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China Corporate Governance Updates

August 15, 2017

The discussion surrounding corporate governance has become more complex, and efforts to standardize governance reporting are a major concern among global companies. Questionable governance practices can cast doubt on a company’s integrity and can negatively affect shareholder perceptions. Sound corporate governance, meanwhile, can have far-reaching benefits, such as increased transparency and board efficiency.

Recently, China has made efforts to revamp its governance policies and corporate culture. Updates to China’s corporate governance policies may prove to be crucial for the region’s economic growth, especially as it opens its markets to foreign investment.  

Survey: Corporate Governance in China Improving 

Institutional Investor released its rankings for the 2017 All-Asia Executive Team Honored Companies. According to the survey, Chinese companies are climbing the ranks and are upholding positive corporate governance standards. 

For instance, the healthcare and pharmaceutical industry has been dominated by India in the past. However, this year the three top Most Honored Companies were Chinese companies: CSCPS Pharmaceutical Group, China Medical System Holdings, and 3SBio. 

The survey involved 2,510 companies in 18 different sectors, and based ratings on six core corporate governance factors:

  • Ability to access senior executives
  • Conference calls and meetings
  • Investor relations
  • Corporate documents
  • Responses to requests
  • Financial disclosures

Why Governance Is Important for China

While these survey results indicate great improvements for Chinese companies, there is still a consensus that the overall corporate governance ratings for mainland China tend to be low. Various factors provide strong incentives for China to improve its overall governance and corporate culture. Some factors include:

  • Industry Growth: As mentioned, Chinese companies are performing well in the healthcare and pharmaceutical industries. They are also showing potential in internet sectors as well. As China continues to grow in these industries, sound corporate governance will be central for maintaining wins.
  • IPO Market Concerns: China is becoming a strong leader for IPO markets. However, there are concerns about regulation in China’s markets, and strong governance is needed to help prevent instances of fraud and corruption.
  • Regional Accountability: Chinese and Hong Kong markets are becoming more integrated. Board accountability is needed in order to facilitate issues like enforcement and disclosure across the two regions, which operate within different legal frameworks.

Major Overhaul of Corporate Structures in China

In order to address corporate governance concerns, China is making major plans to overhaul the unwieldy corporate structures of its large businesses. All major Chinese enterprises owned by the central government will be turned into limited liability companies or joint-stock firms by the end of the year.

In particular, restructuring of state-owned enterprises will involve a separation of government administration from the management of day-to-day business operations, as well as the formation of boards of directors for state-owned entities. This will help get Chinese companies up to speed with current governance practices.

To clarify, the overhaul is not intended to be a privatization of the sector or a “de-nationalization” process. Efforts will still be made to affirm party leadership at big state firms and to prevent losses of state assets during the restructuring process.

While the process is already underway, 69 of the 101 government-owned enterprises have not yet registered as limited liability or joint-stock firms. The overhaul of corporate governance for these firms is part of the government’s larger aims of promoting stability for the country’s financial system, as well as opening China’s markets. 

Regarding financial stability, one of the largest challenges the country faces is a large increase in debts following the global financial crisis of 2008. To meet these challenges, banks may begin withdrawing support from firms that are financially unstable. In terms of opening up its economy and markets, securities regulators have pledged to expand capital markets for investors, while at the same time encouraging more institutional participation. 

Potential Issues to Anticipate

The structural changes listed above will do much to reform the country’s corporate governance. But even with such broad adjustments, China corporate governance policy will still need to undergo refinements in the future.

For instance, it has yet to be seen how Chinese corporations will integrate Environmental, Social, and Governance (ESG) metrics in their reporting. This is a concern for all companies across the board, as ESG reporting is a relatively new area, and reporting metrics are not fully standardized in all regions. The push for transparent, consistent ESG reporting is a global concern, and China will need to integrate such metrics in corporate reporting. 

In addition, corporate governance in China needs to secure boards against the ever-looming threat of securities-related fraud and other violations. As previously mentioned, China is quickly becoming a main IPO market, which can make it particularly vulnerable to violations. 

For example, Chinese courier ZTO Express was recently sued over a dispute regarding its $1.4 billion initial public offering. The company allegedly issued “untrue statements” and “omitted crucial realities” in its registration statements. There are also allegations of inflated profit margins and failures surrounding due diligence. 

These types of legal entanglements can be a deterrent for investors. While ZTO claims the allegations are without merit, it is essential for corporate governance efforts in China to promote an overall culture of accountability. 

Summary

For China and other markets such as those in Southeast Asia, corporate governance is not only a means to prevent internal conflicts and meet local standards — it is also important for improving investor relations and increasing opportunities for global managers. As China continues to open its markets, sound corporate governance policies can help encourage long-term institutional involvement with Chinese organizations. 

Corporate governance affects all aspects of a business, and can include some complex considerations regarding board and shareholder interactions. If you have any questions or concerns regarding governance reform and policies, contact us today at Kessler Topaz. Our team of attorneys has deep experience helping clients implement effective governance changes in diverse areas.