5 Things You Need to Know: Third Party Risk in China

September 21, 2015

By Nathaniel B. Edmonds

In order for a foreign company to be of any scale and success in China, it has to rely on third parties. Third parties are also one of the biggest risk areas facing companies operating in China. Here are five things you need to know about third party risk in China:

1. Third Parties are riskier than you think

Companies operating in China often focus on gifts and entertainment when it comes to enforcement risks. But the use of third parties is going to pose a much larger risk. Why? Companies face the greatest enforcement risk when they are spending a significant amount of money, which most often occurs with third parties.

“Although meals and entertainment are going to be a consistent concern, they will never amount to the same volume of dollars and, consequently, the magnitude or risk that these third parties pose.” – Nathaniel Edmonds

2. Bribery is going further underground in China

Over the past decade, a persistent regulatory focus on China by U.S. regulators has led to heightened due diligence on business partners and more comprehensive financial controls and oversight. As a result, we are seeing a greater awareness in the market of the compliance requirements of multinational companies. However, this increased understanding has in some cases caused improper payments to shift to new areas, making them more difficult to detect.

“In Mandarin, they say that “上有政策，下有对策” – “for every policy, there is a counter measure.” For every new innovation in a compliance program, there is a work-around or a new strategy to evade that control. For that reason, compliance programs must constantly evolve.” – Ananda Martin

3. Risks will vary by industry

In different industries, there are varying types of technical advisors or consultants that are given different names as corruption schemes evolve. Those third parties are accustomed to extract large sums of money from a company to create a slush fund from which money can be passed on to government officials improperly. What these risky service providers look like is very industry specific and in some ways business specific depending on the approach of how a company is going to market.

“Companies need to be very aware of their own specific risks and should not just look broadly at ‘China risks.’ Doing so sometimes misunderstands how specific the industries are and how each of those employees and business advisors can be ingenious in their way of avoiding the controls.” – Nathaniel Edmonds

4. Location is a factor

Preventing corruption becomes more challenging the farther you travel from metropolitan centers. In more remote areas, companies often find it difficult to implement centralized payment and procurement systems due to the limitations of local vendors. They may also find that they have fewer reputable local agents and consultants to choose from, increasing the risk of conflicts of interest between those third party service providers and government regulators.

“The further you go from ‘tier-one’ cities like Shanghai and Beijing, the more likely you will run into due diligence dead ends.” – Ananda Martin

5. For any business in China, third party risks arise with or without government interaction.

In China, unlike many other countries, there are significant government interactions at nearly every stage of a business transaction. Whenever there is a government interaction – and whenever a third party is interacting with the government on a company’s behalf – that creates risk.

“Some of the most obvious examples are the ones where a company’s customers include the government or state-owned entities. In those interactions, either in obtaining the contract or in maintaining that contract afterwards, there are pretty significant third party risks.” – Nathaniel Edmonds

Running a business in China also presents many third party risks, even when the government is not a customer, because operating often requires numerous regulatory approvals and licenses. There are various third parties who can help a company navigate regulatory complexities, particularly with regards to licensing and permitting. But in the absence of proper due diligence, these “advisors” can pose significant risks to companies unfamiliar with the risks of the Chinese market.

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Upcoming Event: On September 30, 2015, Paul Hastings, LLP, Ernst & Young, LLP, and The FCPA Report will host a symposium in Washington, D.C. addressing how companies can mitigate risk when operating in China. The FCPA Report’s Editor in Chief, Nicole Di Schino, will moderate the event. For more information on the event and to register, click here.

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