China's Corporate Social Credit: a Comprehensive Compliance Enforcement System

The system comprises three parts: a national database of social credit information; a blacklisting system that allows government agencies to penalize companies performing badly in terms of compliance with relevant rules and regulations—various levels of government agencies have issued hundreds of blacklists; and an information sharing system that enables multiple government agencies to jointly impose enforcement against companies on any blacklist.

Under the corporate social credit system, multinational companies are subject to approximately 30 different regulatory ratings and compliance records based on 300 rating requirements, from tax and customs compliance to environmental protection, the report says. The vast majority of these are not new. Since 2013, China has published approximately 350 documents at national level and over 1,000 documents at the local level outlining the system.

But so far there has not been a centralized scoring system—the existing national database publicizes company data, such as personnel and financial information, but does not score companies. That, the EUCCC said, will soon change. In July, the State Council issued a guidance document on corporate social credit system that included a proposal to "further develop a comprehensive evaluation system of public credit." The EUCCC said this suggests that the government plans to launch a so-called "meta-score" for every company, integrating all scores and data compiled on a company by different government agencies into one single score. This score would then affect all facets of a company's operations, from its interest rates to the ease with which it can apply for various licenses.

Others have different interpretations of what the government means by "comprehensive evaluation". Jeremy Daum, Senior Fellow at Yale University's Paul Tsai China Center and leading expert on China's social credit, does not believe the July guidance document proposed a single score system; instead, he thinks the government refers to the comprehensive monitoring of companies that is already happening.

Even if there is a meta-score system, it is unlikely to be a 'one-number-to-rule-them-all' type of thing, said Kendra Schaefer, head of digital research for consultancy Trivium, which released its own report on China's social credit system. Schaefer said that China is currently using other scores such as state agency grades, industry grades and third-party credit agency grades to assess companies and that a single rating scale for all Chinese companies would be too difficult to create given how many companies and sectors are in the country.

"You can make a single scale that's incredibly complicated or you can make a single scale that's stupidly simple, neither of which are very useful," she said.

Apart from a meta-score system, the corporate social credit system also gives foreign companies other things to worry about as it effectively entangles companies' social credit with their personnel's. The EUCCC report highlights the example of a tax rating program introduced by the State Administration of Taxation in 2014, whereby a company registered or operated by someone with an "abnormal" individual tax rating automatically receives the same bad rating, while a badly rated company will also cause the downgrading of ratings of its key executives.

Corporate social credit therefore has the potential to detrimentally affect the personal lives of company employees. A company's credit is affected also by the credit of its business partners, which means that company personnel will not only be held responsible for their own company's wrongdoings but also those of their business partners. This makes due diligence and the thorough vetting of a foreign company's partners in China a much more important task as the costs of not doing so properly are higher than before.

But most multinationals are not alert of these potentially dire consequences. The EUCCC said in its report that the overwhelming absence of preparation by the European business community is deeply concerning. A survey conducted by the German Chamber of Commerce found that almost seven out of ten German companies in China are unfamiliar with the system.

The corporate social credit system has not had a lot of impact on foreign companies operating in China so far. But that will also change soon. According to Schaefer, more companies are expected to run into difficulties with corporate social credit once the system is fully implemented by the end of 2020. She also predicts a ramp-up of the system once it is fully rolled out next year, with its effects starting to bite in 2021 and beyond.

A national "social credit law" is being drafted which seeks to standardize the social credit system's implementation across the country, according to a State Council announcement on Sep. 2. It might also help increase awareness of corporate social credit as there has yet to be a single document mapping out the corporate social credit system for foreign companies to refer to.

So how should foreign companies approach corporate social credit? For one thing, they should not be entirely fearful of it. An overarching theme of the corporate social credit system is transparency, Kobre & Kim's Wu said. More data than ever before on companies in China will be publicly available and easily found. This means that foreign companies can take advantage of the system in various ways. For example, they can conduct due diligence on potential business partners and suppliers more easily because of all the information available on companies.

Gary Gao, Shanghai-based head of compliance at Zhong Lun Law Firm, recommends companies set up internal compliance systems that establish a "fire-wall" between the company and its personnel, especially the senior executives, and take out directors and officers liability insurance policies. "The insurance will establish the boundaries between the legitimate cause for indemnification or reimbursement and the (company) directors' or officers' own misconduct," Gao said.

Gao also suggests foreign companies communicate constantly with local authorities about their performance under the corporate social credit system as compliance requirements may vary in different parts of the country.

Wu echoes the point, suggesting foreign companies take a "localized approach" to compliance matters. This includes relying more on on-the-ground legal and compliance teams and consulting local experts to help design compliance programs tailored to address corporate social credit issues. That way compliance operations are not centralized at corporate headquarters but flexible enough to be able to adapt to the nuances of local conditions.

"The social credit system puts the onus on companies to see how they can improve their ratings," Wu said. "It will help them have a holistic picture of how the government is looking at their business operations."