Multinationals Feel the Pressure in China; The extent to which Chinese authorities have recently focused on commercial corruption is unprecedented.

September 12, 2013, 1:34 p.m. ET

Multinationals Feel the Pressure in China

The extent to which Chinese authorities have recently focused on commercial corruption is unprecedented.

ANGELA MANCINI AND BLISS KHAW

China is in the middle of a major anticorruption drive and foreign companies risk finding themselves in the crosshairs soon—if they’re not there already. The clock is ticking for executives to make sure their firms won’t fall afoul of the crackdown. Although Beijing has talked tough on corruption in the past, this time all indications are that serious action will result. The rhetoric from the top, led by Chinese President Xi Jinping, is backed by an ongoing campaign against commercial corruption by the State Administration of Industry and Commerce (SAIC), an investigation of corporate criminal behavior by the Public Security Bureau (PSB), as well as a crackdown on inflated pricing and market dominance by the National Development and Reform Commission (NDRC). On Aug. 28, the Politburo launched a broad five-year anticorruption plan to extend from 2013-17.Even at this early stage, the campaign goes beyond the historically predictable boundaries involved in rooting out official corruption. Individual politicians have been targeted—former Chongqing Communist Party boss Bo Xilai is only the highest-profile example—and the crackdown has continued to expand into the commercial sphere, first encircling the pharmaceutical industry, and now more broadly the medical sector, with the SAIC also focusing on a wide range of industries, including real estate and car dealerships

Foreign technology firms are also concerned about the direction of the crackdown. The level of coordination and organized effort Chinese authorities have focused on commercial corruption in the past two months is unprecedented, involving interagency coordination across the country.

And already the effects are being felt by foreign companies. In late July, NDRC officials gathered representatives from some 30 multinationals operating in China, and ordered them to write “self-criticisms” and to “confess” to unfair market practices. The NDRC claims to be already investigating 60 foreign and local pharmaceutical companies in relation to pricing or other unfair market practices.

This amounts to a new level of scrutiny for multinational companies operating in China. Previously, the main headache had been foreign statutes such as America’s Foreign Corrupt Practices Act or Britain’s Anti-Bribery Act. Under these laws, a string of companies have faced stiff fines over the years for what amounted to normal business activities in a market like China.

However, domestic authorities in China have not previously targeted these practices under their own anti-corruption regulations in any significant or sustained way. This expanding regulatory focus appears to be zeroing in on corruption in business practices that are endemic to the operating environment in China for foreign and domestic companies across all industries. All companies can now anticipate much closer scrutiny under Chinese anti-corruption regulations, enforced with sudden aggressiveness.

A major challenge in navigating the new landscape is that China represents an inherently uneven enforcement environment. The nascent Chinese legislation on anti-corruption does not specify a self-reporting mechanism, the size of fines, directors’ liabilities, bans on future licensing or the ability to negotiate a settlement, which adds an additional element of unpredictably to China’s operating environment. Perceived violations could lead to permanent, potentially irrecoverable, damage to a company’s interests and operations in China.

Meanwhile, executives are likely to find it difficult to get a handle on their companies’ potential exposure under the crackdown. Corrupt sales and business development practices in China are common across all industries, involving internal employees, third-party agents, distributors and business partners.

Anybody familiar with the business environment in China will know this, and foreign businesses with any significant presence in China generally have established anti-corruption compliance programs. However, simply having a baseline program in place has proven inadequate. All of the foreign companies named in major headlines in relation to anti-corruption regulatory scrutiny in China in recent months most certainly would have compliance programs in place.

Many foreign companies can provide proof that all of their employees and third-party partners have undergone regular compliance training as well as acknowledgment of code of conduct requirements as a part of this program. However, not all would be able to say that the related materials are specific to China, with training in Chinese designed to address the challenges and realities faced by employees attempting to meet sales goals and develop business in a market where standard business practices are often synonymous with corrupt activities. Whistle-blower complaints about allegedly corrupt business activities also remain the most common first indication to a foreign company operating in China that something is amiss in their operations.

Most major foreign businesses in China can point to the due diligence on third party relationships they have completed. However, if companies are really looking closely at these relationships to understand what their local business partners are doing and how they are doing it—including an in-depth assessment of their operations, reputation and business practices—the due diligence won’t come back completely clean.

The new, much more uncertain reality of China’s crackdown on corruption will force companies to reassess their expectations and question what they think they know about the rapidly changing Chinese business environment. This will require a candid review of operations in China and openness to potentially significant changes to strategy and tone at all levels of a business.

Ms. Mancini is vice president and head of the financial services practice (Americas) at Control Risks, a global consulting firm. Ms. Khaw is the China lead for Control Risks in the Americas.