The Perils of Guanxi

China’s anticorruption campaign, now into its third year, is presenting real risk to foreign businesses, altering accepted working practices built on guanxi, or connections, and dampening sentiment in key markets, according to a report released today by the country risk firm Steve Vickers Associates.

Because it is aimed at breaking the links that win advantage through association, the campaign is like no other in recent Chinese history. Guanxi is a central idea in Chinese society and has governed the way business is done by Chinese not only in China itself but across the world. China’s new leaders are out to change that.

Because western businessmen so enthusiastically adopted guanxi as a way of navigating Chinese society, those connections are posing risks, according to the Vickers report.

The Vickers firm is hardly alone in identifying the risk. The harshness of the overall campaign has caught the attention of Li Hejun, the head of solar manufacturer Hanergy Group and China’s richest man, who warned delegates to the Chinese People’s Political Consultative Conference last week that the drive is snaring private entrepreneurs to the point where it is damaging the economy. Li said added that the lack of a legal structure to wind down the firms of those netted is resulting in unpaid debt and collapsed companies.

Wang Qishan, the head of the Central Commission for Discipline Inspection, is leading the corruption purge. At last week’s National People’s Congress, he told delegates it is not going to slow or abate any time soon. Some of China’s most senior figures are targets apparently including associates of the retired Jiang Zemin, 88, who headed the Chinese government from 1989 to 2002, and Hu Jintao, who succeeded him to lead the country from 2002 to 2012.

The campaign carried out 53,065 investigations, disciplined 71,747 cadres and severely disciplined 23,646 by the end of 2014, according to the Vickers report. Much of it has been aimed at links that spread far and wide from Zhou Yongkang, the head of China’s security services, who now could face the death penalty.

The report also points out that the purge has also opened up space for others to climb the government ladder, replacing the thousands who are being displaced. “Any business that can identify winners early could forge links that could provide a real competitive advantage.”

That takes careful maneuvering. “This campaign is not just a political curiosity – it poses real risk to foreign investors,” the report noted. “Companies suffer when they lose political protection.” In particular, GlaxoSmithKline was fined US$500 million last October for using travel agencies to steer bribes to doctors and others to boost sales. Its former China head, Mark Riley, received a three-year suspended sentence and a Shanghai health official received 19 years in prison.

“The case is important, because GSK’s activities were illegal, but they had been typical,” the report noted. More broadly, “concerns are rising about weak auditing of state-owned enterprise assets and the campaign has dampened sentiment in certain markets such as luxury goods and gaming.”

And, as in GSK’s case, being caught for corruption in China alerts the domestic authorities. In the United States, the Foreign Corrupt Practices Act makes payments to foreign government officials to help out in obtaining or retaining business a crime. And, since 1977, those provisions have been extended not only to all US persons but to certain foreign issuers of securities as well.

Others that have come under suspicion include Avon, the world’s largest door-to-door cosmetics seller, which spent more than US$300 million seeking to discover if its employees bribed officials in China, and Pfizer Inc. the pharmaceutical manufacturer, which also was forced to settle claims of bribing health care officials.

Patronage networks can stretch far so that the risks can be wider than expected, and foreign businessmen must identify how exposed any current business partner or corporate executive might be. These networks extend from the family to school chums to workmates or clubs or organizations and can last a lifetime.

The report cited the case of Kaisa Group, a property developer that collapsed last October with the arrest of Jiang Zunyu, the former head of the Shenzhen police, who prompted Kwok Ying Shing, Kaisa’s chairman, to resign in December, apparently because of links to Jiang. The developer missed payment on a US$1 million loan, triggering default clauses on loans worth US$10 billion, much of which appears to be irrecoverable.

Other cases, according to the report, include an inquiry into Founder Group, a major tech conglomerate, with interests, in pharmaceuticals, finance, real estate, commodities trading and finance in addition to information technology. After property company Beijing Zenith alleged embezzlement, the claim led to investigations that led ultimately to Minsheng Bank, one of China’s biggest private banks.

Rumors in China, according to the Vickers report, suggest that the family of former Prime Minister Li Peng is exposed, potentially affecting energy companies under their sway. The situation, according to the report, “poses serious risk to foreign investors, both in China and elsewhere, as accusations can prompt mirror and serious investigations” in their home countries.