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China has released the first piece of legislation governing the growing social credit system, the credit rating system that rewards and punishes various society stakeholders for good and bad behavior. The draft law, which has been released for public comment, standardizes the application of the social credit system and provides important legal definitions for various concepts. Below we outline the contents of the draft law and explain their potential impact on companies and individuals in China.
The National Development and Reform Commission (NDRC), China’s macroeconomic planner, and People’s Bank of China (PBOC), China’s central bank, released the draft version of a new law on the building of the social credit system (SCS). The Social Credit System Construction Law of the People’s Republic of China (the “SCS Construction Law”) is the first piece of legislation to be released outlining the legal structure, responsibilities, scope, and legal definitions of China’s SCS. The law provides a legal basis for various governments and industry organizations to build and implement the SCS and actively hold various society stakeholders accountable for dishonest behavior. The government is soliciting opinions from the public on the draft law until December 14, 2022, after which it will undergo another round of reviews and deliberations.
What is China’s social credit system?
China’s SCS was first officially proposed to the public in 2014 with the release of the Outline for the Construction and Planning of the Social Credit System. Often misconstrued as a surveillance system for monitoring the behavior of private citizens, the system is actually an attempt to build a credit rating system for three categories targeting different pillars of society: one for citizens, one for businesses and other organizations, and one for government officials. The latest draft law also includes “judicial integrity” as a category of the SCS, which looks to monitor the behavior of judicial entities and figures in the country. The system seeks to increase social, governmental, and corporate transparency by publicizing and punishing illegal or “untrustworthy” behavior. The types of behavior that are tracked under the SCS are different for these three groups.
For businesses, the SCS monitors companies’ records in areas such as tax, legal compliance, product and service quality, environmental impact, and contributions (or damage) to society, among others.
Under the SCS, companies that have been found to engage in “untrustworthy” behavior may face consequences, such as being placed on a “dishonest entity list”. Being placed on the entity list may lead to consequences such as being restricted from market access, fiscal funds, and preferential policies, as well as increased regulatory inspections and disqualification from streamlined bureaucratic procedures. The company’s credit score, as well as the violations it has committed or untrustworthy behavior it has engaged in – are also publicized for stakeholders, such as consumers, business partners, and suppliers, which may impact sales and business operations.
The Chinese government has released a range of opinions and policy documents on the parameters of the SCS. These include measures on the administration of the entity list, measures for the restoration of bad credit, as well as various blueprints for how the SCS can be used to boost higher-quality trade, investment, and industry development. However, until now, no official legislation outlining the legal requirements and definitions has been released. The draft SCS Construction Law, when passed, will be the first piece of legislation underpinning the SCS.
What is in the new law?
According to the law’s preamble, the law will seek to improve the social credit system and innovate on social governance mechanisms. The aim of doing so is to optimize the business environment and standardize the market, as well as enhance social awareness of corporate integrity and corporate untrustworthiness.
The draft law, which has 110 articles across 11 chapters, stipulates the applicability and scope of the SCS, including the responsibilities of various government departments in ensuring the fair implementation of the system, as well as legal protections for targets of the system. It also provides legal definitions for terms, such as “untrustworthy”, and explains the scope of rewards and punishments for a good or bad credit rating.
Below we provide a brief explanation of some of the main tenets of the SCS Construction Law.
Who does the SCS apply to?
The draft SCS Construction Law outlines requirements for the construction of the SCS for four areas of society: government, social, corporate, and judicial. The draft law outlines the responsibilities of these four segments of society to uphold integrity and trustworthiness within their respective fields or social roles.
What information is collected under the social credit system?
Under the social credit system, “credit information” will be collected from the four target groups – government officials, companies, social organizations, and judicial bodies – which will be used to assess the trustworthiness of a given organization or individual.
Under the draft SCS Construction Law, “credit information” is defined as “information that can be used to identify the identity and credit status of natural persons, legal persons, and unincorporated organizations with full capacity for civil conduct”. The type of credit information that is collected under the SCS differs for the governmental, social, corporate, and judicial areas.
The draft law outlines their distinct responsibilities and tasks for the construction of the SCS, which the draft law calls “key fields” for the first three of the four categories.
For the government, the law outlines six “key fields”. These include holding government bodies and agencies responsible for the fair and equal implementation of investment policies, upholding commitments to market players in government procurement schemes and projects, maintaining debt transparency, and ensuring equality and fairness in government bidding and financing schemes, among others.
For businesses, the responsibilities focus on maintaining a healthy competitive market environment, preventing anti-competitive and monopolistic behavior, ensuring compliance with market standards and regulations, and upholding commitments to clients, consumers, and other stakeholders. The draft law mentions 14 “key fields” for the construction of the SCS for corporate entities.
The draft law requires relevant government departments to improve their capabilities to investigate violations by companies, mete out punishments, and share the relevant credit information across government departments to strengthen comprehensive oversight over the companies. The type of credit information that could be monitored and recorded under the SCS includes (but is not limited to):
- Production safety
- Illegal or false marketing and advertising
- Statistical records, including statistical fraud or illegal or dishonest statistical practices
- Market entity registration, administrative licensing, and other administrative activity
- Accounting, including accounting fraud or illegal or dishonest accounting practices
- Financial activity, including financial fraud or illegal or dishonest financial practices
- Payment of taxes
- Product pricing, including price fraud or other illegal or dishonest pricing behavior
- Construction and engineering safety and fulfillment of contractual obligations in the construction and engineering field
The draft law outlines 11 “key fields” for building the SCS in the field of public services and social governance. Through this, the SCS will seek to strengthen the civil, labor, and privacy rights of citizens and hold entities and organizations that violate these rights accountable. It requires government departments to build the SCS to monitor areas such as employment and human resources, social services, healthcare, education, and the environment, among others. The types of credit information that could be collected include (but are not limited to):
- Compliance (or lack thereof) with labor laws by employers
- Social services fraud, payment of (or failure to pay) social benefits, provisions (or lack thereof) of social and work-related insurance
- Honesty and integrity in the field of healthcare, such as monitoring of pricing, bribery, excessive treatment, or provision of counterfeit or illegal medicine
- In the field of education: issuing fraudulent qualifications or certificates, exam fraud, academic misconduct, non-compliance with education regulations
- In the field of scientific research: plagiarism, forgery, tampering, ghostwriting papers, and violations of scientific research activities management regulations
- Infringement of intellectual property rights (IPR), trademark squatting, and abnormal patent applications
- In the field of environmental protection: compliance with environmental protection laws and fulfillment of environmental responsibilities
- In the field of internet networks: compliance with network security, data security, and personal information protection laws
Finally, for the judicial segment, the draft law does not outline “key fields” but instead outlines areas in which judicial bodies, personnel, and practices are to be improved and monitored under the SCS. The requirements for the judicial segment are broader compared to the other categories, and generally require various stakeholders and bodies of the judicial system, such as judges, judicial and prosecutorial organs, public security organs, and other judicial bodies and personnel to practice the law in an impartial and ethical way and promote transparency within the system.
How will the SCS be applied to businesses?
The SCS Construction Law requires the relevant government departments supervising each industry to establish credit records of market entities within their field.
Companies are given a “unified social credit code”, under which all credit information will be filed. This code is issued by the registration departments and is displayed on the company’s business license.
Certain company credit information – such as general administrative information, equity, information on penalties or fines received, and more – will be made public through the national public credit information sharing platforms and local public credit information sharing platforms. These sharing platforms act as a hub for sharing and exchanging various types of “public credit information”. Public credit information is defined as credit information generated and acquired by state organs and organizations to manage public affairs in the course of performing their statutory duties and providing public services. The government will also maintain a catalogue of public credit information, which the relevant government departments are responsible for organizing and compiling.
Companies will also be given a “public credit evaluation” by the Social Credit System Construction Management Department. Other state agencies may also conduct industry credit evaluations of companies based on these public credit evaluations. Public credit evaluation is defined as the evaluation of the credit status of a company. This is based on public credit information and calculated using various methods, including statistical methods, model building, and on-site certification. The evaluations can then be used as the basis for state agencies and organizations that are authorized to manage public affairs to allocate public resources and implement credit classification and supervision. Market participants can voluntarily refer to the use evaluation results.
What are the consequences of a bad credit rating?
Article 10 of the draft SCS Construction Law enables state organs and organizations with the requisite authority to punish “untrustworthy” actors. The draft law defines untrustworthy activities as “acts carried out by the targets of credit information subjects that have been legally recognized and confirmed by state organs to have lost their integrity. The law stipulates two measures for punishing untrustworthy behavior. These are:
- Organizing a list of punitive measures for untrustworthy behavior. These may include:
- Consolidating and publicizing unfavorable information on a company;
- Including a company within the scope of companies for increased supervision;
- Restricting companies’ ability to apply for financial funds, access to preferential policies or streamlined administration measures, and participation in merit appraisals for industry rewards;
- Adding companies to the “seriously untrustworthy entities list”. This list includes entities that have been found to commit “seriously illegal and untrustworthy conduct”;
- Prohibiting market and industry entry;
- Restricting participation in bidding and government procurement activities;
- For individuals: Restricting employment, restricting the practice of a trade, and restricting relevant consumption behaviors; and
- For individuals: Restricting exit from the country.
- Enabling other organizations and individuals to limit or restrict organizations or individuals with poor credit status from engaging in activities such as credit services, financing and credit grants, bidding, business cooperation, and so on, as befits their own responsibilities and needs.
What are the benefits of a good credit rating?
According to Article 9 of the SCS Construction Law, government bodies are authorized to implement market-based incentives for companies with good credit status. The law outlines two incentive measures for good conduct:
- Providing simplified and priority procedures when:
- Providing them with public services;
- Providing them with financial funds and project support;
- Providing them with public resource transactions; and
- When honoring them with awards or honors.
- Reducing the frequency of inspections or reducing the proportion of random inspections.
- In addition to state agencies, enable other organizations and individuals to provide companies and individuals with added convenience and preferential measures for credit services, financing and credit grants, bidding, business cooperation, and so on, as befits their own responsibilities and needs.
What is the significance of the SCS Construction Law on companies in China?
The new SCS Construction Law – and the SCS in general – significantly ups the stakes for non-compliance and illegal behavior by companies. In addition to the risk of fines and other legal penalties, the SCS pose potential reputational damage and loss of trust between companies and their stakeholders, whether they be a customer, business partner, or supplier, and this may be harder to overcome than a simple monetary fine.
Conversely, the SCS also offers better transparency for companies when vetting a potential business partner or supplier, which in turn can help to decrease business risks posed by untrustworthy companies. A lack of reliable credit information and evaluations of potential companies has long been a headache for foreign companies doing business in China. For this reason, strengthening the social credit system and holding untrustworthy entities accountable can help to improve the business environment and enhance trust between business partners.
Moreover, the SCS also presents an opportunity for companies that are active and meticulous in adhering to laws and regulations and work to create a positive impact for their stakeholders. Getting in the authorities’ good books could help to facilitate certain procedures and improve access to important markets or contracts.
As China continues to build the social credit system infrastructure, companies would do well to conduct self- or third-party audits to ensure that all administrative, operational, financial, accounting, statistical, and all other processes are fully compliant with laws and regulations. In addition, it is also important to ensure that partner companies and vendors within your supply chain are also compliant with laws and regulations, as any third-party products or processes that are below standards or otherwise non-compliant may impact upon the companies’ own products and services. Compliance must be ensured throughout the entire supply chain to maintain a good credit status.
About Us China Briefing is written and produced by Dezan Shira & Associates. The practice assists foreign investors into China and has done so since 1992 through offices in Beijing, Tianjin, Dalian, Qingdao, Shanghai, Hangzhou, Ningbo, Suzhou, Guangzhou, Dongguan, Zhongshan, Shenzhen, and Hong Kong. Please contact the firm for assistance in China at [email protected]. Dezan Shira & Associates has offices in Vietnam, Indonesia, Singapore, United States, Germany, Italy, India, and Russia, in addition to our trade research facilities along the Belt & Road Initiative. We also have partner firms assisting foreign investors in The Philippines, Malaysia, Thailand, Bangladesh.