCUREMENT PRACTICES LACK OF INFRASTRUCTURE LABOR UNREST BUSINESS DISPUTES KEY SERIOUS HINDRANCE SOME HINDRANCE NO HINDRANCE 36.1% 54.9% 9.0% 32.5% 51.7% 15.9% 27.3% 53.6% 19.1% 14.5% 50.7% 34.8% 11.7% 51.2% 37.1% 14.6% 41.7% 43.7% 9.4% 38.3% 52.4% 8.5% 36.1% 55.4% 5.4% 33.9% 60.7% 6.1% 32.2% 61.7% 0% 10% 20% 30% 40% 50% 60% UNCERTAINTY AROUND CHINA’S ECONOMIC REFORM TRANSITION GREATER ATTENTION PAID TO COMPLIANCE EFFORTS RISK OF A SIGNIFICANT ECONOMIC SLOWDOWN IN CHINA GREATER RISKS OF LABOR/ BUSINESS DISPUTES GREATER RISKS OF EMPLOYEE FRAUD/MALFEASANCE NO GREAT CHANGE IN PAST 12 MONTHS KEY 2014 2013 2012 51.7% 45.4% 24.8% 48.7% 44.2% 36.6% 44.9% 34.7% 53.0% 25.7% 31.6% 28.0% 20.6% 21.5% 12.4% 20.6% 27.1% 21.0% Figure 2: Top Business Challenges among MNCs in China in 2014-2015 Source: 2014-2015 China Business Climate Survey conducted in partnership between Control Risks and the American Chamber of Commerce in Shanghai since 2011. Figure 3: Change in Business Risk Environment in 2014-2015 Source: 2014-2015 China Business Climate Survey conducted in partnership between Control Risks and the American Chamber of Commerce in Shanghai since 2011. SURE, WE’LL COMPLY… BUT WITH WHAT? This mix of corporate anxieties is also reflected in how survey respondents perceive risk in China. As shown in Figure 3, the economic slowdown has been a key source of uncertainty for foreign executives, yet they are even more worried about policy uncertainties in today’s business environment. From 2012 to 2013, “uncertainty around China’s economic reform transition” increased from 25% to 45%, reflecting the handover of power to Xi Jinping, and seems to have peaked last year at 52%. “Greater attention to compliance risk” also jumped up from 2012 to 2014, topping out at 49%. Lagging behind was “risk of an economic slowdown”, at 45% last year. As shown in Figure 4, an interesting development in the past three years has been the shift in concern from foreign compliance (FCPA, UK Bribery Act, etc.) to compliance with Chinese regulations. Additionally, 32% indicated a sharply growing concern over the risk of falling victim to Chinese enforcement of anti-corruption and anti-monopoly regulations, as shown below in Figure 6 (under “All Respondents”). As part of the new normal, Chinese regulators’ focus on the “rule of law” has often been at odds with the country’s vague legal code, making compliance just as much a political challenge as it is a legal one. While in many ways purely economic risk is more manageable to experienced global operations, the specifics of political risk are more opaque, less manageable and thus a greater source of uncertainty for MNCs in China. In particular, recent anti-corruption, anti-monopoly, environmental and food safety regulations have proven hard to predict, open to interpretation and at times selectively enforced against MNCs, thus resulting in greater attention paid to compliance efforts. NOT JUST ONE FLAVOUR Business leaders working in challenging markets like China know there is not just one form of corporate malfeasance, but that fraud and corruption come in a variety of stomach-churning flavours (as shown in Figure 5). Our survey shows an intriguing increase in MNCs’ concern over pressure to give sales kickbacks, against the previous survey leader, employee fraud. This makes sense: as the economy gets tighter and competition gets fiercer, the pressure to meet sales targets grows and it’s more likely that any and all methods will be considered to succeed. Another interesting finding from the survey is the relative lack of concern over the archetypal form of corruption in China, official corruption – including issues in government tenders, pressure to give kickbacks to customs and kickbacks in business registration. These three are some of the lowest of corruption concerns, with their respective trends either holding constant or decreasing. This is good news for Chinese government officials who are trying to clean up their own systems and improve their reputations. COMPLIANCE WITH INTERNATIONAL LAWS COMPLIANCE WITH CHINA'S LOCAL AND NATIONAL LAWS COMPLIANCE WITH YOUR ORGANIZATION’S CODE OF CONDUCT KEY 2014 2013 2012 29.4% 32.1% 37.3% 47.1% 46.8% 31.5% 23.5% 21.2% 31.2% 0% 10% 20% 30% 40% 50% 60% 0% 10% 20% 30% 40% 50% 60% EXTORTION AIC/BUSINESS REGISTRATION KICKBACKS PRESSURE TO GIVE KICKBACKS TO CUSTOMS GOVERNMENT TENDERS (STATE PROCUREMENT CONTRACTS) PRESSURE TO GIVE SALES KICKBACKS EMPLOYEES DEFRAUDING THE COMPANY KEY 2014 2013 2012 56.2% 52.5% 50.0% 52.3% 55.0% 58.0% 22.9% 34.0% 22.3% 19.6% 23.1% 13.5% 10.4% 13.5% 11.9% 10.0% 12.5% 26.2% Figure 4: Types of Legal Compliance Most Important to Your Business Source: 2014-2015 China Business Climate Survey conducted in partnership between Control Risks and the American Chamber of Commerce in Shanghai since 2011. Figure 5: Top Corruption Concerns as They Affect Your Business Source: 2014-2015 China Business Climate Survey conducted in partnership between Control Risks and the American Chamber of Commerce in Shanghai since 2011. SECTOR SCARINESS One of the most striking results of the survey is when we break down the business challenges by sector, as shown in Figure 6. The healthcare sector – with its headline-grabbing stories about the travails of pharmaceutical companies – is by far the leader in terms of concern over regulatory investigations in China. We’re also seeing worries from consumer goods and automotive, two other sectors that have been in the news in China over the past year. Interestingly, one of the most highly-regulated sectors in China, energy, shows one of the lowest concerns over regulatory enforcement, despite the authorities’ crackdown on energy giants among Chinese state-owned enterprises (SOEs). The feeling among energy MNCs seems to be the crackdown is more politically motivated – an aggressive move to start cleaning up key SOEs and get them in line with directives from the Party apparatus – rather than purely a sectoral sweep. This position has its merits; however, our experience with Chinese regulatory enforcement is that the authorities tend to target whole sectors, and if one company gets hit, its industry peers should be looking over their shoulders. HOW THEN SHALL WE LIVE? So… challenges certainly abound, this much is clear. But what are companies doing about it? We asked how companies are responding to fraud and corruption risk according to the list of “adequate procedures” recommended by FCPA and the UK Bribery Act. Not surprisingly, nearly 60% of respondents said “improving our compliance programs” – a response that saw the greatest jump over the previous year’s survey – followed by “increasing/improving ethics training” at 49%. However, in a market like China where we find such active circumvention of compliance rules, simply doing more training is not enough; rather, companies need to put in much more proactive measures to prevent issues from happening. Unfortunately, the four procedures we find most effective are not widely used in China: • Third party due diligence (24% of respondents) programs must go beyond simple self-reporting and online searches. Critical distributors and key partners should be thoroughly vetted through discreet market enquiries to assess whether they do business in an ethical manner. • Implementing stronger monitoring programs (20%) is critical these days because, frankly, many employees in China know how to “cook the books” and simple statutory audits are not going to catch the problems before you know about them. Best practice in China today relies on regular and focused monitoring of big-ticket items, such as sales/marketing activities and travel/entertainment expenses, along with data mining of trends in sales and expenses to identify any anomalies. • Improving the ‘tone from the top’ on compliance (17%) consists of much more than senior leaders talking about how important compliance is. That’s easy. An effective message is saying: “Compliance is so important to us that, if being compliant means our business shrinks a bit or we can’t pursue certain opportunities, then so be it!” The “top” of a company sets the strategy, and if compliance isn’t baked into that strategy from the very beginning, then those down the corporate ladder have very little chance of being compliant when they seek to execute that strategy. • Implementing risk assessments (15%) showed a disappointing result in our survey, but based on our experience, this is less than surprising. We find that many companies do not really understand where their key risks lie in a market like China. For example, some don’t have enough details about their sales activities and customer engagements to know if bribes and kickbacks are common and in which parts of the market these occur. We find that, when companies step back and do a thorough assessment of where they are most likely to be threatened with compliance risk, plan their mitigation strategies against that threat and respond to the ensuing risk, they have a much better compliance record. Clearly, MNCs in China continue to work in a challenging business environment. While most are still performing very well, the “immature” market environment is putting significant pressure on them to comply with both local and international regulatory requirements. We believe that, in such an environment, MNCs need to use every tool at their disposal to better understand their markets, map out how they work in them and identify gaps they can close in order to build a stronger, more sustainable business.