In 2014, the Chinese government announced a plan to set up a social credit system by 2020. It will be a reward and punishment system to promote trustworthiness and integrity, aimed at improving governance. While a lot of commentators are talking about this system as some sort of a doomsday system, the reality is that it is a lot more similar to financial credit checks but with a wider coverage. Thus, companies that are trading with, have a presence in, or looking to move into the Chinese market, need to be aware of this new social credit system. Today, more than 40 different government or private social-credit systems are operating across China. These systems monitor and collect data on individuals and companies. Participation in such private and government systems is seemingly voluntary. However, in the future, the official social credit system will most likely be mandatory.
What is the Social Credit System?
When fully implemented, the social credit system will be a nationwide scoring system allowing the government to rate a citizen or a company's trustworthiness beyond their financial creditworthiness. Launched in 2014 as a roadmap to build a system with mechanisms for rewarding trustworthiness and punishing untrustworthiness, China's social credit system is still in the development stage.
Like many developing countries, China’s economic growth has outpaced its ability to create and police institutions that promote trust between citizens, businesses and the government. China has also undertaken major legal and regulatory reforms as it integrates into the global trading community. While some of those changes targeted inward investments and cross border movement of goods, a large number of changes also aimed at policing the way their own citizens and Chinese-owned companies behaved. However, enforcement remains a challenge.
Chinese citizens maintain a healthy distrust of companies. Recalling the 2008 Chinese milk scandal where infant formulas were adulterated with melamine, Chinese parents remain, to this date, distrustful of the country's dairy industry, and other food producers, as evidenced by the huge volumes of such products purchased by Chinese citizens on overseas trips to Hong Kong, New Zealand and Australia. And despite the progress made by China's government in reforming intellectual property protection laws, regulations and processes, China is still considered the counterfeiting capital of the world.
At the individual level, due to scams and fraud, there is also a lack of trust between individuals.
What happens if you are blacklisted?
As the new Social Credit System does not fully exist yet, it is difficult to assess the full impact on Chinese citizens and companies. However, it would be instructive to look at the various private and government systems currently in place.
The 2018 annual report released by the National Public Credit Information Centre (NPCC) stated that over 3.59 million Chinese enterprises have been added to the official creditworthiness blacklist. For example, a health care product maker, which was accused of making false marketing claims about the benefits of a product that a young cancer patient took, was added to the creditworthiness blacklist. A Chinese vaccine manufacturer, was fined US$1.3 billion and was added to the creditworthiness blacklist.
Being on the blacklist means that:
- Companies can lose out on government contracts and bank loans, and be restricted from importing goods.
- Individuals could be banned from a wide range of activities, including travel restrictions. Employees may also be prevented from representing companies or taking senior management roles.
Currently, the various private and government systems do not provide official advance notification to a person or company of their creditworthiness status, and there is little a blacklisted company or person can do to get off the blacklist. There is, however, a little relief under the government systems as removal from the blacklist may simply involve paying delinquent bill(s) or appealing to the court.
What companies should look out for?
The social credit system is already in place in various permutations, and will continue to be developed more expansively into a nationwide system. For businesses, there are potential areas of risk to their operations.
As the government system develops, we expect to see more linkages from the various private sector systems to the government system, giving the government access to a colossal amount of data on citizens and local companies. Inferring from the types of punishment currently being applied, individuals and companies may be prevented from undertaking certain normal activities.
The following are some scenarios that may happen and companies should prepare for:
- A key employee whose role involves substantive domestic and international travel gets blacklisted. The blacklisted person may not be allowed to travel via air or high-speed train, and may not be able to act on behalf of the company in discussions with government departments such as China Customs or the State Administration of Taxation. The employee may be unaware of the blacklisting until booking a flight or making a customs import declaration.
- A manufacturing company in China is either outsourcing some of its manufacturing to a third-party, or sourcing parts and components from a local third-party supplier. The third-party gets blacklisted and is no longer able to complete its obligation to supply the manufacturing company. If this third-party is a key component supplier and is supplying on a just-in-time basis, the manufacturing company may have to close its production line until it finds another supplier or it tries to help the third-party clear itself off the blacklist through the payment of fines or unpaid bills.
- A company outside of China has contracted with a company in China to be the importer and distributor of their product in China. The Chinese company gets blacklisted and is no longer able to import products or make payments to the supplier of the product.
If the above scenarios occur, the damage to an unprepared company may be substantive. Companies may take the following actions to mitigate such risks:
- Contractual agreements with third-parties and employment contracts should contain provisions dealing with situations of blacklisting.
- Due diligence on a new employee or new third-party service provider should include reviews of the government blacklist(s), if available.
- The company's quality/internal controls should cover regular updates of the blacklist(s).
- Ensure that there is a suitably qualified and approved person who can immediately assume the duties of the blacklisted person. Consider appointing more than one third-party supplier of key components so if one is blacklisted, the other(s) can immediately take over.