January 17, 2020

ARE YOU READY, ARE YOU COMPLIANT? CHINA’S SOCIAL CREDIT MANAGEMENT SYSTEM 2020

According to the 2018 Annual Report published by the People's Republic of China's ("PRC's") National Public Credit Information Centre ("NPCIC"), approximately 17.46 million people have been barred from purchasing air tickets by the PRC Government.  A further 6,908 were restricted from flying by the Civil Aviation Administration of China ("CAAC") due to "serious dishonest acts".  This is as a result of the PRC's new Social Credit System ("SCS") which is currently being trialled in just a few provinces around the PRC.  It is due to be implemented across the PRC in 2020.  Apart from the obvious impact to the aviation industry due to a potentially significant decrease in sales of airline tickets in the PRC, the implementation of the SCS will have a number of significant impacts on all multinational aviation related companies with a footprint in the PRC.

Origins of the SCS

During the 6th Plenum of the 17th Party Congress in 2011, a decision was taken to construct a credit system to foster sincerity in society, not only in commercial affairs, but also in matters of social and political morality.

The current system was laid out in the 2014Planning Outline for the Construction of a Social Credit System”. This plan put forward a timetable until 2020 for the realization of five major objectives: (i) creating a legal and regulatory framework, (ii) building credit investigation and oversight, (iii) fostering a flourishing market built on credit services, (iv) completing incentive, and (v) punishment mechanisms. It identified priority fields in four major policy areas:

  • In government affairs, the system would increase transparency, enhance lawful administration, build trustworthiness for government actors, and display the government as a model of sincere conduct.
  • In the market economy, social credit would enhance efficiency, trust and transparency across a range of sectors, ranging from finance to construction, food and ecommerce.
  • In social services, the system would enhance trust in healthcare providers, strengthen management over particular professions and enhance scrutiny over online conduct.
  • Lastly, the introduction of credit mechanisms would enable courts to more effectively implement judgments, enhance information sharing about parties in lawsuits and support norms for the legal profession. 

What is the SCS?

The SCS is a system whereby the PRC Government will track and monitor in detail the activities of individuals and businesses in the PRC, including multinational companies who operate in the PRC.  The information obtained will be used to reward and punish businesses and their directors and management teams based on what is deemed to be good and bad behaviour by the PRC Government. 

Thus the SCS expands the idea of the "credit check" to a system that standardises the assessment of citizens' and businesses' economic and social reputations.  It aims to reinforce the Government's ideology that "keeping trust is glorious and breaking trust is disgraceful." 

The collection and use of reputational information is not in itself a new concept.  In fact, financial institutions worldwide collect information and "score" both individuals and companies before deciding whether to provide loan services.  So what is the difference with the SCS?

The SCS will monitor all aspects of individuals' lives and organisations' dealings, and will rank them:

  • For individuals, having a high credit score will give them easier access to such things as internet services, luxury hotels, overseas travel, school admissions and scholarships, favourable loans and eligibility for government jobs. On the other hand, social credit offences will be committed by individuals if they do not pay individual taxes or fines, cheat in exams, spread false information or take drugs. More minor violations include using expired tickets and smoking on a train. The lower each individuals' credit score, the higher the chance he/she will be denied access to aircraft and train travel, overseas trips, schools, social services, the internet and other benefits.
  • For organisations, having a high credit score could mean easier access to credit, more public procurement opportunities and even lower tax rates.  However, lower scores could mean at best the opposite (this is referred to as being "greylisted"), but at worst being blacklisted from conducting business in the PRC, or with Chinese companies and individuals.

Aviation

The Civil Aviation Industry Credit Management Measures ("Credit Measures"), which were introduced in 2017, are aimed specifically at the aviation industry, and currently cover 177 foreign or regional airlines operating flights in and out of the PRC.  They were introduced in order to implement the SCS and to "enhance the building of a credit culture in the industry, maintain the order of civil aviation activities and promote the healthy development of the civil aviation industry"1   According to the CAAC, "an administrative subject with a poor credit record due to general dishonest acts is subject to strict administration as appropriate, and an administrative subject with a poor credit record due to serious dishonest acts is subject to joint punishment measures in multiple forms by heavier standards, so as to realise the result of ubiquitous restrictions due to one dishonest act."2  

The Credit Measures identify 15 categories of "serious dishonest acts" and individuals and companies found having engaged in these acts are recorded on a list entitled the Information List of Serious Dishonest Acts of the Civil Aviation Industry ("CAA List").  As at August 2019 the CAAC reported 2 companies3  were listed on the CAA List. 

Similarly, there is a further list for air passengers.  Passengers who are subject to administrative punishments or prosecuted for criminal liabilities by public security authorities for conducting specific acts at airports or in an aircraft shall be included in the List of Passengers Restricted from Taking Civil Flights ("Restricted Passengers List"), and their ticket purchases must be automatically rejected by the ticketing system.  In August 2019 the CAAC issued a notice to operators that they must prevent themselves from providing services to people on the Restricted Passengers List on both scheduled and non-scheduled commercial flights, and general aviation flights which are either chartered or scheduled short haul flights.  This includes business jet services ("Restricted Passenger Requirements").

Operators who conduct flights into China will be required to submit to the CAAC a form on an annual basis outlining measures they have taken to comply with the CAAC relating to the progress and effectiveness of implementing the Restricted Passenger Requirements.

Despite not coming into full force until 2020, aviation companies worldwide have already been impacted by the SCS, despite full implementation being scheduled for 2020. 

In 2018 the CAAC sent letters to many international airlines demanding airlines refrain from designating Hong Kong, Macao and Taiwan as countries, and requested these airlines to describe these places as part of the PRC.  In these letters the CAAC stated that if the airlines were not compliant, "our bureau will take further measures according to regulations, including on the basis of Article 8, Section 11 of the Civil Aviation Industry Credit Management measures (Trial Measures), and make a record of your company's serious dishonesty and take disciplinary actions against your company…"  Airlines who did not comply would have the non-compliance recorded on their Social Credit records in the PRC (effectively negatively impacting their Social Credit rating).  Therefore, non-compliance could have resulted in more frequent inspections by the PRC government, and the airlines' acts of "serious dishonesty" shared on an aviation industry credit platform for others to see (for, amongst other things, a form of public shaming as punishment) which would in turn be shared with other national credit platforms in China.  Many viewed this move by the PRC Government as a way to control its political agenda on a worldwide basis, and are suggesting that this will not be the last time this type of requirement will occur.

How will the SCS work for Companies?

The full extent of how the SCS will operate nationally has not yet been disclosed by the PRC Government.  However, we know that the reporting criteria will be stringent.  Any organisations operating in China will have to regularly collect data and submit it to the PRC Government.  While the rules have not been fully revealed, some sources have suggested that there will be up to 300 topics that must be reported on, covering issues relating a wide range of issues including taxation, the environment and corporate social responsibility.  This information will be analysed along with information sought from various government agencies and even industry associations, and will include information such as court decisions, environmental records and potentially even how many employees are members of the Communist Party.  The information will then be used to assess the organisations' Social Credit ratings, in turn providing rewards or punishments based on compliance. So it is a system that will significantly increase compliance costs.

The way companies do business with other companies will also be affected.  It will be up to companies to monitor their business partners' and suppliers' Social Credit ratings, and refuse to do business with any whose Social Credit ratings are too low.  If a company conducts business with another company or individual who has a poor Social Credit rating, that company will itself be risking having its own Social Credit rating negatively affected.  Purchasing parts, for example, from a manufacturer with a low Social Credit rating may well in turn affect the purchaser's rating.  The rationale behind this is the lower a company's rating, the more reluctant both organisations and individuals will be to engage that company.  Therefore, companies and individuals will seek to comply with the requirements of the SCS in order to be able to provide or acquire goods and services in the future. 

Doing business with a company that has been blacklisted may result in a company being blacklisted itself, regardless of whether it was aware of its business partner's Social Credit rating or not.  The company seeking to do business with another company bears the burden of ensuring a high Social Credit rating of its business partner.  All this, according to the PRC Government will tackle issues of corruption, unethical behaviour and lack of compliance with regulation.

Will the Companies System be linked to the Individual System?

The companies and the individual SCS will be intrinsically linked.  Of particular note is that if a company is negatively rated, or finds itself on the blacklist, then individual managers and/or directors of that company may also be treated in the same way.  Conversely, if an individual who is employed or is a director of a company has a low Social Credit rating then this could impact negatively on the company's rating.  Therefore, it is imperative that companies know and understand not only the Social Credit ratings of its employees, but also those of the senior managers of their business partners, suppliers and other associates.  This extends to PRC nationals who are not currently resident in the PRC.

What can Businesses do to Prepare?

There are many things that we suggest that companies do as a matter of urgency to ensure compliance with the SCS, Credit Measures and Restricted Passenger Requirements, to help avoid the disadvantage of being assessed with a low Social Credit rating at the outset of the SCS's full implementation:

  1. Most importantly, conduct an audit on the organisation's current practices to ensure compliance with the SCS, the Credit Measures and the Passenger Requirements.  It is important to remember that once the first reporting requirement becomes due, any non-compliance will be assessed and may have immediate effect on an organisation's rating.  Organisations conducting business in the PRC will need to ensure strict compliance to avoid a poor rating, which could result in other organisations and individuals avoiding doing business with them.
  2. Consider what information the organisation will be required to supply to both the PRC Government and the CAAC (if not doing so already), and when.  Ensure that this information is currently being collected and usable.  For example, can the organisation point to a policy that was distributed internally outlining the collection and reporting requirements?  How is the organisation going about tracking which individuals are on the CAAC's Restricted Passengers List, and how is it ensuring that these individuals are banned from flying?
  3. Conduct a supply chain/business partner audit to ensure all businesses and their managers and directors that the organisation currently works with have a high Social Credit rating, to avoid being affected by others' low ratings, and put a policy in to place to ensure that these ratings are checked regularly to ensure they have not negatively changed.
  4. Similarly, conduct an audit on all senior staff to ensure they are not blacklisted, or on the grey list.  Businesses will potentially be affected by the Social Credit rating of their senior managers and directors.  Once again, put in place a regular audit policy to avoid the company being tainted by the Social Credit rating of an employee or director of the company.
  5. Consider drafting clauses into all commercial contracts allowing the organisation to terminate the contract with immediate effect should a business partner or its senior management make the blacklist or the grey list. 
  6. Check the organisation's data security capabilities.  It has been suggested that much of the reporting will be required to be done online, which means that potentially sensitive data relating to employee information (and possibly even trade secrets) may need to be provided to the PRC Government electronically.  It is also important to note here that all data must be saved onto PRC servers, and our research suggests that the technology companies maintaining these servers will pass on any information that it is asked for by the PRC Government.
  7. Re-evaluate the organisation's approaches to issues such as the environmental impact that the organisation has in the PRC, how it conducts its public relations (and how that will be perceived by the PRC Government) and even corporate social responsibility in the areas of the PRC in which it operates.  It is likely that all of these issues will have a direct bearing on the organisation's Social Credit rating.

Whilst in theory the full implementation of the SCS should not actually impose any new requirements for businesses in terms of a change in the way business is conducted, it certainly imposes burdensome reporting requirements that were not previously required of multinational companies conducting business in the PRC.  The SCS along with the Credit Measures do carry significant risks to conducting business in the PRC.  An organisation failing to comply (even inadvertently) may suddenly find itself on a grey list whereby conducting business in the PRC will become difficult, or even worse blacklisted from doing business in the PRC at all.  Alternatively, businesses may find themselves, at least during the early stages of the full introduction of the SCS, working in a more level playing field with PRC companies suddenly being more highly regulated than previously (for example in relation to pollution emissions).  It may, for example, transpire that those manufacturers who are low polluters will be allowed to continue to operate in circumstances whereby other higher polluters will be required to shut down periodically, or even blacklisted.

It is important to remember that it is the companies that bear the burden of demonstrating to the PRC Government that they are complying with the SCS, the Credit Measures and the Restricted Passenger Requirements.  Thorough preparation will assist with compliance and avoid companies being greylisted or blacklisted.

The Clyde & Co Aviation Team can assist you if you would like more information on the SCS, what to do to prepare for its imminent commencement or whether it will affect your organisation.


1 http://www.caac.gov.cn/en/XWZX/201712/t20171208_47931.html
2 CAAC paper to the 56th Conference of Directors General of Civil Aviation Asia and Pacific Regions, 19-23 August 2019
3 One Airport (ZQZ) and one operator (General Aviation)