China Due Diligence
The risks to operating and succeeding in China are well-documented. Corruption, fraud, intellectual property theft, unpredictable legal frameworks and law enforcement, and a rapidly changing regulatory environment are all to be expected in China. Despite the complications and difficulties, China’s current market and even larger future potential are too good to ignore. Rather than skipping the market, companies need to learn to navigate around the obstacles safely and effectively. For that, a lot of help is needed.
The Chinese Economy
The Chinese economy needs no introduction. It is the 2nd largest in the world by nominal GDP and perhaps the largest by purchasing power parity. China is the world’s largest exporter and second largest importer, the world’s largest manufacturer, and has the fastest growing consumer market.
Having said all of the above, China is still ranked low by GDP per capita. A demographic time bomb is brewing in the future as the country rapidly ages due to a decades old one-child policy that is now all but irreversible.
China (and the rest of the world, particularly Asia) will face major headwinds in the future as the country’s economic growth slows, and the economic environment matures. Today China is becoming a more middle-class economy, with its legal environment, regulatory environment, intellectual property protection regime, and law enforcement regime all mature.
Some Risk Factors
China’s rapid growth has created pockets of problems in the economy. There are both ineffective industries and bubbles. The People’s Republic of China has the world’s second largest economy by nominal GDP. The country was the world’s fastest growing major economy for decades, but because of the lingering influence of its command economy, it still today has a larger public sector than private sector.
China still closely manages its economy from the top down. This means its currency is still manipulated, local companies still receive favoritism, and IP is protected unevenly.
Some Limitations on Due Diligence in China
- Company listings are by Chinese name only. English language company names may have romanized names that are unrelated to the original Chinese and, therefore, be very difficult to identify without the original Chinese.
- Shareholders may not reflect actual beneficiaries of the business. Actual Chinese shareholders often use proxies to hold shares to shield themselves from taxes and lawsuits.
- Searches of official published media may not reveal much related to the company or individual due to censorship. Social media may be more useful, but will have a window of life that closes over time.
- Birth certificates, death certificates, and marriage certificates are all not available by law. Identification of indivduals is very difficult without identifiers in excess of just name. Privacy laws are strict and getting stricter over time, while enforcement is selective and often focused strongly on those who work with non-Chinese firms.
- Litigation searches can be done covering all lawsuits from 1996 to the present time. From the time a lawsuit is finished until it is published takes about 50 days. Currently ongoing lawsuits are not accessible.
- Criminal records are not available, by law, but national blacklists/watch-lists are maintained that may be checked if additional identifiers, such as date of birth, are available.
- Some local due diligence providers will engage in illegal or questionable searches, which may provide incorrect or misleading results, in the best case scenario, or lead to legal problems, in the worst case scenario. There are no licensing requirements for investigators in China. Anyone can become an investigator. Some professionals seek certifications for marketing or knowledge purposes, but they are not required by law. At the same time, those serving foreign companies cannot be too overt about their services due to China's increasingly stringent crackdowns on due diligence in the country.
- Many global databases and database aggregators are not likely to have accurate and exhaustive information on Chinese companies and individuals due to the nature of their information gathering efforts. Actually researching subjects in China cannot be effectively accomplished by database.
- Financial results for private companies are only available if self-reported. These results are, therefore, not audited and not reliable. They may be valuable as guidance, however.