Chinese National Security Laws Hinder Foreign Companies’ Operations in China

Investigations into alleged misconduct and criminality by companies are to be expected, and welcomed, in any country. However, the problems facing foreign companies in the People’s Republic of China (PRC) depart from normal legal checks and balances. The lack of separation between the judiciary and the state, and the uncertainty around China’s interpretation of the “rule of law,” is a risk factor for companies doing business there (See: China Brief, September 8). In addition, “state secrets” in the PRC are defined widely in relation to national interest. Consequently, a foreign company can inadvertently breach the law by obtaining and using commercial data.

This week the US Department of Commerce’s Bureau of Industry and Security (BIS) announced updated export controls on advanced computing semiconductors, semiconductor manufacturing equipment, and supercomputing items to the PRC (BIS, October 17). Foreign companies doing business in the PRC are likely to face continued uncertainty as a consequence. The response from the PRC was swift, stating that the United States has constantly “overstretched the concept of national security” and resorted to “unilateral bullying” (China Daily, October 18), which suggests that there is a risk the PRC will take retaliatory measures against foreign companies.

Western companies involved in the PRC have long understood that when investing in China they must lose a little bit of money in the short term to win a lot of money in the long term. Doing business in China has always been complex, but with the continued expansive approach to national security, it may now be increasingly untenable (See: China Brief, September 22). After three decades of huge investment in the PRC by international companies, there are growing concerns that the growing emphasis on national security is harming the confidence of overseas investors. As the European Union Chamber of Commerce in China reports, “the politicisation of business, and ambiguous laws and regulations…increases risk for companies operating in Chinas” (EU Chamber, September 20). In recent weeks, this ambiguity has been exacerbated by the growing number of “exit bans,” whereby PRC authorities forbid specific business executives at international companies, such as Kroll and Nomura, from leaving the country (Stratfor, September 29).

China’s Increasingly Restrictive Legal Landscape

National security has become paramount in the Xi era. In 2014 at the very first meeting of the National Security Commission, President Xi announced that “To secure its leadership role and unite the country in upholding and developing socialism with Chinese characteristics, our Party should make national security its top priority (Qiushi, April 15, 2014).” New laws have given formal structure to the Party’s ideological emphasis on national security and are having a tangible impact on the conduct of business by foreign companies and businesspeople.

In May 2020, the National People’s Congress (NPC) adopted “The Law of the People’s Republic of China on Safeguarding National Security in the Hong Kong Special Administrative Region,” which the city government claimed would “boost both local and foreign investor confidence in the future of Hong Kong and brighten our economic prospects (HKSAR Government, June 15, 2020).”

In April 2023, a revision to the Counter-Espionage Law was adopted by the Standing Committee of the NPC, updating what was hailed as the country’s first law implemented in 2014 to “implement the overall national security strategy” (China Daily, April 27).

In July 2023, the Ministry of State Security (MSS), in its first ever public WeChat post, indicated how all-pervasive the PRC “intelligence state” seeks to be (See: China Brief, September 22). The post explained how state organs, enterprises, and other social institutions need to implement various counter-espionage security measures. It also urged further education to maintain national security, and the mobilization of personnel to prevent espionage activities. Additionally, news, broadcasting, television, cultural, and internet information service units were encouraged to carry out targeted counter-espionage publicity and education facing the whole of society (Global Times, August 1).

How Firms Fall Afoul

From feedback provided by multiple due diligence and risk consulting firms this year, it is clearly no longer possible to conduct work in certain commercial areas within the PRC due to the risk of falling afoul of ambiguous national security laws. Multiple foreign commercial due diligence firms have therefore withdrawn from Mainland China along with Hong Kong, as certain research products (for instance PRC economic data) are perceived to be accessing “state secrets,” however nebulously defined by the authorities. Much due diligence work requires access to live sources to add context to open-source research. However, not only are these firms now reluctant to access well-placed Chinese sources, but those same sources are also reluctant to talk, for fear of being accused of espionage.

It is impossible for such an all-of-society approach not to have an impact on foreign companies conducting business in the PRC. Manufacturing and procurement companies with operations in the country are required to build in national security requirements to their local corporate structures and policies. Services and consulting companies gathering information in China also need to be cognizant of restrictions on state secrets. These restrictions are so opaque, and have such a broad scope, that the core services and products of these companies are increasingly rendered untenable. Recent cases involving Bain, Capvision, and the Mintz Group illustrate how certain areas of business that are acceptable and a necessity in most of the rest of the capitalist world can no longer be safely conducted in the PRC, if it all.

Bain

Bain & Company, a global consulting firm founded in the US in 1973, has offices in Beijing, Hong Kong, and Shanghai. Like most strategy consulting firms, a major segment of Bain’s income comes from public sector and government clients, notably the US government. In May 2023, Chinese police officers reportedly visited the Bain office in Shanghai, questioned employees, and seized phones and computers. Five months on, the reason for the police raid has still not been publicly disclosed, though Bain subsequently announced that it was offering some employees in China the option to take six months leave as a “career enrichment program.” This indicates that the action by the authorities may have had an impact on business (SCMP, May 14).

In July Yu Yong (于勇), Party Secretary of the CCP Jing’an District Committee, visited the Bain office in Shanghai. He stated publicly that “We will adhere to the enterprise-oriented approach, continue to do a good job in our services, and create a first-class business environment, and be a partner for the development of the enterprises” (Global Times, July 11). The visit by Yu Yong is likely to be an effort by officials at the local level to stabilize relations with foreign companies, and Yu pledged to provide better services for “foreign-funded companies.”

Capvision

Capvision was founded in 2006, and is headquartered in both Shanghai and New York. It provides of expert knowledge services through access to over 450,000 industry experts around the world. These experts are introduced to clients such as consulting firms and global corporations to provide insight into issues in their respective commercial sectors. The founder and CEO, Xu Rujie (徐如杰), previously worked at China Resources (Holdings) Co Ltd, Siemens China and General Motors (China) Investment Co Ltd., and the firm’s top five clients are reportedly Chinese financial institutions (Reuters, May 9).

In May 2023, Chinese news media reported that state security agencies had launched an investigation into Capvision relating the company’s inducement of “Chinese experts in key fields, including the military and high technology, to … become complicit with foreign intelligence agencies in helping them spy, buy off experts and obtain state secrets and intelligence” (China Daily, May 9). The report alleged that state security police found that a number of overseas organizations had been attempting to steal state secrets and key intelligence by making use of domestic consulting companies, violating the law in pursuit of economic gain. PRC state media has sought to diminish the significance of this by arguing that the Capvision case is not indicative of a broader shift in the environment, and that there is no impact on foreign firms as long as they are abiding by Chinese laws (Global Times, May 10).

Capvision admitted that it had not fulfilled its national security prevention responsibilities and that there were significant hidden dangers and loopholes in their business practices which have caused serious harm to national security, and agreed to establish a compliance management committee (Global Times, May 10). The firm continues to operate in the PRC, but it is likely that Chinese state-owned companies will no longer use their services. Reputational damage might cause local experts to hesitate before registering with the company. Many other similar now also face a major challenge in accessing commercial information from experts in the PRC. The action against Capvision, casts doubt on the entire expert network services business model in China, in turn raising a major hurdle for consulting and investment firms to gain accurate analysis regarding potential investments in the country.

Mintz Group

The Beijing office of the Mintz Group, a US firm founded in 1994 that conducts due diligence operations and investigations around the world, was raided by the authorities in March 2023. The company (trading in China as 美思明智商务咨询（北京)), was later found by the Beijing Municipal Bureau of Statistics to have violated the law in its business operations by failing to obtain approval for foreign-related statistical survey qualifications and illegally engaging in foreign-related statistical survey activities. The Bureau imposed a penalty on Mintz of confiscation of 5.35 million yuan ($731,000), imposed a fine of the same amount, with total administrative penalties of 10.7 million yuan ($1.46 million) (Beijing Municipal Bureau of Statistics, July 14).

The raid and penalty may have been triggered by the publication in 2022 of an article co-authored by Randal Phillips, then Mintz’s Asia chief and a former CIA chief representative in China, on “Sanctions Due Diligence” relating to the Uyghur Forced Labor Prevention Act. The article highlighted that Mintz conducted due diligence for clients to determine if Uyghur forced labor had been used in the supply chains of products exported to international markets (Reuters, May 19). PRC state media denied that the Mintz due diligence investigations in Xinjiang were related to the enforcement action: The Global Times stated that “US politicians have fabricated outrageous lies including those surrounding ‘forced labor,’” and continued by arguing that this was “only part of the extensive US efforts to contain China’s rise. China must defend itself against US economic attacks” (Global Times, August 22). By linking the two subjects in the article, this Party mouthpiece undermines the regulator’s denial of any correlation.

China’s Perceptions Run Counter to Business Requirements

The Global Times piece also states that to operate a business in China, “enterprises with foreign capital must abide by Chinese laws and regulations, and they must not engage in any activities detrimental to China’s national interests” (Global Times, August 22). This statement identifies the intent of enforcement action against foreign companies conducting due diligence investigations in China, which is to prevent them from gathering business information that may be “detrimental to China’s national interests.” These national interests include maintaining confidence in and support for Chinese firms, which could be affected by adverse or inconvenient data. However, access to this information is a crucial prerequisite to any investment deal. A reduced ability to perform due diligence translates into fewer IPOs, fewer private equity deals, and a less dynamic Chinese economy.

The comprehensive approach to national security in the PRC has become an increasingly important factor for foreign companies to consider when planning their operations in China. Other risk factors that have emerged recently include the opaque approach taken by the CCP in uncovering the origins of the COVID-19 pandemic, deteriorating relations between the PRC and the US Government, and general economic uncertainty due to the property sector crisis and the weakening external demand for Chinese exports. Increasing volatility from Beijing is pushing the limits of what foreign enterprises are willing to tolerate when it comes to their cost-benefit calculus.

Conclusion

The development of comprehensive national security during the tenure of Xi Jinping has altered China’s trajectory away from being a welcoming environment for foreign business to a hostile focus on foreign espionage. This has led to a rise in suspicion as a default approach from China’s regulators and national security apparatus. This nationalist approach to security is already making operating businesses in China more complex, costly, and for some companies untenable. Beijing is aware of these concerns but is yet to undertake any actions that would alter this deteriorating trajectory. Perhaps, given the country’s push towards self-reliance, it no longer feels that it needs these foreign enterprises in the same way it did in the earlier parts of this century. However, it is likely that such a hubristic view will hinder China’s growth in the coming years.