China has warned of decoupling and “de-risking”. But its recent actions may get just that.
China ended its draconian “Zero COVID” policy nearly six months ago and has declared that its “door to the outside will only open wider.”
But a confluence of factors could cause havoc and create new risk for companies trying to operate businesses in China.
The Chinese government has launched a campaign of investigations and intimidation targeting Western due diligence firms operating in China. In March, Chinese police closed the office of the US consulting firm Mintz, and detained five of its staff members for questioning. In April, police raided the Shanghai offices of Bain & Company, management consulting firm. In May, police launched a national security investigation into Capivision, a consultancy firm, raiding their offices in Shanghai, Beijing, Suzhou, and Shenzhen.
A state TV news program made clear that this was a “coordinated” effort related to anti-espionage and national security, and not just a one-off action by a local police department. The program stated that, “national security authorities have investigated several special cases and found that many overseas organizations with complex backgrounds have stolen China’s national secrets and intelligence in key areas through domestic consulting firms and other industries.”
What makes this campaign against foreign due diligence firms particularly ominous is that it comes just as China promulgated its revision of the Counter-Espionage Law. The new revisions expand the scope of the previous law and perhaps most notably, the new revision now includes language that defines “acts of espionage” as “to steal, pry into, purchase or illegally provide…documents, data, materials, or items related to national security or interests” in addition to the previous “state secrets [and] intelligence.”
But in another sense, the revised law does not alter any real power dynamics in China: after all, the Chinese Communist Party runs the police, prosecution, and courts and has complete leeway in national security affairs.
And yet, the changes to the law, combined with the coordinated raids, signal a new intent by the party-state to limit due diligence efforts.
Meanwhile, in many jurisdictions across North America and Europe, new requirements are being rolled out that build on the global standard, the UN Guiding Principles on Business and Human Rights, and mandate companies to conduct human rights due diligence, a process in which companies must identify, prevent, mitigate, and account for how they address their human rights impacts.
On January 1, a new supply chain law came into effect in Germany. In May, a Canadian bill was passed that will require companies to conduct due diligence to prevent forced labor and child labor. The bill is awaiting royal assent but is expected to come into force in 2024. On April 25, the European Parliament voted to approve the draft EU corporate sustainability due diligence directive (CSDDD). The law, whose final text will be finalized this year by the European Council, will likely compel European firms above a certain size to identify, and where necessary prevent, end or mitigate the negative impacts of human rights problems, including those related to “child labour, slavery, labour exploitation, pollution, environmental degradation and biodiversity loss.”
Japan, too, is also recommending that companies carry out due diligence according to new guidelines, and it is encouraging companies to do so by making due diligence a factor in securing public procurement.
Why is all this significant?
Although these new legal changes are global in scope, and the impetus to enact them is not focused on China per se, the laws are bound to affect any business operating or sourcing from China, and yet, China has punished firms for carrying out due diligence the sort of due diligence envisioned by the laws.
As the Financial Times reported, Mintz was targeted precisely because it was helping firms assess their supply chains involving Xinjiang, where there are allegations of widespread forced labor involving the textiles, cotton, solar, and automotive industries.
It should be noted that it was not easy, or arguably even possible, to conduct on-the-ground human rights due diligence before with respect to Xinjiang and supply chains affecting Uyghurs. In an authoritative assessment of human rights issues in Xinjiang, the UN Office of the High Commissioner noted that staff attempting to conduct due diligence according to international standards had reportedly faced threats of reprisals, something CHRD also noted in a submission to the UN Committee on Economic, Social and Cultural Rights.
However, a new focus on espionage will undoubtedly create fear and dissuade firms from conducting on the ground investigations.
China, in turn, has repeatedly denied allegations of forced labor in Xinjiang and called it “the lie of the century.” And yet the Chinese government is effectively making it impossible for companies to ascertain whether allegations of forced labor are a “lie.”
Chinese leaders have repeatedly warned about economic decoupling and disruptions to supply chains, and just last July, Chinese President Xi Jinping warned that such actions could make “the world economy more vulnerable.” Most recently, Chinese state media has hit back at the concept of “de-risking”, seeing it as “decoupling” in just another form.
However, unlike deliberate government-led decisions to “decouple” or “de-risk” from China, the introduction of new mandatory human rights due diligence laws combined with a lack of space available for companies to carry out their due diligence in China creates an incentive structure that will encourage companies to end business relationships in China or not to make new investments.
Unless the Chinese government reverses course and allows greater transparency, it should be prepared for prolonged economic disruptions.
But a change of course, however beneficial for China’s long-term interests, is unlikely to happen.
Wall Street Journal reporter Linling Wei described the contradictory thinking in the minds of Beijing officials in wanting to both welcome and pressure Western businesses:
“They [government officials] still believe China is such a big market that foreign companies cannot just pick up and leave. So access to China’s markets still is the leadership’s trump card…And, in fact, they still believe they can keep foreign capital from leaving, while at the same time keeping the pressure on the foreign firms.”
Foreign companies operating or sourcing from China must be prepared for uncertainty ahead.
