With the “One Belt, One Road” concept being heavily promoted by the government, Chinese companies are going global with much gusto. However, this approach brings with it a number of legal risks, putting the role of lawyers in the spotlight. The following is an excerpt from the White Paper of Opportunities and Challenges for Chinese Businesses in Going Global. Additional reporting by Li Shangjing.

The “One Belt, One Road” (OBOR) initiative refers to the open strategy of the “21st Century Maritime Silk Road” and the “Silk Road Economic Belt” that connect more than 60 countries along the route. This year, the government work report proposed combining the OBOR initiative with regional development. As a result, all provinces in China have made their own OBOR-related plans, including a lot of infrastructure and transportation projects.

There has been a substantial increase in the “go global” endeavors of Chinese businesses in the past two years. China’s outbound direct investment (ODI) reached $116 billion in 2014, approaching the $119.6 billion of foreign direct investment (FDI) actually used. In the first half of 2015, China’s non-financial ODI stood at $56 billion, up 29.2 percent from a year ago, data from the Ministry of Commerce show.

Against such a background, Thomson Reuters organised the “Forum on the Globalization of Chinese Enterprises – Global Road, Global Perspective” in Beijing on October 22, 2015, where the White Paper of Opportunities and Challenges for Chinese Businesses in Going Global was released. Lawyers from firms including Jun He, King & Wood Mallesons, Han Kun and Dacheng, professors from Peking University Law School, experts from Deloitte, KPMG, Ernst &Young and other consulting firms, executives from enterprises such as Huawei, and other industry leaders gathered at the forum to share their insights on the global expansion of Chinese businesses.

According to the white paper, legal risks are what Chinese companies will encounter first as they invest in foreign countries.

1. GOVERNMENT REVIEW AND INDUSTRY ENTRY

In the past decade, a number of overseas acquisition projects by Chinese enterprises were halted due to government regulation. In 2005, China National Offshore Oil Corporation had to withdraw its offer to acquire American gas and oil giant Unocal due to concerns over U.S. security review. In 2008, Huawei’s proposed 3Com acquisition flopped as the Committee on Foreign Investment in the United States (CFIUS) vetoed the deal on national security grounds. In 2009, Aluminum Corporation of China’s plan to acquire a stake in Rio Tinto also failed to pass the review by Australia’s Foreign Investment Review Board.

Moreover, most developing countries impose many restrictions on the industry entry of foreign investment. For example, Indonesia has fields closed to foreign investment and conditionally opened fields. Among the 18 industries opened conditionally, each industry sets corresponding entry thresholds based on the development needs of Indonesia’s domestic economy.

As Xu Ping, partner at King & Wood Mallesons, points out that “Western countries and Southeast Asian countries have very different foreign investment regulatory regimes.” He adds, “Developed nations in the West mainly rely on anti-monopoly laws and systems like national security review and foreign investment review. Their legal systems are well established. But in some less developed regions, unstable political situations or changes of administration may put Chinese investments under political risks. In addition, these countries may impose restrictions or special regulations on foreign investment in terms of industrial policies, exchange controls and market entry. To varying degrees, law en-forcement by governments of such countries may also be opaque or uncertain. All these could expose Chinese investors to investment risks, so they must be treated seriously by Chinese businesses. Chinese enterprises should not only fully study the local political and legal environment, but also consider buying insurance that covers political risks.

2. LABOUR AND LABOUR UNIONS

In the West, labour unions are very powerful and can participate in collective bargaining on behalf of employees as their statutory representatives. Laws in Western countries explicitly give labour unions the right to interfere with corporate layoffs. France’s labour laws, for instance, grants corporate committees the right to protect employees in layoffs. Specifically, layoff standards need to be drawn up with the participation of corporate committees; companies are required to consult corporate committees or employee representatives while cutting their workforce, and need to develop social plans to place employees and avoid job losses. Otherwise, their downsizing plans will be deemed in-valid by labour administrative authorities or judicial authorities.

Given high labour costs in foreign countries and the difficulty in finding suitable employees, some Chinese companies tend to export cheap domestic labour to the countries in which they invest. However, some countries have special rules on foreign labour as well as labour export and visas, and these pose risks to outbound investment projects.

Chinese companies should ensure that they have a good grasp of local labour regulations as they design their outbound investment plans. They also have to promptly adjust their perception that Chinese labour is relatively cheap and easy to dismiss or cut. They need to be fully aware of overseas labour costs and labour protection systems.

3. ENVIRONMENTAL PROTECTION

On the one hand, environmental protection regulations are becoming increasingly stringent in every country, and those who violate such regulations are now subject to harsher legal liabilities. On the other hand, environmental protection organisations have attracted an increasing number of investors, and such organisations have various advantages and diversified ways of expressing their appeal. Investors should pay sufficient attention to such regulations and organisations as environmental protection issues could trigger crisis and even lead to investment failures.

State Power Investment Corporation once broke ground for the Myitsone Dam power plant in Myanmar – China’s largest overseas project and also known as “Overseas Three Gorges”. However, this hydropower project was put on ice shortly after construction began, mainly due to environmental protection issues. In September 2011, Myanmar’s then-President Thein Sein announced that to respect the will of the people, the project would be suspended until the end of his five-year term. The Myitsone power plant was widely questioned by environmental protection groups and local communities since the beginning of its construction. The fact that the environmental assessment was not transparent and its failure to benefit local communities also added to public objection to the project.

Therefore, before considering “going global”, Chinese companies should fully evaluate the environmental protection risks of the destination countries and learn about their environmental protection regulations to ensure that project design meets local requirements on environmental protection. They should also communicate with local governments, influential non-profit NGOs and environmental protection groups, local residents and media in a timely manner.

4. POLITICAL RISKS AND NATIONALISM

Before making investment decisions in politically unstable countries, Chinese enterprises must consider whether there will be significant changes in foreign investment policies or industry entry requirements there if the ruling government changes.

At the beginning of this century, Venezuela, Bolivia, Ecuador and other leftist members in the Bolivarian Alliance for the People of Our America became countries with the most sweeping nationalisation in Latin America. A Chinese oil company once spent $1.42 billion to acquire an oil project in Ecuador in 2005, only to see 99 percent of its extra income suddenly nationalized by a presidential order in 2007, suffering huge losses.

Moreover, regional turmoil and terrorism are frequently found in regions with prevailing nationalism. Local residents are more likely to riot, triggering anti-Chinese and racist sentiments. Radicals sometimes beat people and smash businesses under the banner of nationalism, potentially causing huge losses to Chinese companies there. For example, Russian skinheads expelled Chinese companies and workers, and Vietnamese radicals also attacked local Chinese companies in May last year.

5. COMPLIANCE AND BACKGROUND CHECK

Compared with domestic investment, the need to conduct compliance and background checks, also an important part of due diligence that law firms are usually tasked to perform, is more pressing for Chinese enterprises during outbound investment. Pursuant to the U.S. Foreign Corrupt Practices Act (FCPA), UK Bribery Act (UKBA), Combating the Financing of Terrorism (CFT) and other laws of developed nations, Chinese companies need to know about the background and business reputation of their local partners or clients to discover hidden risks in a timely manner.

For instance, while conducting transactions or commercial activities overseas, Chinese companies need to perform compliance screening of client backgrounds in advance and pay attention to whether their clients and relevant transactions are explicitly banned or identified as highly risky by the Ministry of Public Security and the Ministry of Commerce of China, as well as by over 100 overseas organisations, including the countries where the clients are based, the institutions and individuals involved, the ports at which relevant vessels are berthed, the vessels that ship cargoes, etc.

If Chinese companies want to set up branches in foreign countries, they should not only abide by relevant laws and regulations of China but also meet local regulatory requirements such as anti-money laundering. Thomson Reuters’s risk management solutions data show that globally important regulatory updates have been increasing continuously in the past six years – from more than 8,000 annually in 2008 to over 40,000 annually in 2014. In other words, there was on average over 110 regulatory updates per day in 2014.

Whether the risks are political, such as government reviews and market entry, or legal, such as labour requirements and environmental protection, they are crucial to Chinese companies in their overseas investment and acquisition endeavors. As such, they need to be investigated and understood by Chinese enterprises during or even before feasibility studies. Currently, the more mature solution is to engage lawyers or professional consulting firms based in the destination countries to conduct detailed due diligence so that Chinese companies can have a grasp of various risks involved and develop corresponding solutions.

Lawrence Zhu, senior partner at AllBright Law Offices, believes that there are three ways that companies can set up a lawyer team: directly engage an international law firm; directly retain lawyers from the target country, use a combination of Chinese law firms plus lawyers from investment destinations. Each of these three options has its own pros and cons. For example, international UK and U.S. firms have relatively wide coverage with offices in Beijing, Shanghai as well as the destination countries. But he also stressed that since the OBOR initiative covers a vast land area that includes more than 60 countries and regions, it is impossible for international law firms to cover all of them.

“We recommend the approach of hiring Chinese law firms plus lawyers from investment destinations. Chinese firms know their own clients very well. Asking lawyers to find other lawyers is better than the clients searching for lawyers themselves, as lawyers know their peers better and can make judgments more easily. But are domestic lawyers fully prepared? Just like 20 and 30 years ago when foreign capital was introduced into China, many U.S. lawyers studied Chinese laws and found Chinese lawyers since their companies wanted to invest in China. Now as our clients invest abroad, are we prepared?” Zhu asked.

Hua Xiaojun (Warren), partner at Jun He, told ALB that the persistent growth in outbound investment projects by Chinese enterprises as brought about by OBOR is no doubt good for Chinese law firms in many aspects. He believe that the most direct positive effect is business growth, while deeper advantages is how OBOR offers unprecedented opportunities for industry consolidation and service quality improvement.

“We noticed that given the positive outlook of internationalisation of Chinese enterprises, Chinese law firms have adopted different strategies in their business presence. Some try to accelerate their international development by merging with foreign firms, some build their own overseas networks, while others seek to form alliances with foreign peers. Whatever the strategy, the relationship be-tween Chinese law firms and their foreign partners is always characterised by cooperation and competition. However, the balance of power in this relationship is quietly changing. Chinese law firms have gradually shifted from a passive and subordinate position to a leading and dominant role. This cannot be achieved without the knowledge and experience accumulated by Chinese lawyers over more than three decades of reform and opening up,” said Hua.