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Compliance in China between social points and growing regulation
AdminNov 23, 2022 3:30:00 PM8 min read

Compliance between social points and increasing regulation

The compliance requirements for companies have increased significantly in the People's Republic of China in recent years. Foreign-invested companies and their parent companies abroad in particular are increasingly faced with the challenge of ensuring compliance with laws and regulations as well as internal company codes. The government's social points system, which affects companies and employees alike, as well as the frequent revision of existing laws, make it increasingly difficult for management to maintain a detailed and comprehensive overview of the rights and obligations currently applicable to their company. This not only increases the risk for companies of being affected by sanctions and penalties, but also for the individuals involved, who can be held personally liable if compliance requirements are breached. How should these challenges be dealt with and how can digital compliance solutions provide the necessary overview?

Compliance – Concept and historical development

Put simply, the term "compliance" describes adherence to applicable laws, administrative regulations and voluntary codes as well as organizational, regulatory and technical measures to prevent legal violations within the company.

Compliance has its origins in the Anglo-American legal area, where companies have been required to take measures to prevent legal violations in their own operations since the 1930s on the basis of so-called "regulated self-regulation".

The term compliance has not yet been legally defined in the German legal system. However, a definition can be assigned to the voluntary German Corporate Governance Codex from 2002.

General compliance-related obligations arise from company law and the provisions of criminal and administrative offense law, on the basis of which the management can be held liable for violations of the law as part of its duty of care under company law.


German company law enshrines the principle of business judgment (business judgment rule), according to which the management cannot be held personally liable for an incorrect decision if it has no relevant interest of its own in the decision made, was sufficiently informed before making the decision and acted in the best interests of the company in a comprehensible manner. However, this principle only applies if the law does not provide for any sector-specific regulations on risk prevention, e.g. in the areas of occupational health and safety, data protection and product safety.

Compliance in China

 

Compliance in China
Quelle: https://npcobserver.com/2021/12/31/year-in-review-the-npc-and-the-observer-in-2021/

ICompared to the developments in Western countries described above, the topic of compliance has arrived relatively late in China. If one measures the importance of compliance by the number of newly enacted and revised laws, among other things, it is easy to see from the following overview that the importance of compliance has increased significantly in China over the past 8 years: from 2013 to 2021, legislative activities have increased sixfold!

In addition, the Chinese government has recognized compliance as a useful tool against nepotism and corruption in business and politics. Since then, even the famous networks (关系 "Guan Xi"), consisting of connections to other companies, authorities and social representatives, can no longer solve every problem or provide advantages. Xi Jinping's extensive anti-corruption campaign, which initially targeted officials, has reinforced this development. Public officials have become cautious and adhere strictly to the legal framework, even refusing to use the discretionary powers granted to them by law. Authorities are also relying on digital systems that
compliance processes and make possible influences in the decision-making process visible.

However, the state anti-corruption campaign has not only declared war on corruption, but has also enacted changes to the law as part of this, according to which the list of penalties has been tightened and companies, both domestic and foreign-invested companies, can and should be subject to increased scrutiny and monitoring. The Chinese government has also endorsed the implementation of compliance structures and issued corresponding legal obligations. In addition to voluntary internal rules of conduct, companies must now also meet government compliance requirements and document their implementation.

The social points system, including the corporate social points system, is one of the cornerstones of this development. Planned since 2014, it has been active since the beginning of 2021 and combines findings and data from numerous authorities to reward individuals, companies and other organizations for "good" behaviour and punish them for "bad" behaviour. Local, provincial and national data and records are integrated into central databases and a rating or points are awarded on this basis.

The social points system is currently still being developed and expanded. However, penalties and sanctions issued to companies are already online and therefore publicly visible. However, a full analysis has not (yet) been carried out. However, there was an addition at the beginning of 2022, according to which companies are to be assigned to dynamic risk classes ABCD in the foreseeable future in order to facilitate classification and enable faster action. The full implementation of the social scoring system, including digital monitoring, is therefore only a matter of time.

As in German law, Chinese law also applies general civil, administrative and criminal compliance obligations, and managers, directors and legal representatives of companies can be held liable if these are breached. Under Chinese company law, for example, a member of the company management must compensate the company for any damages incurred by the company as a result of a breach of the statutory or legal obligations of the respective member of the company management. Chinese company law also recognizes the principle of entrepreneurial discretion limiting liability, albeit only as a judicial expression and not enshrined in law.

In addition, there are numerous special provisions in China according to which members of the management and other responsible persons can be held personally liable. The special liability bases can be found in various laws and administrative regulations, such as the PRC Export Control Law of December 1, 2020, the PRC Law on Workplace Safety of September 1, 2021, the Antimonopoly Law amended in August 2022 or the new laws on data protection and data and cyber security.

The growing number of laws is thus constantly increasing the compliance requirements for companies operating on the Chinese market. In addition to more than 290 laws and thousands of national, regional and local administrative regulations, numerous voluntary and mandatory industry standards also apply. Mandatory industry standards are legally binding norms whose compliance is strictly monitored by the relevant authorities. Mandatory industry standards therefore fall under compliance requirements.

Digitale compliance-solution

The growing complexity of the legal framework for corporate governance means that companies need a strong compliance culture, comprehensive documentation and constant updating of the relevant laws, administrative regulations and mandatory industry standards in order to prevent poor ratings, penalties and sanctions or at least reduce the risk of them occurring.

In addition, the Chinese government gives a positive rating to companies that demonstrably address grievances internally at an early stage and initiate countermeasures or introduce general corporate standards in order to make processes transparent and comprehensible, and sometimes gives them a better rating or imposes lower penalties.

Web based compliance management software

The first digital compliance solutions are providing practical support for companies in China. Checking relevant legal regulations, audit-proof documentation and the transparent delegation of tasks to specific employees helps companies to maintain an overview and also act in accordance with compliance requirements when dealing with the authorities. As the increasing compliance requirements affect all companies in China, companies that "live" compliance and ensure it digitally gain a major advantage over their competitors and are one step ahead of them.

Whistleblower systems and ombudspersons

Reports of legal violations by dissatisfied employees, competitors and professional shoppers to the authorities are another serious source of compliance risks in China. In addition, reports of breaches of the law are encouraged by the state through monetary rewards under several industry-specific regulations. This leads to increased compliance risks not only for companies but also for their management.

Internal whistleblower systems for reporting legal violations and other irregularities are effective compliance instruments that can help to avoid or reduce direct reports of legal violations to the authorities. Internal whistleblower systems uncover control deficiencies and irregularities at an early stage and give management the time and opportunity to take remedial action, prepare for possible official inspections and avoid reputational and financial damage.

The introduction of an electronic whistleblowing system in combination with the appointment of a local ombudsman has proven to be a cost-effective solution for small and medium-sized companies. Local ombudsmen can receive information via the electronic whistleblowing system and communicate with the whistleblower in the local language and taking into account local cultural characteristics. They are well acquainted with the company from their legal support activities and can clarify the facts of the case in accordance with local law prior to the legal assessment of the tip-off.

Conclusion

Medium-sized companies operating in China are exposed to increased compliance risks and requirements due to the increasing complexity of the law. In view of the legal developments in China, it is important for foreign-invested companies and their parent companies abroad to maintain an overview of the legal requirements in order to avoid undesirable sanctions and liability, which can affect not only the company but also the management personally. It is therefore advisable to analyze and evaluate compliance risks of the subsidiary in China in good time and to take appropriate measures. A web-based Compliance Management Software sand whistleblower systems supplemented by local ombudspersons can be of great help.

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dominik-nowak2-rund
DOMINIK NOWAK
Eticor International
Managing Director & Legal Representative China