Beyond the org chart
- Asia Pacific
- Ethics, Compliance and Governance
Beyond the org chart: Implications of China’s government reorganization
The National People’s Congress (NPC – legislature) on 17 March will approve a plan to reorganize government ministries, commissions and other agencies, and their roles and responsibilities. Important details such as a timetable and how various approval processes will change are not yet available, but there is already some basis for analysis beyond the widely-reported basic facts of the reorganization outline (see China forms new ministries, overhauls government depts and China to merge regulators, create new ministries in biggest overhaul in years).
We wrote about several of the changes prior to the plan’s release (see hyperlinks), but here we summarize our bottom-line initial conclusions on the plan’s significance; practical implications for companies adapting to these major changes; and analysis of how the plan will affect some specific sectors and regulatory areas.
- Alongside personnel turnover, the plan will change companies’ policy and regulatory stakeholders and their roles and responsibilities, which firms must now remap and reassess.
- Key changes for businesses involve the financial and healthcare sectors, anticorruption, antitrust and environmental regulation, and the new Market Supervision Administration (MSA).
- The plan reflects and will reinforce President Xi Jinping’s shift of policymaking and enforcement power towards the centre, and from the bureaucracy towards the Communist Party of China (CPC).
- The plan has positive implications for effective implementation and streamlined bureaucracy, but businesses face a less familiar, less accessible and potentially more volatile policy and regulatory environment.
- Officials’ profiles, priorities and pressures are changing. Company approaches to understanding and engaging them must adapt accordingly, for both strategic and risk-management purposes.
Business implications and actions
1. Understanding stakeholders
The government reorganization follows widespread personnel changes in local and CPC organizations over the past year. It will be followed by appointments of new central government officials at the NPC on 19 March; further local-level changes will follow the NPC. This reorganization and personnel change is more extensive than the normal, cyclical tinkering and turnover that occurs every five years when a new NPC is elected (this is the first annual session of the 13th NPC). It also goes deeper – formalizing and furthering Xi’s first-term efforts to give CPC groups more direct control over policy matters that were once left largely to the State Council (cabinet).
Collectively, these changes constitute a major transformation of the policy and regulatory landscape for companies in China. Firms’ stakeholder maps have changed, in some cases dramatically, and must be reassessed. In doing this, an updated organization chart of central government agencies and top leaders is of very limited use. Each company’s stakeholder map is unique and – despite Xi’s dominance, centralization and bureaucratic consolidation – the regulatory environment has become more, not less complex to navigate (see point #3, below). For example:
- A healthcare company could find that understanding changes to the role and composition the relevant CPC Leading Small Group (LSG) is more important than who heads the new National Health Commission.
- Beyond national-level policymaking, local and departmental leaders are usually closest to the day-to-day areas impacting business. A city vice-mayor with a relevant portfolio, the head of a development zone or district-level Market Supervision Bureau might be key stakeholders for certain issues.
- Some new officials will bring increased focus on priority sectors or development initiatives, others will tighten scrutiny of priority areas for regulation; both have business implications.
2. Engaging stakeholders
Identifying and understanding a changing web of policy and regulatory stakeholders is essential, but only actionable alongside an understanding of their policy priorities and goals, and a strategy and plan for engagement. Companies’ treatment by officials today depends on their ability to understand these stakeholder priorities and goals and position themselves accordingly, more than their ability to tap into personal connections. This has been clear for many years but stereotypes still linger about the centrality of guanxi (relationships) in doing business in China. For some, this prevents the evolution of corporate government affairs strategies from keeping pace with the evolution of government.
- As in any country, access to and positive relationships with key stakeholders and senior leaders are very important but they are not a panacea. Contrary to some old-school advice, the answer to China’s current transformation is not simply to switch relationships from one generation of leaders to another, developing ties to access officials seemingly close to or favoured by Xi. There are several problems with this approach, in particular:
- It is increasingly difficult to achieve as officials in Xi’s China are often reluctant to indulge in business relationships outside of formal settings and activities within scope of their official duties.
- Many traditional forms of access and relationship-building are inappropriate and risky, both in ethical and compliance terms, and because dependence on ties to powerful or well-connected individuals can be a liability in an environment where such figures more frequently fall out of political favour or are reassigned.
- The guanxi-guru idea of a mysterious “Chinese way” of government affairs leads companies to substitute relationships for a comprehensive engagement strategy. Companies certainly must develop and maintain strong official ties, but directly and transparently based on shared goals, not behind-the-scenes personal relationships; and broadly across their new stakeholder map, not dependent on a few high-level “fixers”.
3. Regulation and resilience
From bribery and antitrust to environmental protection and food-and-drug safety, unprecedented levels of regulatory enforcement were a theme of 2012-17. This enforcement will only grow. Consolidated, better-resourced agencies with clearer mandates and new leadership will bring fresh momentum to an already heightened level of regulatory scrutiny. In the next section we highlight two sectors (finance and healthcare) and two enforcement areas (antitrust and anti-corruption) for particular attention, but there are many others, and several practical responses to consider:
- Almost every major sector is impacted in some way, from natural resources, food and agriculture to manufacturing, transport and tourism. Even in sectors where the most relevant ministry or industry regulator remain are not reorganized, there are significant changes to regulators enforcing across all sectors on issues including tax, customs, visas, intellectual property, labour and workplace safety.
- Besides mapping and understanding regulators, companies should monitor indicators of their priorities and enforcement targets. As well as major policies, explicit directives and authoritative state media, indicators include comments by incoming (national and local) senior regulators, and articles in specialist regulatory or industry publications. These days, regulatory rhetoric is usually matched by enforcement action.
- Companies can then create or update thorough threat assessments specific to their own unique exposure, and review the adequacy of their mitigation measures. This is usually most effective starting with a broad, comprehensive approach that considers more strategic political and policy risks (such as how geopolitical and industrial policy drivers could impact regulatory treatment), as well as more immediate concerns such as from legal and compliance perspectives, or for licencing and approvals. Assessments should consider the implications of growing party encroachment into business, such as via party committees in private firms.
- The National Supervision Commission (NSC – see here for details) reinforces the need for thorough understanding of potential exposure to state entities. If partners, other stakeholders or invested companies meet corruption and disciplinary problems it can cause financial losses and business disruption, or even expose foreign companies to scrutiny themselves. This usually means state-owned enterprises but could also mean, for example, public healthcare or educational institutions. Companies need a clear picture of state stakeholders such as joint venture partners, key clients or distributors, and their potential exposure.
Impact on industries and regulatory areas
A National Health Commission (NHC) replaces the former National Health and Family Planning Commission (NHFPC), and also takes on some responsibilities from other agencies as part of the consolidation. One potentially significant change is incorporating the office of the State Council’s LSG on healthcare reform into the NHC. There is very little information available on the details or purpose of the changes but our initial observations are:
- The NHFPC was itself only created in 2013 by merging the Ministry of Health and National Population and Family Planning Commission, but this is widely seen as having failed to overcome problems of leadership and fragmented bureaucracy in this crucial and daunting policy area – reforming China’s healthcare system.
- This latest restructuring may seek to address this by removing some peripheral roles; giving the NHC a clearer leadership role on healthcare reform relative to the National Development and Reform Commission (NDRC - the agency which loses the most power from the reorganisation); and perhaps giving central party leadership more scope to overcome fragmentation (the LSG involved at least 16 government agencies).
- The form that stronger party control will take is unclear, while key personnel changes are imminent at the NPC. Although many key issues for healthcare companies today involve implementation and local-level actors, this overhaul of central personnel and system-wide structure is still a crucial development to monitor.
- Meanwhile, roll-out of the MSA (see below) has strong relevance to the pharmaceutical and medical devices sectors: together with the food industry, they were a major consideration behind the MSA’s emergence, and of now-consolidated regulation of anti-bribery, quality supervision, pricing and anti-monopoly issues.
2. Market Supervision
The State Market Supervision Administration may seem one of the more mundane and obscure new agencies but, for firms operating in most industries in China, it is very significant indeed. It consolidates the State Administration for Industry and Commerce (SAIC); some antitrust divisions of the NDRC and Ministry of Commerce (MOFCOM); the General Administration of Quality Supervision, Inspection and Quarantine (AQSIQ); and the China Food and Drug Administration (CFDA – though a lower-ranked China Drug Administration is created at national and provincial levels).
- It consolidates roles and responsibilities in some of the “hottest” areas for tightened regulatory enforcement over the past five years: commercial bribery, price supervision, anti-monopoly and anti-competitive behaviour, supervision of product safety, and food and drug administration.
- There is already evidence of how local-level Market Supervision Administration bureaux operate, as they were piloted as far back as November 2013 and have been operating in several important locations since 2015, including several districts of Shanghai. It is one of the most frequent sources of scrutiny of companies.
- For the most part, the MSA’s component departments – for example those that were formerly the local Administrations for Industry and Commerce (AIC) – have continued to operate largely as before, so the consolidation has not seemed a dramatic change. However, roll-out at national level and its effectively elevated status could see the MSA feature more heavily on companies’ radars starting this year.
- The biggest unknown may be how it operates as a consolidated antitrust regulator assuming antirust roles from NDRC and MOFCOM in addition to those of SAIC. A unified antitrust regulator has been mooted for years but combining it with the MSA’s other roles makes it a particularly significant upgrade for the agency.
- Based on experience of local MSAs and past agency mergers, personnel involved will be the same as the relevant NDRC and MOFCOM departments, whose staff may operate largely as before but within the MSA. However, this is speculative at this stage, and an important area to watch given the major impact that pricing and anti-monopoly investigations had on many major multinationals in China in recent years.
The MSA is also important because it takes on the AICs’ role as the main enforcer of commercial bribery provisions within the Anti-Unfair Competition Law. Anticorruption is thus another area to watch, and is addressed further below.
For foreign and other private companies, local AICs – and in some cases the public security bureau (police) – will remain the primary regulators responsible for tackling commercial bribery. This issue has retreated from the headlines since the extremely high-profile GlaxoSmithKline bribery case that resulted in a record fine and prison sentences for some of its staff. However, it remains an important part of the AIC – and MSA – mandate and foreign firms continue to face scrutiny, often triggered by whistle-blowing complaints. Mitigation of anti-bribery and corruption risk thus remains a priority in China, amid close domestic and international scrutiny. Fresh enforcement momentum could come from the MSA reorganization and new leadership, and also indirectly from the new National Supervision Commission.
The NSC will be a unified, better resourced anti-corruption agency with upgraded bureaucratic status, based on the CPC’s Central Commission for Discipline Inspection (CCDI) system – the party’s longstanding internal disciplinary and corruption watchdog which has led an unprecedented crackdown on graft in the past five years. Institutional reforms including the NSC are improving oversight of local officials, but suggest Beijing will rely on centralized power, party discipline and ideology as a substitute for institutions with any meaningful independence or transparency. The new commission seems set for such a broad role that it could encroach increasingly into the business sphere.
This will not become clear until more local Supervision Commissions (SCs) throughout the country become active in the coming months, but it will combine with other trends to multiply channels for political pressure on businesses. Regulations have long called for companies, including foreign ones, to have CPC committees, but there are numerous anecdotal reports of committees seeking a more active voice in decision-making, and of pressure to establish committees in firms without one. In a longer-term trend, a social credit system is due by 2020 to rate companies’ performance and compliance on multiple criteria including several open to politicized interpretation, with scope for punitive action. We have written more extensively on the NSC and its implications here and here.
4. Financial sector
As expected, the banking and insurance regulators have been merged to form the new China Banking and Insurance Regulatory Commission (CBIRC), while the central bank has taken over some powers for designing major banking and insurance regulations. This follows the creation in November of a Financial Stability and Development Committee under the State Council (cabinet), and will be followed by important personnel changes due on 19 March. The latter will likely see Liu He – a Xi confidant and CPC Politburo member since October – take roles which confirm his eclipse of Premier Li Keqiang as the main driver-in-practice of economic and financial policy.
Both personnel and structural changes will support further limited liberalization (such as lifting the cap on foreign ownership of securities firms), and increasingly aggressive moves to reduce financial-sector leverage and reduce space for firms to exploit regulatory loopholes. This is generally positive for China’s debt risk situation, but also portends more heavy-handed regulatory intervention. More dramatic cases of this – notably the recent government interventions in the management of Anbang Insurance and CEFC China Energy – are not going to become the norm, but Beijing has made clear it will do whatever it deems necessary to maintain stability (and sometimes control). Such interventions rarely directly impact foreign companies, but indirect financial, regulatory or reputational exposure can be very significant. More rapid and aggressive implementation could also bring further episodes of market volatility.
Party leadership system
Xi’s driving logic behind the reorganization is to tackle three sources of bureaucratic inertia that have often frustrated the leadership in making and implementing policy: Local resistance to implementing central directives; powerful vested interests in or channelled by the State Council bureaucracy, and the difficulty of reaching consensus across a fragmented system. The plan is the latest of his reforms to overcome all three problems: centralization and strict party discipline to bring local cadres in-line; putting CPC bodies in more direct control of the central bureaucracy and greatly consolidating it. This has real benefits for bureaucratic streamlining and effective policy implementation. But the party leadership system raises serious potential systemic problems. For businesses, efficiency and transparency of many day-to-day bureaucratic and regulatory processes is improving, but they must also anticipate less transparency, accessibility and predictability, and more scrutiny and intervention than MNCs were long accustomed to in China.