Analysis

Automotive brief: China

  • Automotive
  • China
  • Delivering Growth and Opportunity
Julia Coym

Julia Coym

China: Regulatory reforms bring opportunities but also increased business partner risks to foreign automotive suppliers



China is expected to finalise several new competition rules and regulations for the automotive sector this year, particularly on liberalising components sales and after-market services. This will bring significant new business opportunities to automotive suppliers, both foreign and domestic, as automakers’ ability to restrict suppliers’ or dealers’ sales and purchase of parts will be considerably reduced. However, changes to how companies do business in this sector also bring increased business and compliance risks relating to relationships with supply and distribution partners.

Sector reforms to trigger heightened anti-competition enforcement

The central government has spent the last two years drafting automotive sector reforms that will boost competition in order to promote the growth of domestic automotive companies, and lower prices and improve quality for Chinese consumers. The draft Antitrust Guidelines for the Automotive Industry (关于汽车业的反垄断指南) were reportedly submitted to the State Council (cabinet) in March 2017, and are expected to dramatically liberalise automotive component sales in line with similar reforms seen in Europe and the US. This is likely to benefit automotive component manufacturers, unless they obtain most of their revenue from exclusive supply agreements with major automakers.

At the same time, the rules specify new areas for enforcement on non-pricing competition restrictions, which will most likely trigger new investigations by regulators not only into automakers, but also into automotive component companies. Such enforcement is likely to see higher fines than the USD 180m imposed on 10 Japanese automotive component companies in 2014. In addition to investigations into price-fixing or cartels, regulators will look at auto suppliers who enforce ‘unreasonable’ sales targets, inventory levels, or tie-in sales. Importantly, the new automotive antitrust guidelines will place the burden of proof on automotive companies to show that any cooperative ventures they have is not in violation of competition regulations.

Innovation vs. violation

Automotive suppliers and distributors have been adjusting their commercial strategies in anticipation of the regulatory changes, not only by diversifying or changing the terms of their supplier and distributor relationships. Chinese auto distributors in particular have been looking to new, innovative business models to avoid being cut out of transforming automotive supply chains. This includes both online and offline ‘alliances’ and other cooperative ventures.

However, Control Risks’ research and investigations into such business ventures has found heightened business risks and regulatory exposure, especially for automotive sector companies that do not fully understand the ownership structures and practices of their business partners. In some cases, Chinese shareholders in the desired business partner held stakes in competing companies, presenting a potential conflict of interests. In other cases, potential local business partners were participating in alliances in clear violation of antitrust regulations, either ignorant or indifferent to their regulatory exposure. Automotive industry alliances engaged in potential price fixing or other anti-competitive activities exist widely in China, with participants often falsely claiming they serve merely to ‘maintain market stability’.

The risk to foreign automotive companies
  • The high prevalence of conflicts of interest in many Chinese companies has led some foreign MNCs to underestimate or even turn a blind eye to activities that may potentially harm their interests. Establishing a clear understanding of the prevalence and potential impact of such conflicts is essential during the due diligence of any commercial partners. For the auto parts distribution sector – where a plethora of small-sized distributors exist and the details of their operations are highly opaque – a thorough review of the key shareholders’ background, corporate interests and targeted enquiries are needed to understand such risks.

  • We have seen multiple cases where foreign firms ignored these risks in a local partner, leading to more significant problems such as losing control of a business venture’s operations, a significant decline in profits, or legal proceedings. This is particularly of note for foreign investors where additional challenges of cultural difference and gaps in communication may exist. Companies can do more to identify such conflicts, for instance by asking business partners or employees to declare their interests, rather than only their conflicts of interest. Such disclosure should also cover direct family members of potential business partners’ shareholders. Undisclosed business relationships may also exist between the companies’ employees and business partners. Where these relationships cannot be sufficiently unearthed through public domain information, companies (or third party professional firms) can either make direct enquiries with the partners or employees through technical interview strategies or by conducting discreet enquiries with industry sources.

  • Although there has been tighter scrutiny in the auto sector on price fixing and monopoly, local companies who are members of such alliances may not consider themselves at risk of regulatory enforcement due to the limited size and number of members involved in these organisations. Indeed, in the past, government agencies have focused on larger, foreign players rather than smaller domestic automotive companies. However, the latest regulatory changes will spur heightened scrutiny and whistleblowing against violations, particularly if the company or alliance in question has a foreign partner or investor. Moreover, the changes in relationships between suppliers and distributors are likely to lead to increased business disputes and potentially greater regulatory exposure, as whistleblowing by disgruntled business partners is typically a key trigger for regulatory investigations.
       

Authors

  • Julia Coym, Senior Analyst
  • Carmen Liu, Associate Director

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