Maggie Jia
By Maggie Jia & Terina Nie
Over recent years, the challenge of restructuring or downsizing business operations in China has been faced by many companies. During the process of business restructuring or downsizing, compliance related issues have intensified this challenge, even becoming a matter of business survival in China.
Take the contribution of social insurance and housing provident fund (“Social Benefits”) as an example. Due to a long-standing disconnect between the understanding and implementation of related legal laws and regulations in different regions, many companies have issues with underpayment or non-contribution of Social Benefits, particularly those have operating business in China for more than two decades.
When labor relationships are stable under developing economic environment, Social Benefits related issues are often overlooked. However, in recent years, when companies have to plan and implement the restructuring or downsizing their operations, these issues are almost certain to be exposed mainly through the reporting by the employees, leading to unexpected costs and disturbance. Companies are not only required to make up the contribution in full but may also be punished to pay fines, the amounts of which can be comparable to the required back payments. For some companies, this “unexpected” burden may exceed their budget for business restructuring or even beyond their capacity to bear the costs.
In addition to Social Benefits, China has significantly increased its focus on corporate compliance, especially concerning issues related to production safety, environmental protection, operational norms, and worker safety. As the country’s regulatory environment evolves, together with the significant impact caused by the changes of the global economic situation, many foreign invested enterprises (“FIEs”) operating in China are facing growing pressure to update and upgrade their compliance management systems to align with these new standards, practice and situation.
Good news is that compliance related risks can be managed and mitigated through effective compliance management, as the administrative management in China is in principle in accordance with laws and regulations instead of “negotiation”. However, even with considerable time and resources spent developing compliance management, many FIEs still encounter significant hurdles in transforming compliance requirements into day-to-day practices.
This article explores the key challenges faced by FIEs in managing compliance in China, analyzes common obstacles, and outlines a step-by-step approach to setting up effecitve compliance management in China.
The Challenges in Effective Compliance Management
These challenges stem from various factors, including organizational inertia, cultural differences, and operational limitations. Based on various case studies and our practical experience, the following factors have been identified as major contributors to the difficulty in implementing effective compliance practices:
1. Historical Factors: The Impact of Long-Established Practices
For FIEs with a long-established presence in China, many senior management members have been with the company for a considerable period and may have developed a set of ingrained operational practices. These practices often become deeply embedded in the company’s culture, and these long-standing operational modes are difficult to be disrupted, even when they may not be fully compliant with current regulations.
2. Cultural and Mentality Differences: Risk Perception in Different Management Levels
One of the most significant challenges FIEs face is the difference in risk perception between local employees and senior management from the foreign headquarters. For many employees in China, if a certain practice has not caused problems in the past or resulted in major issues, they often perceive it as “low-risk” and are reluctant to take initiatives, as they do believe it would not cause problem but increase their workload and burden. From a senior management perspective (especially headquarters’ managers in Europe), the deviation from compliance should be considered a potential “time bomb” that could lead to significant legal or operational risks down the line. The difference between these two viewpoints often makes it difficult to achieve consensus on compliance priorities and initiatives.
3. Geographic Challenges: The Distance Between Headquarters and Local Operations
In many FIEs, the decision-making process is centralized at the headquarters, which is often located outside China. Due to time zone differences and efficiency considerations, it is not feasible for headquarters to be involved in the day-to-day operational details of local subsidiaries. When local team do not present the incompliance or potential risk timely and correctly, it is quite challenging for headquarters to truly understand the latest realities of compliance implementation in the factories in China. As a result, the ultimate decision maker is not able to notice or understand the situation correctly and make the right decision, then the compliance breach could remain undetected or unchanged for longtime till it leads to serious problem or even punishment by government.
Effective Compliance Management: Key Pathways for Companies to Thrive
- Identifying Compliance Issues
Before any effective measures can be taken, companies must first identify where compliance issues lie in the organization. A crucial first step is conducting a comprehensive compliance audit (“compliance health check”). Engaging a professional third-party entity to perform such health check of FIEs is often an effective way for uncovering potential gaps in compliance management. Here are several reasons why a third-party audit can be beneficial:
Objectivity: External firms bring an unbiased, objective perspective to the evaluation process. They are not constrained by the internal practices or operational habits that may have become entrenched within the company.
Local Expertise: Local third-party consultants possess a better understanding of the Chinese regulatory environment and are more familiar with the cultural and operational nuances that may affect compliance status. Additionally, they can overcome language and cultural barriers and time zone issues that may hinder communication with overseas headquarters.
Experience: Third-party firms, especially those with experience in conducting compliance audits, can quickly and accurately identify potential gaps and areas of concern based on their deep knowledge of both local and international compliance requirements.
- Step 2: Resolving Identified Issues
Once the compliance health check has been completed, the next step is to address the identified issues. A comprehensive oral and written report and communication shall be conducted by both the local and headquarters’ management team in detail about the problems discovered during the health check, as well as thorough analysis on them.
Based on such communications and analysis, efficient and practical approach on both the structural changes and operational improvements of the identified issues can be designed. For example, it might be necessary to update or expand existing policies, adjust or set up operational protocol, introduce monitoring systems, or create new channels for reporting violations and communications.
Together with improving the “paperwork” as described above, the effectiveness of compliance management ultimately depends on how well the system is implemented and operated. Trainings always play a crucial role in ensuring the effective implementation and operation of the compliance management. It is essential for the managers and staff involved to reinforce the importance of compliance and ensure they understand how to implement and enforce the measures and initiatives effectively. Moreover, ongoing support and close communication between local management and headquarters are essential to ensure that compliance practices are adhered to consistently and thoroughly.
- Step 3: Building a Sustainable Compliance Management System
The development of a robust compliance management system is an ever-evolving journey. Although the pressing issues have been pinpointed and tackled, it is far more advantageous to seize this moment to lay the foundation for a long-term framework that not only sustains but also continuously elevates the compliance endeavors.
Outlined below are several key steps that can assist FIEs in constructing and sustaining an effective compliance management system:
- Compliance System Review and Development
The process of reviewing and developing a compliance system is multifaceted and begins with a thorough examination of the company’s historical context, organizational structure, and existing compliance policies. This foundational review serves as a springboard for identifying areas that require enhancement and for establishing strategies and approaches to align the company’s compliance system with both local regulations and international best practices. This alignment process may necessitate several key updates, including corporate governance structures, compliance responsibilities, risk management procedures, and employee training protocols.
- Conducting In-depth Assessments on key areas
Thorough assessments of key risk areas are cost-effective approach to mitigate major compliance risks. These areas may be different from industries, some common areas including corporate governance, anti-bribery measures, product quality, environmental, health, and safety (EHS) standards, anti-monopoly and anti-unfair competition regulations, as well as data and cybersecurity.
By identifying compliance gaps in these critical areas, management can gain a profound understanding of the major risks they face. This deep insight enables the development of targeted and effective strategies to proactively address and mitigate these risks moving forward.
- Compliance framework construction and monitoring.
Building an effective compliance framework is essential to ensuring long-term compliance success. This includes developing detailed compliance procedures for risk identification, investigation, and mitigation, as well as establishing clear channels for reporting and addressing violations. It also requires continuous monitoring and adjustments as new risks emerge and regulations evolve. Setting up internal compliance controls and regularly assessing the effectiveness of these controls should be a regular exercise. This may involve periodic compliance health check, compliance training, and process optimization to ensure the company’s practices remain aligned with the latest regulatory and practice changes.
Compliance is Critical in China’s Current Business Operations
In today’s China, operating in compliance is not just important—it’s critical. As the current economic situation unfolds, business restructuring and downsizing are becoming increasingly inevitable topics for the near future. Concurrently, China is tightening its regulatory environment,
to safeguard their operations and interests in the market, FIEs must prioritize effective compliance management.
By taking proactive measures, FIEs can navigate the complexities of operating in China in the most cost-effective manner. This approach not only ensures compliance but also helps them remain competitive in the rapidly evolving Chinese market, securing their position for long-term success.
If you are interested in topics related to compliance in operating a business in China, please feel free to send an email to info@dawo-lf.com to receive the 2025 China Compliance Booklet, which covers hot issues and trend forecasts in the top ten key compliance areas..
