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China’s corporate social credit system (CSCS), a national regulatory framework intended to audit the nation’s industries and hold individual players to account, is inching toward completion—and it may pose a new challenge for foreign firms operating in China.

The CSCS, first proposed in 1999 by then Premier Zhu Rongji, is a centralized database that gives Chinese authorities greater oversight of businesses operating in China—both foreign and domestic—and provides a system by which to blacklist those deemed out-of-line.

Improved regulation could help China crack down on wayward businesses—tackling issues of pollution and tax avoidance, for example. But some Western observers fear the system will be used to restrict market access to foreign firms.

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“[The CSCS is] a new source of risk to foreign companies operating in China [that] could magnify the impact of arbitrary enforcement or regulatory bias against foreign companies,” the U.S.-China Economic and Security Review Commission—a government advisory panel established by Congress in 2000—said Tuesday.

The Commission was summarizing a report authored by Beijing-based consultancy Trivium China. (Trivium wrote the report for the Commission.) The 95-page document is the most comprehensive assessment yet of what China’s impending regulatory system means for U.S. corporations and interests.

But the report itself is arguably more conservative than the Commission’s summary. Trivium notes that while the CSCS “could evolve to disadvantage U.S. firms” as U.S.-China relations plummet, the firm seems to downplay—at least for now—the chances of a worst-case scenario in which Beijing wields the CSCS as a weapon against foreign firms that fall out of its favor.

Corporate credit

The notion of social credit scores typically sparks ire among Western commentators, many of whom view the idea as Orwellian: an authoritarian government leveraging Big Data and mass surveillance to crack down on social liberties.

China already operates a “social credit score” system for individuals and issues petty punishments for some transgressions, such as defaulting on debt. Preventing bad debtors from boarding trains is one common discipline. But social credit, and the CSCS in particular, is much more bureaucratic and technologically less advanced than fears of a moralistic panopticon suggest.

“The term ‘Corporate Social Credit System’ is somewhat of a misnomer, and the use of the word ‘system’ is misleading, as it implies that the CSCS is a single, holistic, techno-regulatory apparatus, and that each policy under the social credit banner is a node in an integrated regulatory framework,” the report from Trivium says.

Currently, the CSCS remains largely disjointed. Beijing formally proposed creating the system in 2000 and published a plan for how to implement it in 2014, scheduling the system for completion by the end of 2020.

But China might not meet that deadline. A number of provinces have issued papers on how they will enforce CSCS standards, but other provincial authorities have not. With the year racing to a close, the full system might not be online until 2023, Trivium says.

Black and red

At its core, the CSCS is a database of all companies operating in China, complete with lists of each firm’s various regulatory lapses. The system compiles data gleaned from at least 44 states agencies and their branch offices across every province in China to create one centralized list.

“The scale of this data aggregation scheme cannot be overstated,” Trivium says. According to Trivium, the scope of interagency operation is equivalent to the IRS, the FBI, the Environmental Protection Agency, the Food and Drug Administration, the Department of Agriculture, the Health Department, the Department of Housing and Urban Development, the Department of Energy, the Department of Education, and every courthouse, police station, and state agency sharing records across a single platform.

Regulators and authorities can then access the CSCS’s databanks and use the information to either “redlist” corporations that frequently perform well—marking the companies for incentives and priority treatment—or to blacklist companies that frequently violate regulations—opening the business up to sanctions and scrutiny.

In theory, companies can’t be blacklisted arbitrarily under the CSCS. Authorities have to prove the business has violated some specific rule first, which typically involves some legal proceeding. For example, the blacklist reserved for debt defaulters is overseen by China’s highest judicial authority, the Supreme People’s Court.

However, Trivium notes regulatory bias and corruption could result in abuse of the system—particularly when it comes to foreign firms.

“In the event of increased trade tensions, regulatory bias could result in regulators applying penalties more stringently to U.S. companies,” the report says, noting that there are “avenues through which the system could be politicized,” like in trade wars.

Comply

The U.S.-China Economic and Security Review Commission isn’t the first foreign body to sound alarm bells over the CSCS. In a report published in August last year, the European Chamber of Commerce in China warned that the CSCS should be a “wake-up call” for European business in China.

“China’s Corporate Social Credit System is the most concerted attempt by any government to impose a self-regulating marketplace, and it could spell life or death for individual companies,” said Jörg Wuttke, president of the European Chamber of Commerce in China, urging businesses to adapt to the new system.

But that adaptation does not necessarily mean implementing a radical overhaul of corporate morals, as the term “social credit” appears to suggest. Rather, the risk to foreign firms—excluding corruption and abuse of the system—is one of compliance.

“It is a complicated and time-consuming endeavor to detect, distill and keep track of the concrete details of the CSCS,” the Chamber wrote in its report. “As the System remains a ‘work in progress’, with adjustments being made almost daily, keeping a continuous eye on these developments remains a necessary task.”

As China’s presence on the international stage continues to grow, there’s also a risk that the CSCS could someday surpass the international credit scoring standards set by the U.S. and led by firms like Moody’s and Fitch. China’s foreign investment schemes, such as the Belt and Road Initiative, could be used to convince developing nations to adopt CSCS, too.

According to Trivium, CSCS’s potential to “erode” the U.S. lead in financial services like credit rating is a “more immediate geopolitical risk” than the CSCS being used against U.S. companies.

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