China’s Corporate Social Credit System

published on October 1, 2019 | reading time approx. 4 minutes

by Christina Gigler and Sebastian Wiendieck

The Corporate Social Credit System of China (SCS), although in public discussion and discourse only over the past few months or years, is in fact not a very recent development, but has already been introduced in 2014, when the Chinese government authorities started to publish numerous regulations, laws and policies defining and explaining the SCS. Until today, nearly 1,500 government documents have been published by central and local level government authorities within the framework of the SCS.

Without question, the SCS is the most comprehensive system made by a government in order to introduce a self-regulating marketplace. However, as especially German news understandably report about the SCS from a Western perspective, this article tries to show a neutral viewpoint on this topic and to give a broad overview of the status. This article has its main focus on the Corporate SCS, which is by far more developed than the SCS for individuals.

How does the rating work?

In the framework of the SCS, both government authorities as well as private companies (e.g. Alibaba and Tencent) collect data on the behavior of individuals and companies registered in China. Based on these data individuals and companies are rated on a basis of specific parameters and defined requirements of the government. The SCS basically covers all aspects of doing business in China (e.g. tax, customs, product quality, environmental protection, pricing and licensing, data transfer etc.). The goal and idea behind the SCS is to share the data between different parts of the system and also the public in order to monitor and guide market participants`behavior. A good rating leads to rewards and can mean lower tax rates, easier market access or better credit conditions, whereas a bad rating leads to sanctions, such as penalty fees, court orders or even blacklisting. Reward mechanisms are however less developed than sanction mechanisms so far.

One important characteristic of the SCS are the so-called “joint sanctions”. This means that sanctions are not only levied by one authority based on the rating it is directly responsible for, but also in response to negative ratings in all other fields. For example, a rating as a distrusted taxpaying company not only leads to tax-specific sanctions, but may also effect approvals or land use rights of the company or travel restrictions of the legal representative of the company.

The timeframe in which a rating is updated is not uniformly regulated. Some ratings change in real time, some are updated every few months, while some are updated only once a year. Nevertheless, a blacklisting or rating can happen at any time.

Please note that the Corporate SCS only applies to companies which are registered in China. This means that the rating starts from zero at the moment when the company is successfully registered in China.

What is the concrete impact for companies?

While the implementation status of the SCS is far from its full potential and still varies between different locations and industries, many of the system`s mechanisms are already operational today. Even now, companies with a bad rating are facing higher inspection rates and targeted audits. Affected companies may have to deal with restrictions for the issuance of any sort of government approval and restrictions from public procurement. Moreover, bad ratings may also lead to an exclusion from certain preferential policies, such as subsidies.

In any case, the Chinese government aims a full implementation by the end of 2020. However, this does not mean that the uncertainties of the system will be fully resolved by then. At the end, the SCS is an evolving system, which will be continuously amended and improved, likely also based on changing economic and political goals.

Is there a possibility to reduce the impact?

Not really. The SCS applies to all companies registered in China.

However, once the company is confronted with a bad rating, there is the possibility to object against the rating. To reset its negative rating a company shall submit a “credit restoration commitment letter”. Depending on the type of the rating, additional materials may be necessary. The deadline for restoration is not consistent, but varies from case to case. In addition, standard administrative remedies may apply.

Is there anything positive about the SCS?

In theory, one positive aspect could be that there is an equal enforcement of the regulations among Chinese companies and foreign-invested companies, as the ratings are mostly algorithm-based and therefore do not distinguish between domestic or foreign-invested companies as long as they are registered in China. Thus, in principle the SCS creates a more level playing field, because the data is processed automated and can eliminate arbitrariness. But, it cannot be ensured that the system will not be applied in a biased way. Also, some requirements are naturally more difficult to fulfil for foreign-invested companies. At the end, Chinese companies might at least have an advantage in understanding the subtleties of the system, as first the regulations are mostly only published in Chinese language and second it will be easier for Chinese companies to communicate with the authorities to clarify certain points.

As second aspect, although the SCS also introduces new requirements, the majority of the requirements have been existing before. Thus, most of the requirements should not come as a surprise. The difference now is however the stricter and faster enforcement of the requirements and the interchange of information between various authorities.

Connection between company ratings and individual ratings

The Individual SCS is still in a pilot stage compared with the Corporate SCS and is not systematically applied at the moment. However, the two systems are somehow interlinked for legal representatives and responsible personnel. There exists no official definition of “responsible personnel”, so one must expect that the application will vary from place to place and authority to authority. For the time being, other personnel cannot influence or be influenced by the Corporate SCS.

Outlook

Currently, a consortium comprised of Huawei, Alibaba, Tencent, VisionVera and Taiji Computer Corporation is working on a new meta-database, which is supposed to collect all relevant data on one central database only. Up to now, there exist several different databases, but none of them collects a complete set of data, which makes it very burdensome for companies to collect all relevant information. A test version of the new meta-database shall be released in September 2019.

In general, foreign-invested companies with internal compliance systems of international standard might be in a good position to fulfil a majority of the requirements or might at least be able to adjust certain internal processes according to the SCS, as they may already feature a relatively advanced compliance structure. However, the biggest challenge will be to know exactly what must be done to secure and keep a high rating and to successfully delete a potentially bad rating.

It is not yet too late for taking action, but it can be assumed that the regulations and enforcement measures will improve over time and the gaps and starting points for negotiations will become smaller and smaller.