Wise companies prepare for-and minimize their exposure to-risks when investing in China
On the surface, China appears to be one vast market with a strong central government. But deeper down, China is a conglomerate of disparate markets that vary in their levels of economic and social development-from modern municipalities like Shanghai and Beijing, where officials are used to dealing with foreign investors, to the less-developed "Wild West." Though the central government has been taking steps to improve overall business operating conditions by instituting a stronger rule of law, building a more modern financial system, and creating a more transparent business environment-especially since China joined the World Trade Organization (WTO) in 2001-development and implementation remain uneven across the country.
As a result of this inconsistent investment environment and China's rapid economic growth, the country provides foreign companies not only with enormous business opportunities-but also with enormous risks. Companies seeking to make their first investment in the country or expand their existing presence must be fully aware of the risks of doing business in China and prepare to take appropriate measures to mitigate those risks. Though foreign companies in China face legal, financial, political, social, and environmental risks, they can employ strategies to prevent them.
Legal and regulatory risks
Regulatory risk in China is high. Although many sectors of China's economy have become more market oriented, numerous restrictions and a massive bureaucracy still hinder full implementation of regulations and make the approval process unpredictable. Moreover, the interpretation of PRC regulations tends to vary from place to place, and, in some cases, several authorities or departments are responsible for implementing the same regulations. Because companies must consult all of the relevant authorities-and often incur additional costs for doing so-the cost of doing business in China is frequendy higher than companies expect. These issues, coupled with a recent rise in policies aimed at protecting domestic companies from foreign competition-especially in engineering and construction, legal services, and banking-create risks and obstacles that few foreign companies are aware of until too late.
Foreign-invested enterprises (FIEs) that plan to operate or invest in China or partner with a Chinese company need to understand how the regulations apply to them before entering into any agreements. Many FIEs wisely seek legal and regulatory advice from experienced professional firms in China. The Chinese business landscape is littered with unsuccessful ventures that tried to save money by "going it alone."
Using China's judicial system also involves risk. Because of China's WTO membership and growing pressure from foreign investors for greater transparency and rule of law, China increasingly recognizes overseas arbitration awards and rulings. It is, however, still risky for companies to rely solely on the PRC judicial system to protect their interests. Few judges in China understand and have significant experience in handling commercial disputes; many are susceptible to pressure from local interest groups and governments. Even after receiving a favorable ruling, some companies have reported enforcement problems. For example, companies often find that authorities fail to implement judgments in bankruptcy proceedings.
In a relatively opaque environment, careful preparation to avoid legal problems in the first place is the best solution. Companies can minimize legal risk by conducting due diligence on the legal and financial background and reputation of key joint venture (JV) partners, acquisitions, senior managers, vendors, and suppliers before entering a formal relationship. Companies should also conduct pre-employment screening of all employees. Finally, companies may also wish to check …