China’s Current Business Climate: Questions Answered
Because of our vantage point as an international law firm, we frequently get asked questions by boards of established companies, startup founders, regulators, and reporters. Below are some of the questions about China we have received lately.
What is the threat level for foreign individuals and companies doing business in China, especially the risk of arrests and seizures?
We have not seen a significant uptick in the threat level within China since the Capvision Partners raid and the Bain & Company inquiry earlier this year. Keep in mind that arrests are not the same as temporary detainment and informal questioning, which can and do happen without any formal charges. Those are intended by local Chinese law enforcement to either investigate potential wrongdoing or just to intimidate those temporarily detained for questioning. This is considered a normal occurrence within China’s business community, including among PRC nationals who engage in foreign business.
How has China’s Anti-Espionage Law affected the business environment?
China’s Anti-Espionage Law essentially encoded portions of the written and unwritten law regarding the breadth of the national security umbrella. Prior to the passage of that law, virtually every Chinese law contained (and still contains) a provision regarding enforcement against any behavior that could be considered to negatively impactChina’s public security or national security. You can think of public security as a shortcut term for the CCP’s need to keep the peace at home, where national security refers to anything that the CCP considers as falling within China’s sovereign interests vis a vis other nations. This continues the trend of China’s rule by law rather than rule of law.
The law’s expansive definition of state secrets increases risks for foreign companies, especially those in sectors like technology, telecoms, chemicals, and transportation that routinely handle information the Chinese government considers sensitive. Violations can lead to prison sentences of up to 10 years.
What other factors are relevant for foreign individuals and companies doing business in China?
China’s general economic turmoil continues to rattle its domestic industries, and foster a business environment where a scapegoat other than the CCP needs to be targeted. The blame often starts at the national level, which then trickles to a blacklisted country’s businesses and then to its brands, and eventually to the employees in China. Japan, Korea, and Australia are frequent targets of this type of behavior.
It is not uncommon for foreign businesses to see decreased sales in China due to consumer boycotts. Both companies and foreign employees can become scapegoats tied to their home country’s diplomacy.
Are foreign companies more concerned about doing business in China compared to previous years?
We have not seen a major uptick in concern from foreign companies this year, but we have seen a steady continuation of concern growing among foreign companies. We are in the middle of a years-long process of maturing thoughts regarding the CCP’s way of doing business.
Many of our client inquiries lately have centered around getting better clarity around China’s risks and around securing their China business relationships. The slipshod way of doing business previously, assuming that China’s growth curve would always be positive, is no longer a reality for many businesses. We’re not in the early 2000s anymore. Companies are getting serious about registering and protecting their intellectual property, and many are seeking to unwind non-performing or risky joint ventures in favor of more arm’s length licensing and distributor relationships.
What factors increase the likelihood of becoming a target, either as a foreign individual or a company?
There are many ways to become a target, but most of them have been publicly telegraphed by the CCP for those who are paying attention. China’s Made in China 2025 priority industries and technologies have not changed, and anyone involved in these industries is especially in the crosshairs.
Those of us associated with countries and regimes that China considers problematic will have outsized risks compared to those who come from neutral or friendly countries. Anyone with a history of any formal disciplinary or legal trouble within China, whether personal or business, should also consider themselves at heightened risk of future problems in China. In particular, foreign nationals working for companies in semiconductors, AI, aerospace, and other areas deemed critical to national security should be aware of heightened personal risks during times of geopolitical tensions.
For more on what makes someone a prime China target, check out China Exit Bans: You Can Check Out Any Time You Want, But You Can’t Ever Leave.
Does following Chinese law really reduce the risk of becoming a target?
Yes, to the extent that any enforcement action is only tied to a person’s actions. A person with no negative record in China should not have issues traveling to China for business, as long as there are no macro geopolitical factors causing heightened tensions at the time and so long as they are not in any high risk category. Unfortunately, an executive with a baby products company and an executive with a technology company have significantly different risk profiles. Also, we have written previously (see here), if that person’s company has any real or threatened legal issue with a well-connected Chinese company, they are also at heightened risk even if they have followed the law in China.
What are some common questions companies have about successfully doing business in China?
Many companies are still questioning how important it is to travel to China or at least engage in in-person discussions with their Chinese counterparts. Traditionally, companies that wanted red carpet treatment throughout their business relationship needed to establish strong in-person rapport by traveling to China. Post-Covid, I have seen clients make great inroads by meeting their Chinese partners at a trade show in the client’s home country or in a neutral country.
As going to China has become more risky, expensive and even time-consuming, fewer companies are going and China is adapting. Our few clients who keep going back to China tell us that the value of doing so — when so few others are — has increased.
I have seen companies starting to take their intellectual property registrations and contractual protections much more seriously than in years past. This is part of what I consider the maturity process regarding doing business in China.
How do companies deal with information asymmetry, specifically around due diligence?
Due diligence in China has always been difficult, and it has become a significant pain point, both for potential acquirers (see here and here). The CCP does not want negative information flowing out of China. Our due diligence team regularly accomplishes very important due diligence from afar by getting a complete suite of contracts and related documents and comparing those to financial and bank records, and by scouring the Chinese Internet for hepful official and unofficial records. China increasingly seeks to block this, but we consistently have found ways around these attempts.
Having contacts on the ground in China is still sometimes essential. There are still some longstanding companies with excellent track records that can provide real-time video due diligence in factories and other facilities. They are taking on an outsized risk by continuing to provide this service.
When should a company pull out of China altogether?
Risk mitigation means different things to different companies. It should always be in the discussion based on the many potential risk factors and opportunities. There remain significant opportunities with China’s flagging economy, even if those likely have only yearslong instead of decades-long runways. But unless a company has an extremely high risk profile, such as semiconductors and other high technologies a la Made in China 2025, I think that pulling out of China just because of China’s risks is usually too extreme, and any such action should be preceded by a thorough risk analysis .
Short of pulling entirely out of China, what other ways can companies restructure their China operations to enhance due diligence and set themselves up for success?
Companies should always be on the hunt for quality personnel and business partners. The best Chinese entrepreneurs are some of the most creative people in the world because they have to build both within and outside the rigid Chinese business environment. They are pragmatic, almost to a fault, but they have learned to thrive where others have failed.
Due diligence should be an ongoing priority for foreign companies. Every contract should have robust reporting provisions that are tied to concrete penalties for noncompliance.
To some extent, China’s retrenchment is providing some of the best economic opportunities for companies with a significant risk appetite. In that regard, President Xi’s insistence that China is still a developing country is true and will remain true for the foreseeable future with him at the helm.
Navigating China’s increasingly complex business landscape is a growing challenge for foreign entities. Though there has not been a notable increase in direct threats, such as arrests and seizures, the underlying risk factors associated with China’s evolving legal environment, economic conditions, and geopolitical relations persist.
Prudence dictates a vigilant approach to compliance with Chinese laws, particularly those around national security interests, and a keen focus on due diligence to avoid becoming an inadvertent target. The shift towards more robust intellectual property registration, careful restructuring of joint ventures, and persistent due diligence reflects a maturing perspective on long-term success in China. As companies grapple with these dynamics, the key will be to maintain agility, forge strong, direct relationships, and stay informed to navigate the risks while capitalizing on the potential rewards the Chinese market continues to offer.