China Tightens its Environmental Law Control over New Investment Projects

Environmental protection in China has traditionally been ineffective because of a disconnection between environmental law and its implementation at the local level. Although the State Environmental Protection Administration (SEPA) has the responsibility to conduct unified supervision and management of environmental protection at the national level, the responsibility for local enforcement remains with local governments' environmental protection bureaus. In their eager pursuit of economic development and outside investment ­ particularly from multinationals ­ local governments are often willing to overlook environmental non-compliance, resulting in local asylum for non-complying enterprises.

SEPA announced in January 2007 that it has withheld approval of industrial projects belonging to certain geographic areas or enterprises with previous projects that have seriously violated environmental law, until such environmental
violations are resolved.

On another front, SEPA is teaming with the People's Bank of China (PBOC) in a joint initiative to include the environmental records of enterprises in a nationwide corporate credit system. Once the system goes into effect on April 1 2007, commercial banks will be requested to consider the environmental records of potential borrowers as an important factor in lending decisions.

NEW ENFORCEMENT Efforts

Blanket Suspension of Approvals

On December 13 2005, the State Council issued
the Decision to Implement Scientific Development and Increase Environmental Protection (the Decision), setting forth certain environmental protection measures regarding, among other things, all new, expansion or modification projects. Specifically, Article 21 of the Decision provides the following:

¡P For geographic areas with serious environmental damage, approval of industrial projects having potential adverse environmental impact shall be suspended.

¡P A unit unable to comply with emission limits should restrict production or emission, and shall not undertake additional industrial projects having potentially adverse environmental impacts. If compliance is not achieved within a prescribed time, the unit shall stop production.

¡P If an industrial project was launched or put into production without undergoing the requisite environmental impact assessment, the construction or production must stop and an environmental impact assessment shall be taken. An inquiry shall be conducted to identify persons responsible for the non-compliance.

Based in part on the policy in Article 21, SEPA announced in January 2007 that it has ­ for the first time ­ suspended the approval of all industrial projects having potentially adverse environmental impacts in four cities because the cities have suffered serious environmental damage, and can no longer endure such heavily-polluting industries. SEPA also suspended the approval of all industrial projects with potentially adverse environmental impacts by four large power producers, because of past projects that were not in compliance with environmental impact assessment requirements. In total, in January 2007, SEPA blacklisted and exposed 82 projects (with a total investment of US$14 billion) because they seriously violated environmental rules. SEPA further revealed that in 2006, it suspended 163 projects (with a total investment of US$96 billion) because they were heavily polluting and energy hungry.

No Lending to Enterprises with Poor Environmental Records

Article 23 of the Decision provides that credit, land-use permits and company registration shall not be granted to enterprises not in compliance with environmental law.

Article 23 is consistent with a circular¹ issued on April 30 2004, which provides that financial institutions must not extend new credit to projects that gravely pollute the environment or damage the environment, and that the loans previously granted to projects that gravely pollute the environment must be repaid in full, despite mandatory closure of such projects.

To implement Article 23, SEPA and the PBOC are conducting a joint initiative to include enterprises' environmental records into the PBOC's national credit database. Specifically, information about enterprises' environmental compliance collected by SEPA in enforcement activities since 2003 would be included in the database. After the nationwide corporate credit system goes into effect on April 1 2007, commercial banks will first check and consider the environmental records of enterprises applying for loans before making lending decisions. According to SEPA and PBOC, the initiative not only protects the environment but also protects commercial banks from risks of lending to enterprises with projects that contravene environmental law, since such projects may be halted for environmental non-compliance.

Alleged Environmental Non-compliance by Multinationals

In October 2006, the Chinese media reported certain alleged environmental violations of 33 foreign invested enterprises (FIEs) in China, generating negative publicity for the multinational parent corporations of the FIEs. Many of the named multinationals are well-known brands, including five corporations on Fortune's Global 500 list. According to news reports, the alleged environmental violations of the 33 FIEs ranged from above-limit discharge of polluted waters to non-compliance with environmental impact assessment requirements.

The reports quoted environmental authorities as explaining that the alleged environmental violations occurred because some FIEs have quickly and substantially adopted Chinese characteristics in their management and operations in China, thus deviating from and falling below the usual high standards of environmental conduct of their parent corporations at home. The environmental authorities noted that multinationals are tempted to take on local characteristics because they wish to compete against local enterprises, and because local governments are often eager to attract and accommodate foreign investment by being lenient.

CHINESE ENVIRONMENTAL LAW

Environmental Legislation

Primary environmental legislation includes:

¡P PRC Environmental Protection Law (1989)

¡P PRC Environmental Impact Assessment Law (2002)

¡P Law on Prevention and Control of Atmospheric Pollution (2000)

¡P Law on Prevention and Control of Water Pollution (1996)

¡P Law on Prevention and Control of Environmental Pollution by Solid Waste (1995)

¡P Law on Prevention and Control of Pollution from Environmental Noise (1996)

Environmental Impact Assessment Requirement

One of the requirements of Chinese environmental law most relevant to multinationals planning to set up operations in China is the environmental impact assessment (EIA) requirement.

Specifically, before the start of any industrial project within China, the PRC Environmental Impact Assessment Law requires an objective EIA to be conducted in order to analyze, predict and appraise the potential environmental impacts of the project, to enable the relevant environmental authorities to determine the approvability of the project, to allow the enterprise to propose countermeasures for preventing or mitigating the adverse impacts, and to allow for follow-up monitoring.

Depending on the level of potential environmental impacts, one of three classifications of EIA documents must be submitted for approval:

(i) If the environmental impacts are expected to be significant, an EIA report including an all-round appraisal of the environmental impacts must be submitted, and must contain among other things:

¡P an analysis, prediction and appraisal of the environmental impacts that may be caused by the industrial project;

¡P the measures for protecting the environment of the industrial project as well as technical and economical demonstrations; and

¡P suggestions for carrying out environmental monitoring over the industrial project.

(ii) If the environmental impacts are expected to be moderate, an EIA report form including an analysis or special appraisal of environmental impacts must be submitted.

(iii) If the environmental impacts are expected to be minimal, an EIA registration form should be submitted.

Three Simultaneous Requirements

Another requirement of Chinese environmental law with relevance to multinationals setting up operations in China is the Three Simultaneous Requirements.

Under Article 26 of the PRC Environmental Protection Law, installations for the prevention and control of pollution at an industrial project must be designed, built and commissioned simultaneously with the design, construction and operation phases of the project. During the design of the project, the designs of the installations for the prevention and control of pollution must be submitted to the relevant environmental authority for approval before construction may be commissioned. During construction, relevant installations must be set up to prevent and control pollution caused by construction. Finally, the prevention and control installations must be put into operation simultaneously with the project's launch, and may not be dismantled or left idle without authorization.

Legal Liabilities

An enterprise that is not environmentally compliant can incur a range of administrative, civil and criminal liabilities, depending on the severity of the resulting harm, under the relevant laws and regulations.

¡P Administrative Liability: As enforced by environmental authorities, this may include fines ranging from Rmb50,000 (US$6,000) to Rmb200,000 (US$25,000) as well as suspension of the project, for projects that violate EIA requirements.

¡P Civil Liability: A violator that causes environmental pollution has the obligation to eliminate the pollution and to compensate aggrieved parties for their direct losses.

¡P Criminal Liability: In cases where a violation causes a serious environmental pollution accident leading to heavy losses of property, injury or death, the violator shall be subject to criminal liability and may be fined and/or imprisoned for up to seven years.

RECOMMENDATIONS FOR BEST PRACTICE

The significance of Article 21 of the Decision and the related SEPA enforcement measures cannot be understated. An enterprise may be punished with blanket suspension of approvals for all its major projects because of the environmental non-compliance of even one of its projects. Even worse, any enterprise may face a suspension of approval for its industrial project in an area simply because of the poor environmental protection record of a local government that has brought punitive actions from SEPA against it.

The inclusion of environmental records of enterprises in the upcoming national corporate credit system is also a significant development, particularly for enterprises planning to rely on credit from onshore commercial banks. Enterprises with poor environmental compliance records may face denial or restriction of credit, or unfavorable interest rates and other terms when attempting to borrow onshore.

Of course, beyond the legal liabilities and consequences, the negative publicity that may arise from environmental non-compliance should not be overlooked ­ especially in light of growing public awareness of environmental issues. Multinationals should be particularly cautious, since the public abroad and in China tend to hold multinationals to a higher standard of conduct, due to a higher level of recognition and the perception of a greater capacity to comply.

As such, it is advisable that multinationals adopt the following best practices when setting up operations in China:

¡P Conduct full environmental, health and safety (EHS) due diligence before setting up an operation.

¡P Be proactive about environmental compliance, and establish effective internal monitoring, control and training systems to guard against environmental pollution and accidents.

¡P Strictly comply with environmental laws and regulations, including the EIA and Three Simultaneous Requirements, regardless of how accommodating or lenient the local government may be.

¡P Avoid taking on characteristics of local enterprises when it comes to environmental compliance. To as great an extent as possible, include environmental obligations into the corporate code of conduct and enforce the code uniformly at home and abroad, and minimize any deviation between environmental conduct at home and in China.

¡P Be selective about the area in which to construct projects, taking into consideration the integrity of the local government's environmental protection history, and the consistency of its implementation and enforcement of environmental laws and regulations.

¡P Have definitive documents (such as the investment contract in the case of a wholly foreign-owned enterprise, or the joint venture contract in the case of a joint venture) ready, and secure the endorsement of such documents by the relevant environmental authorities in addition to other government authorities, so as to prevent environmental challenges or the reopening of environmental issues at a later stage.

FUTURE LEGISLATIVE DEVELOPMENTS

In response to rapid economic growth at the expense of China's environment in the past decade, along with the total failure to meet 2006 national targets for pollution control and energy conservation, SEPA has formed a task force to study and propose possible amendments to China's PRC Environmental Protection Law, which has not been amended since its promulgation in 1989. The major legislative changes under serious consideration by SEPA include the following:

¡P Local governments/officials shall assume clearer and higher responsibility for environmental protection and thus will be held more accountable for failure to meet environmental protection targets, for cross-border environmental disputes, for interference with law enforcement, for decision-making mistakes leading to significant environmental accidents and for apparent omissions in fulfilling environmental protection responsibilities.

¡P Blanket suspension of approvals for new industrial projects in blacklisted areas, an interim harsh measure first adopted by SEPA in early 2007, will become a permanent part of the new regulatory regime for environmental protection.

¡P Liabilities of provincial governments/officials and polluting parties for cross-(provincial) border pollution damage and intra/inter-province monitoring/coordination system for environmental protection will be established.

It remains to be seen when and how these and other aggressive proposals will become law to effectively counterbalance the seemingly irreversible trend of economic growth over environmental concerns. Until then, active compliance with existing legislation and sincere efforts towards best practice by domestic and foreign businesses alike can go a long way in the protection of China's environment.

The author would like to thank Ken Chang and Guan Yang for their contributions to this article.

Endnotes

1. Circular on Issues Regarding Better Coordination and Balance between Industry Policies, Lending Policies and Control of Credit Risks, jointly issued by PBOC, the State Development and Reform Commission and China Bank Regulatory Committee on April 30 2004