Stuck in a Chinese intelligence squeeze

The Chinese government's decision to dial down its supply of private intelligence to foreign investors will make informed business decisions more difficult, and doesn't look like changing soon.

Since the beginning of 2012, Beijing has been unofficially tightening regulations on private intelligence companies both foreign and domestic, as well as restricting the availability of public data. As China's 2012 transfer of power approaches, Beijing will likely continue to tighten restrictions and limit information flows in an attempt to bring the intelligence industry under government control.

This environment will make it more difficult to make informed investment and business decisions in China in the short term, although such obstacles have yet to deter investors significantly. China must balance domestic security concerns with its need for foreign investment. However, due to investors' seemingly unflagging desire to enter the Chinese market, it is unclear whether the long-term flow of foreign capital will decrease. Even if it does, it is difficult to tell how much investment China is willing to sacrifice in its effort to control information.

Prior to 2012, obtaining records on Chinese companies from the State Administration of Industry and Commerce was relatively commonplace; Chinese lawyers could simply request the information on behalf of their clients. Indeed, the SAIC often would release private information about domestic companies that, by international standards, should have been withheld. In some ways, therefore, the tightened information restrictions have aligned China with international principles. However, because the Chinese government has not officially announced the new rules, companies conducting due diligence cannot discern beforehand the legality of their actions.

China has always been a risky place to perform due diligence because of ambiguous state secrecy laws and the government's ability to declare almost any collection of information illegal, even retroactively. For example, as investment into China increased over the past decade, Chinese and foreign firms offering investigative and due diligence services to foreign investors have proliferated. These firms are technically illegal – no company in China is authorised to sell private company data, and only the state can perform investigations.

In July 2010, US citizen Xue Feng was sentenced to eight years in prison for buying a database about the Chinese oil industry. Although the information was open source, Chinese authorities claimed that the database violated a state secrets law by compiling the material in a single place. Earlier in 2010, the Chinese government decided to require all mapping and locations services to apply for official approval.

Beyond private information, Stratfor sources indicate that Beijing has also unofficially restricted access to records normally considered public, such as land ownership. Such restrictions violate international standards and China's own property laws, and they affect Chinese firms as well as foreign investors.

Protecting the Party

With a politically sensitive transition looming, Beijing sees widespread availability of information as a liability. Limiting access to corporate information increases the risks faced by foreign investors, but it also masks evidence of wrongdoing in cases such as a recent series of stock fraud scandals involving family members of Chinese leaders.

The government is also concerned with the ability of Chinese citizens to build intelligence dossiers on others, including Chinese government officials, with the intention of exposing government corruption, blackmailing citizens, or revealing issues within companies. It is rumoured that former Chongqing Party Secretary Bo Xilai used private intelligence operators to build dossiers on many government officials, including members of the Standing Committee of the National People's Congress. Regardless of whether Bo did this, the capability exists. For Chinese authorities, this threat is unacceptable.

Beijing understands that a tightened grip on information could lead to decreased levels of investment, but thus far foreign manufacturers have continued to flock to China. A return to free-flowing information is unlikely so long as investor enthusiasm persists. If foreign investors and companies accept the information controls, Beijing has no reason to relax the restrictions.

Guanxi networks necessary

Large foreign corporations with established "guanxi," a complex cultural system of personal relationships, will not suffer as much as the smaller foreign companies, but they will become more reliant on Chinese contacts who may not have the companies' best interests at heart. Going forward, at least through the political transition and into 2013, it will become increasingly difficult for companies without proper guanxi networks to obtain information.

In the short term, the landscape for foreign investors is reverting to a more traditional paradigm in China. Historically, investors have been forced to rely on guanxi networks to access information and make informed business decisions. Although Beijing may ease information restrictions after the transition, it is unlikely that private intelligence companies will be allowed to operate outside government control. China wants to better protect its companies and comply with international business standards, so conducting due diligence will likely remain possible. Foreign investors will just have to do so through the government in a more tightly controlled environment. Reprinted with permission of STRATFOR.

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