Visits first by police, and then by senior government officials, to US consultancy Bain & Company’s Shanghai office hint at a “back-and-forth” discussions on security and economics within Chinese Communist Party (“CCP”) policy circles.

This policy tussle has created uncertainties for business, but executives should not over react. Whilst focusing on national security, the Chinese authorities are mindful that a balance needs to be struck, and foreign companies can still prosper in China, provided they carefully navigate a currently unpredictable policy landscape.

SVA is in a strong position to guide international companies past these pitfalls.

What has happened?

The Party Secretary of Shanghai’s Jing’an district, Yu Yong, visited Bain & Company’s offices in the city, and met with the firm’s managing partner Han Weiwen on 5 July 2023.

That meeting followed a series of raids targeting foreign consulting firms in the People’s Republic of China (“PRC”) in the spring of 2023 – including a police visit to the Bain offices in mid-April 2023. As such, the meeting hints at an “olive branch”.

Other companies have come under pressure. Auditor Deloitte Touche Tohmatsu had its Beijing operations suspended for three months in March 2023 owing to flawed auditing of brokerage China Huarong Asset Management.

Mintz Group, an American, due diligence provider, had staff arrested in April 2023, allegedly owing to inquiries in Xinjiang Uyghur Autonomous Region, and Capvision, a firm that operates an “expert network”, was reportedly also raided over national security concerns. The impact of these raids sent a shockwave through international consulting firms and due diligence providers, some overreacted and extracted their staff from the PRC.

Security first

What seemed especially worrying in April and May 2023 was that the raids were part of increased emphasis on national security.

Chinese Communist Party (“CCP”) General Secretary Xi Jinping commented in October 2022 as to the need to “shore up” internal security, and in March 2023 he called for closer coordination between development and national security in the context of rising tensions with the US.

Moreover, the National People’s Congress (“NPC”) passed a Counter Espionage Bill in early May 2023, which expanded the crime of espionage from theft of state secrets to the taking of “all data and items related to national security”. Such wide drafting bolstered fears of international businesses inadvertently falling foul of the new rules.

These actions appeared to underline Beijing’s desire to curtail outside access to financial and other information for national security reasons, and so stoked worries amongst foreign investors that a blanket of opacity was about to descend. The measures also posed broader questions about the treatment of foreign business and their ability to perform due diligence in the normal course of business.

It was in this context that foreign investors watched these raids with deep misgivings.

Striking a balance

However, the recent visit to Bain suggests that Chinese policymakers are aware of the need to strike a balance. The policy “pendulum” now appears to be swinging back towards the advocates of growth, as the cost of the “security first” stance is becoming dearer.

In particular, the visit hinted at awareness in policy circles that too overzealous an emphasis on national security may yet jeopardise China’s prosperity and stability, given weaker employment levels amongst university graduates, a flailing property market and rising local government debt, and concerns about a “balance-sheet recession”.

Moreover, the move hinted at a recognition that foreign investment and know-how remained important to China, especially as the government is seeking to engender an industrial shift in key sectors, such as electric vehicles, semi-conductors and aerospace.

The upshot

The threat from such raids is real, then, but is not perhaps as overwhelming as sometimes presented in the mainstream foreign media – particularly for companies in non-sensitive sectors.

Rather, what appears to be under way is a tussle for influence between camps within the Chinese Communist Party (“CCP”), comprising one group espousing even stronger national security and another seeking to bolster growth, faced with a faltering economy. Advocates of each camp endeavour to sway the party leadership, resulting in sometimes contradictory policy measures.

The impact

Policy contradictions will take a toll, for sure. A greater emphasis on security erodes foreigners’ willingness to invest; a survey in April 2023 noted that 27% of the members of the American Chamber of Commerce in China were prioritising other locations for investment, up from 6% a year earlier.

However, the CCP remains mindful of the need to maintain economic growth, and the Chinese economy is not going away, for all the talk of “decoupling”. Trade with Europe, Asia, and even the US, is extremely strong; and China’s growth rates are amongst the fastest in the world – reaching 4.5% immediately after relaxation of the pandemic restrictions early in 2023, if falling back in April 2023.

Should growth remain above 3% in the years ahead, the opportunities for investors will remain attractive, albeit in a prickly business climate.

What to do

The official visit to Bain thus hinted at policy divisions within the CCP, in part between those advocating security and those hoping to stoke economic growth. However, the visit also suggested that policymakers are seeking to strike a more effective balance.

Looking forward, policy “ping-pong” may become more frequent. Such unpredictability will undoubtedly pose challenges for business, but executives should not panic. Companies can navigate these uncertainties, by taking key steps such as:

• Continued adherence to robust due diligence standards is as important as ever. Boards should continue to require background information, and ensure that oversight is in the hands of a “neutral” party – not under the control of a local deal team. Investors seeking data may also have to work more closely with mainland or other firms in gathering detail. SVA are in a position to assist and to facilitate such services in an appropriate fashion.
• Analysing and auditing the structure of investments through the lens of (geo)political risk is crucial, so as to forestall threats. Such assessments should take place at a senior level, and on a group-wide basis, as needed, and should include re-examination of compliance and due diligence mechanisms, to identify possible liabilities. SVA are specialists in this area.
• Monitoring developments for further deterioration is essential, so as to ensure compliance with all relevant laws, and to protect a business’ interests and personnel. Such monitoring should be closely integrated into broader risk systems accessible to senior executives. Looking over the horizon is a necessary skill.
• Adapting board-level risk structures to take account of the reduced access to information and changing direction of trade and capital flows. A narrow focus on reputational and media issues, for instance, will not suffice in this much more complex environment. Retaining a specialist company to advise as to these risks is appropriate. SVA are available to assist and have handled many such assignments.
• Companies should carry out a review of regulatory risks, which should examine vulnerabilities in the event of the “weaponisation” of supervision and enforcement actions against particular business sectors. Executives should understand that failures could result in investigation or prosecution. Regulatory approvals may be of particular consideration when selling out of current investment or result in an inability to extract funds.
• Executives should examine the perceived “nationality” of a business, or its subsidiaries. Corporate restructuring to distance a business from a particular state may be wise, as may be partnering with local entities.
• Companies may wish to examine the citizenship of executives posted to China; those from the US or other western states may prove less able to protect a company’s interests than those from more “neutral” states. This appraisal should also take account of the risk of exit bans on executives.

SVA has much experience of assisting companies in navigating such risks, and can assist with any of the above.

SVA

SVA (www.stevevickersassociates.com) is a specialist risk mitigation, corporate intelligence and risk consulting company. The firm serves financial institutions, private equity funds, corporations, high net-worth individuals and insurance companies and underwriters around the world.

SVA has three core lines of business, which are: Business Intelligence and Political Risk; Corporate Investigations; and Special Risk. SVA also has a dedicated crisis management team which, for our retained clients, stands ready to assist companies during crisis situations.