One Stone May Kill Two Birds in China

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China’s “One Set-Two Plates” corporate structures present regulatory and reputational risk for US firms

 

Executive Summary

 

Because China’s unique economic system allows state-owned enterprises (SOEs) to register the same company under multiple tax IDs and names, while remaining part of the whole, one designation by the US Treasury’s Office of Foreign Assets Control (OFAC) or the Commerce Department can impact multiple entities, in essence using one stone to “kill” multiple birds. However, failure to identify corporate ownership, location, and structure of complex Chinese conglomerates can result in both regulatory penalties and reputational damage. FiveBy assesses that recent increased US restrictions against China require extra due diligence research by cultural and compliance experts to navigate China’s complex corporate environments.

 

Introduction

 

Although the Biden administration has yet to outline the details of its comprehensive China strategy, President Biden’s first call with Chinese President Xi Jinping suggests that his administration will remain tough on China because of “fundamental concerns about Beijing’s coercive and unfair economic practices.” In addition, Secretary of State Tony Blinken’s condemnation of China’s treatment of its Uyghur population in Xinjiang as “genocide” suggests that Biden will continue the Trump administration’s tough approach toward Beijing, including economic restrictions. However, due diligence research into Chinese entities listed by the US government is challenging given China’s unique socio-economic system, which integrates private and public sector entities, creating complex corporate structures that sometimes are a multi-layered hybrid of state- and privately-owned enterprises. FiveBy’s analysts use their cultural expertise to unravel these complexities and provide insight into China’s complicated corporate configurations.

 

Case Study: China State Shipbuilding Corporation, Ltd. (CSSC)

 

The China State Shipbuilding Corporation, Ltd. (CSSC), was added to the Bureau of Industry and Security’s (BIS) Entity List, along with 58 other Chinese entities on December 22, 2020, prohibiting US and non-US persons from providing the listed entities with goods, software, or technologies subject to the Export Administration Regulations (EAR) without first obtaining a BIS license.

The BIS designation exposes US firms conducting business with Chinese entities to both regulatory and reputational risk and will require proactive, enhanced due diligence to ensure compliance.

Regulatory risks

The BIS listing imposes a licensing requirement on all items “subject” to the EAR when they are to be exported, reexported, or transferred (in-country) to any of entities on its list. No license exceptions are available for these transactions, and designated entities cannot participate in these deals because a government end-user review committee has determined their activities to be contrary to US national security. Therefore, engagements with listed entities require enhanced due diligence.

Reputational risks

Numerous US businesses consider national security concerns a red line when determining whether to engage with foreign partners. Even legal transactions with entities deemed to be a national security risk can result in negative publicity and a consequent decline in profits.

Reputational risk is in addition particularly significant for US companies engaging with Chinese entities designated for human rights concerns, according to a joint Commerce, Homeland Security, State Department and Treasury Department advisory issued in July, 2020. The departments highlighted that businesses with potential supply chain exposure in the Xinjiang Uyghur Autonomous Region should be aware of reputational and other risks of engagement with companies involved in human rights abuses, especially entitles located in Xinjiang, where most abuses against China’s Uyghur population occur.

 

Challenges detecting and identifying CSSC-related entities

 

CSSC is a complex conglomerate, which is currently undergoing a corporate restructuring. CSSC split into two separate entities in the late 1990s but announced that it would merge back into one corporation in 2019 under the guidance of the National Development and Reform Committee (NDRC)—a merger that is still ongoing, according to CSSC’s latest public disclosure. Figure 1 shows that CSSC’s corporate reorganization is ongoing, with much of its structure left blank on its website.

The structure of CSSC reflects China’s unique “One Set Two Plates” (一套机构两块牌子) framework, which refers to the specific setting of organizational structures in China, in which one corporate entity has multiple corporate identities (i.e. different names, tax IDs and official duties) for “convenience” since a public institution has tax benefits and can receive direct funding from the state, while a private company has more flexibility navigating the market. The framework is a vestige from China’s planned economy before the country transitioned to a government-controlled market economy.

  • The most common form of “One Set Two Plates” is a government agency that takes on a Chinese Communist Party (CCP) identity, such as the State Council Information Office, which is also registered as the CCP’s publicity department: the Central Publicity Office of the Communist Party of China. The entities are engaged in the same activities as media industry regulators and are located at the same address but are registered as separate entities allowing them to wield different authorities when regulating China’s media industry combined with state-owned and party-owned enterprises.

In the case of CSSC, the “One Set Two Plates” scenario presents as separate identities registered as “public institutions” and commercial entities under the CSSC SOE umbrella. Historically, China’s public institutions included organizations fully or partly funded by the government such as public schools, universities, and hospitals. These were quasi-governmental organizations whose budget management and personnel were tightly controlled by the government. The various research institutes within the CSSC conglomerate have been registered as “public institutions” largely for commercial reasons, allowing their employees to be covered by health insurance and receive pensions and other employee benefits directly from the state instead of the entity itself.

 

Figure 1. Screen capture from CSSC website.

 

Figure 2 shows various CSSC research institutes that focus on building and maintenance of different vessel components, such as the engine, body, and navigation software. At the same time, their commercial counterparts engage in industrial transactions, such as importing more sophisticated technology from the private sector and selling self-developed technology to other private companies.

  • The BIS-listed CSSC 709th Research Institute is registered as both a “public institution” that “provides services to the general society” and as a commercial entity, Lingjiu Hi-Tech Co., Ltd.[1] The two entities share an address, same staff and same website. The latter’s name translates literally into “709th high tech,” and it provides information security, custom computer programming, and engineering services for industries such as China’s IT and professional sectors.

 

Figure 2. Created by FiveBy Solutions analysts. Source: Chinese corporate registry

 

“One Set Two Plates” exists across the CSSC conglomerate. The double identities of some of the BIS-listed CSSC research institutes in Figure 2 make untangling CSSC’s corporate structure particularly challenging. Because China is still undergoing market reforms, the “One Set Two Plates” concept will continue to exist in state-funded entities, which comprise the largest segment of the Chinese economy, and given their strategic importance, probably the largest portion of future US policy restrictions against China.

 

How to kill two birds with one stone

 

China’s complex corporate structures require additional due diligence conducted by experienced China analysts with linguistic and cultural expertise. At a minimum, companies that transact with Chinese corporations should consider updating their compliance programs, particularly their end-use and end-user screening for exports and other transactions, to avoid engaging with Chinese corporations on the BIS Entity List and understand the intertwined corporate structures on the ground.

A simple ownership check is insufficient when performing due diligence and compliance checks for Chinese SOEs. Cross-referencing entities business activities with detailed ownership information and the history of the entity can build a more comprehensive profile and expose the embedded, secondary, and even tertiary enterprises that may fall under the compliance requirement. Researching and, in some cases, compiling a database mapping complex corporate structures and specifying the business activities of each individual entity could be the due diligence stone that kills two or even more birds in China’s corporate environment.

 

FiveBy is a specialized risk intelligence services firm. We give you the insight you need to move faster and further with the confidence to transform your risks into opportunity. The opportunity to grow your profits, strengthen your brand, and exceed your customer expectations.  

Our unique point of view brings together expertise spanning security, technology, data science, and business operations to connect your dots. By turning data into an enabler, FiveBy designs adaptable responses—whether to an ongoing incident or to implement preventive measures—tailored to your business needs and always with a human touch. 

[1] China Shipbuilding Industry Corporation (Wuhan) Lingjiu Hi-Tech Co., Ltd. with tax ID 91420100679113828E in corporate registry

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