Governance and business ethics
Investing directly in China is still relatively new for foreign investors. The start of the privatisation of the economy and the acceptance of foreign investment in the eighties made it an attractive market given the opportunities. Foreign investment really took off only in the twenty-first century following the creation of the Qualified Foreign Institutional Investor scheme. However as with so many aspects of its economy, Beijing keeps a tight control over its capital markets and who can access them. For instance, foreign investors do not have access to all companies and sectors. China maintains two negative lists (National Negative list and Free Trade Zone negative list) restricting foreign investments in various sectors. 2020 saw a large number of sectors removed from the list including the finance industry and power. Rare earths, news agencies, editing & publishing, television, telecoms, internet services, legal services, education and other sectors remain prohibited for foreign investors. Yet, where it is possible to invest, the corporate governance landscape looks rather different to developed markets and investors have also faced various business ethics challenges.
Foreign investors can gain access to the Chinese economy through different markets or mechanisms:
China A-Shares are the shares of mainland China-based companies listed on the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE). Both were launched in 1990. Shanghai is the largest of the two stock exchanges, and a large part of its market cap is from formerly state run companies, whereas Shenzhen has more smaller and emerging sector companies.
H-Shares refer to the shares of companies incorporated in mainland China that are traded on the Hong Kong Stock Exchange. H shares are regulated by Chinese law but denominated in HKD. Many companies float their shares simultaneously on the Hong Kong market and one of the two mainland Chinese stock exchanges in Shanghai or Shenzhen, they are known as A+H companies.
VIEs are variable-interest entity corporate structures. These have been used by private firms raising capital for entities operating in restricted sectors of the economy, such as telecoms and internet services, and listed typically in Hong Kong or New York. Sina.com, the online news provider and owner of Weibo, was the first VIE structure in New York in 2000.
Increasingly Chinese companies are also listing in the US. As of October 2, 2020, there were 217 Chinese companies listed on the 3 main US exchanges with a total market capitalization of $2.2 trillion, Alibaba being the largest one.
China has had a corporate governance code since 2002, issued by the China Securities Regulatory Commission (CSRC), which covers shareholder rights, and rules for shareholders and Directors as well as disclosure requirements. An updated version was published in 2018 and also includes environmental and social requirements.
An important feature of capital markets in China are the so called State Owned Enterprises (SOEs). Ownership can take different forms, including through the China Investment Corporation, the Ministry of Finance, or the State-owned Assets Supervision and Administration Commission. Many SOEs are in sectors considered to be strategic such as Sinopec (energy), Industrial and Commercial Bank of China (banking), China Mobile Communications (telecoms) and State Grid (electric utilities).
Despite the concept of public markets, Beijing continues to have an important role in the management of businesses, no matter whether they are state owned or not. The revision of the governance code in 2018 saw the addition of the requirement for companies to establish Party Organisations playing a political role in the company. A “Party organisation” or “Party committee”, is a body established by and reporting to the Chinese Communist Party1.
It is no longer possible for China’s trader partners to assume private enterprises are free agents. - FT Editorial Board, October 2020
Party organisations are mandatory for SOEs, however according to the Asian Corporate Governance Association: “They are also widespread in domestic private firms where they serve as a focal point for Party members, exercise leadership over the trade union, and provide guidance on complying with state laws”2. Multinationals operating in China have also been encouraged to create such bodies. The FT Editorial Board recently warned that Beijing’s influence is increasing3. Additional laws in recent years including the 2016 Cybersecurity Law and the 2017 National Intelligence Law, also require all enterprises to assist with national security and intelligence work, whilst keeping their assistance secret.
Whilst governance practices seem to be improving and the CSRC tries to raise standards, it is worth noting that Beijing’s influence remains superior to any codes or guidance. The perfect example of that is probably Huawei – a Chinese multinational technology conglomerate based in Shenzhen, and a provider of telecoms infrastructure worldwide. Huawei has become a ‘political football’ over charges of Chinese State influence, links to the Chinese military, and allegations of surveillance and data theft through the roll out of 5G technology. The US in particular has banned Huawei and exerted pressure on allies to follow suit – the UK recently announced its exclusion. Whilst Huawei’s ultimate owner is described as employee led, the company is mired in international controversy due to concerns over Beijing’s influence.
Investors in Chinese companies, but also in multinationals operating in China will be well familiar with the issue of corruption too. Many well-known companies including GSK, Nestlé and IBM have had their fair share of corruption scandals in the Chinese market. Beijing wants this to change; during his inauguration speech, President Xi stated that corruption was a threat to the party’s survival and launched a widespread anticorruption campaign targeting all levels of the party. The campaign has targeted all acts of bribery large and small as well as abuse of power. So far over 100,000 people have been sent to jail over corruption charges, however Transparency International, an organisation which measures corruption worldwide notes that China’s score on the Corruption Index has barely changed4.
The recent events in Hong Kong and the National Security Law bring new governance challenges for investors. Whilst previously investing in H shares provided more confidence of robust governance standards and independence from Beijing, this can no longer be assumed. As China’s grip on Hong Kong increases, there is a risk of growing influence of the CPC on Hong Kong based and listed businesses, despite the stock exchange being independent.
1. Glass Lewis, https://www.glasslewis.com/regime-change-begins-at-home-chinas-new-governance-code/
2. Asian Corporate Governance Association - ACGA China CG Report 2018: The evolution of corporate governance in China
3. Financial Times, https://www.ft.com/content/c70ff5bb-dff9-4ad1-9574-75e58c3c87c1
4. Transparency International