In the face of overwhelming macroeconomic complications, China’s in-house counsel, at the very heart of the problems, are finding their expertise and services immensely valued. Kevin Cheng reports
Entering the second half of 2022, businesses in China are breathing a collective sigh of relief at the resumption of production activities, having ridden out the worst domestic covid-19 resurgence since the original outbreak, but must immediately brace for escalating geopolitical tensions, mounting regulatory pressure and a disrupted supply chain.
If there is any silver lining to the uncertainties, it would be that legal teams and in-house counsel are getting plenty of the spotlight to demonstrate their indispensable value to their companies, and by extension the entire economy.
SUPPLY CHAIN REACTION
Luca de Meo, CEO of Renault, said recently that there will be no sudden let up in the supply chain shortages that have dogged the auto industry. The truth is, the auto industry is not the only victim. In the past few years, a perfect storm of interwoven, mutually escalating factors has shaken the roots of the global supply chain on which our world’s economy precariously hangs in the balance. The crisis has also manifested in surging prices for and often shortages of aluminium, palladium and nickel, critical raw materials for the automotive and semi-conductor sectors.
Port congestion and risings logistics costs are also major concerns facing transportation and shipping operators, who recently witnessed an alarming sevenfold surge in freight rate from April 2020 to September 2021, according to the World Container Index.
“This year, we see growing supply chain risks due to the ongoing pandemic, the Russia-Ukraine war, and the contest between US and China, resulting in an amalgamation of adverse factors contributing to the worldwide economic downturn,” says Xie Chenyang, vice president and chief legal officer at Foxconn Industrial Internet, a Shenzhen-based provider of intelligent manufacturing integration solutions.
Under China’s adamant “dynamic zero-covid” strategy due to devastating Omicron-induced regional outbreaks that included a two-month lockdown of Shanghai, manufacturers nationwide have experienced varying degrees of either diminished production capacity of complete halts in the first half of 2022.
The ongoing Russia-Ukraine war, initiated in February 2022 and prompting a series of US and EU-led economic sanctions against Russia, has exacerbated a tense international environment already plagued by the Sino-US trade war continuing in its fifth year. These geopolitical conflicts are sending palpable ripples across the worldwide flow of raw materials, food and electronics.
“Global supply chain turmoil, mandatory compliance requirements on multiple fronts, inflation in the US and deceleration of China’s economic growth invariably pose challenges to the new generation of in-house counsel,” says Xie.
So what roles should be played by legal departments and in-house counsel, dwarfed by these colossal challenges?
Huang Yiyun, general manager of the China legal department of Autoliv, the world’s leading automotive passive safety supplier, points out that, unlike external legal advisers, in-house counsel should not limit their perspectives to only legal matters. “We are not limited to reviewing contract clauses,” she says. “By helping the supply chain and sales teams formulate strategies, we bridge the legal and business sides of the operation.”
Automotive is among the industries hit the hardest by supply chain issues due to exceptionally lengthy, often multi-jurisdictional processes. Each step, from purchase of raw materials, design and engineering to sales at the dealership, if not completed in time, may result in the entire production chain grinding to a halt. Shanghai posted zero car sales in April as dealers were universally closed.
“When issues occur, the upstream supplier tends to claim force majeure in the hope that we will exempt them of some liabilities,” says Huang. “In the past, supply chain problems were solely managed by a dedicated department and rarely needed to come through the legal team, but we are seeing a lot more of them in recent years.”
Highlighting chip and raw material shortages as prominent issues in the auto chain in recent years, Huang says that big problems plaguing suppliers are not necessarily an inability to supply, but more the rising costs of raw materials. “As costs have gone up rapidly, suppliers are finding it difficult to make both ends meet when sticking to the original agreements,” she observes.
Anticipating these challenges, Foxconn established a risk control and compliance committee last year, designed to identify and preliminarily manage global operating risks. “By constantly monitoring regulatory updates, the in-house team has offered strong legal support to supply chain-related compliance issues, anticipated and responded to new trade compliance requirements and sanctions in many jurisdictions, and effectively safeguarded the interests of the company in its global voyage,” says Xie.
Supply chain disruptions also pose challenges to Schaeffler, a global supplier to the automotive and industrial sectors. Richard Nie, general counsel at Schaeffler Greater China, believes that, in addition to ensuring the quality of legal services, in-house counsel should demonstrate flexibility in the face of business or legal landscape changes, and provide feasible solutions even when legal opinions are “less than welcome”.
“Legal teams should prioritise company interests and work closely with other departments,” he says. “In-house counsel should apply compromises and ‘grey management’ in legal analysis, and concentrate on ‘preventing fire’.”
‘GOING OUT’ ON A LIMB
While supply chain is perhaps the aspect of international trade most widely affected by unabating global diplomatic tensions, there are more direct hindrances to trade that make international compliance a much different game than just a few years ago.
China’s first quarter 2022 statistics on outbound investment, released by the Ministry of Commerce, paints a mixed picture. Compared with the same period last year, while the overall outward direct investment (ODI) recorded a 7.9% increase, with Belt and Road Initiative non-financial ODI growing by 19%, the announced value of China’s overseas M&A activity dropped by 65%, and the value of newly signed overseas engineering, procurement and construction (EPC) contracts decreased by 11.5%.
“Compliance has become more complicated in 2022,” says Xu Jie, chief compliance officer and legal director at Junzheng Logistics, which has a worldwide network of subsidiaries and itself a global presence that makes it imperative to follow local laws and regulations of all jurisdictions it operates in. Xu highlights the Russia-Ukraine conflict and subsequent sanctions as among the biggest compliance challenge to international trade.
Echoing her emphasis on politically induced market uncertainty, Xie at Foxconn says: “With no end to the Sino-US trade war in sight, multinational companies operating in both countries are faced with the paramount task of maintaining compliance on two sides.”
According to Xu, Junzheng tackles these issues with a focus on assembling the necessary legal talent, which includes both concentrating compliance personnel to the head office, and establishing closer long-term relationships with law firms.
Wang Dingxian, head of legal compliance at State Grid Overseas Investment, a Hong Kong-based wholly owned subsidiary of the State Grid Corporation of China, the largest utility company in the world, lists three main challenges: (1) domestic regulators are imposing tighter restrictions on Chinese-funded enterprises, especially state-owned ones, in terms of the manner and channels available for overseas financing; (2) rising costs of overseas US dollar financing; and (3) significant changes to the overseas investment environment in electricity and energy, with keenly felt downturns and diminished investment opportunities.
To counter these adversities, he proposes to increase co-operation with Chinese-funded financial institutions and add domestic direct financing to the list of solutions.
Wang Xiaojing, the head of legal at China Nonferrous Mining Corporation, observes that the company faces both frequent changes in the laws and regulations of the host countries and a continually elevated entry threshold for foreign investors in many countries.
“We have compiled investment risk guidelines for key jurisdictions, as well as special guidelines for preventing the risks of violating laws on mining or subcontracting”, says Wang. “These guidelines are designed to highlight important legal issues in investment, which goes a long way in ensuring legality and compliance of operations.”
DATA TRAVEL RESTRICTIONS
Richard Nie, at Schaeffler, lists the pandemic and changes in the legal operating environment as top challenges facing his team. “Changes in the legal operating environment,” he explains, “refer primarily to a quick succession of new laws and regulations that require legal teams to ‘go beyond law’, understand the management and shareholders’ expectations and needs of the in-house counsel, and integrate legal opinions effectively into business operation.”
Easily one of the most prominent of new domestic laws and regulations affecting compliance procedures across all sectors is the Personal Information Protection Law (PIPL), effective since November 2021.
“Given our enormous numbers of employees and clients, we are under more pressure than most peers in terms of protecting their personal information and compliance management,” says Xie, of Foxconn. “Since the PIPL came out, our legal team immediately revised our guidelines on personal information protection and urged all business units to put in order all personal information involved in their activities, thereby being able to form a top-to-bottom system of personal information protection within a short time.”
By extension, the enormous pressure keenly felt by all data controllers and processers, including foreign players given the law’s interjurisdictional nature, comes not only from the PIPL but its combined application with the previously enacted Cybersecurity Law and Data Security Law, together forming the legal bedrock of China’s data protection system.
Huang Yiyun, at Autoliv, says China has been putting the pedal to the metal in data protection since 2017, which includes not only laws and administrative regulations, but also many elevated national standards.
“Standards are higher for foreign-invested companies,” says Huang, “as personal information needs to be transferred to affiliates outside the border.”
In July 2022, the Cyberspace Administration of China (CAC) issued the Measures on Security Assessment of Cross-Border Data Transfer, imposing a mandatory security review for cross-border data transfer, especially if “important” data or “sensitive” personal information are involved, or if the transferer is a “critical information infrastructure operator”, or handles the personal information of a significant number of Chinese residents. The measures, containing definitions and specific standards for the above-mentioned requirements, are set to be implemented in September.
Security risks in outbound data transfer have long been regarded as a touchy spot with Chinese regulators. In July, the CAC announced a RMB8 billion (USD1.2 billion) fine against Didi Global, China’s ride-hailing juggernaut, citing, among other things, data processing activities that threatened national security, as reflected by the security review results.
The penalty arrived a few months after the CAC halted Didi’s Hong Kong listing due to its failure to overhaul its systems to prevent security and data leaks as demanded by regulators, potentially concluding the highly publicised crackdown that began with the CAC’s order to remove DiDi from app stores a year ago.
DOMESTIC GROWING PAINS
In the past year, China made a string of key revisions and complements to its business regulatory approaches that left many companies in various sectors, and their in-house counsel, racing against time to ensure both compliance and commercial sustainability, complicated further by a slowing economy.
The market watchers are persisting with high-intensive antitrust enforcement, with amendments to the Anti-Monopoly Law coming into force on 1 August, the first major update to the law since its enactment in 2008.
The amendments added the “stop the clock” and “safe harbour” mechanisms, enhanced the overall level of fines and penalties, and reinforced a focus on monopolistic conduct with data, algorithm and technologies. Internet giants such as Alibaba and Meituan were heavily fined in landmark antitrust cases last year.
As with data compliance, companies with an international presence must keep an eye out and withstand an extra layer of legal pressure, as China’s tightened grip on tech companies’ market conduct is but one piece, albeit a large one, of a global domino chain. Recently, the European Parliament passed the Digital Markets Act and the Digital Services Act set to restrict the behaviour of large tech companies, while India announced plans to amend its competition law so global tech companies must obtain antitrust approval to proceed with large M&A transactions.
“These landmark new laws have filled critical vacancies in legislation, and profoundly affected business developments from all walks of life,” comments Xie, of Schaeffler. “To companies undergoing a transformation, they should seize the opportunity to ensure immediate compliance, which paves the way for long-term lawful operation.”
In the second quarter of 2022, China recorded a GDP growth of 0.4% compared with one year ago, the weakest growth since the beginning of the pandemic. Cheng Jiejiya, manager of the audit and legal department at Hangzhou International Airport, cited an unstable economy and its debilitating effect on the airline business as the most prominent challenges for her company.
Other than the pandemic and resultant lockdowns, many have pointed to the slump in China’s property market as another major contributing factor to the economic deceleration.
“Our firm mainly invests in the property development projects,” says Zhao Li, vice general manager of the legal and compliance department of Chenxifunds. “With so many property developers going through financial hardship, our investment projects are having a hard time exiting on schedule.”
The default of debt-ridden real estate giant Evergrande on interest payments to its international loans in December sent disquieting signals to creditors, stakeholders and homeowners, but the dilemma continues. As of July 2022, China’s value of bond defaults recorded had more than doubled the full-year total of last year, with 19 Chinese companies, of which 18 are property developers, having defaulted in the offshore market.
“We have set up an assessment system of green, yellow, orange and red lights,” says Zhao. “Apart from the day-to-day monitoring, we hold biweekly meetings for red-light projects attended by various departments to discuss the best solutions.”
Zhao’s team is affected by not only market-wide shakedowns, but also industry-specific legal updates closely related to Chenxifunds’ businesses, which it must closely monitor and study. This includes the Notice on Matters related to the Registration of Private Fund Managers, issued by the Asset Management Association of China in June, which made notable updates to the Material Requirements for Registration of Private Securities, Equity and Venture Capital Managers, and released the Key Points for Private Investment Fund Filing.
“The updated list of materials lifted the qualification threshold for the role of manager or senior executives in private funds,” says Zhao. For equity funds, senior executives in charge of investment are required to provide proof of at least two investment projects in the equity of unlisted companies led by their former institutions, and the total initial investment amount of all projects should not be less than RMB10 million in principle.
As for security funds, Zhao adds that senior executives in charge of investment, in principle, may no longer use personal securities and futures investment, investor experience in fund products, market simulation results or other materials that do not reflect investment ability, or are unrelated to securities and futures investment, as evidence of performance in security investment.
MARKET’S GOT TALENT
Problems are always at the most solvable when the right person is placed in the right position. With compliance becoming ever more difficult and critical, attracting and retaining valuable in-house talent has never been more important.
“Corporate culture, team culture and capability of superiors are some of the factors that talent takes into consideration when choosing a career path,” says Huang Yiyun, of Autoliv. “What we can do is to create the healthiest corporate and team cultures possible, and help the talent achieve progress and self-development.”
To effectively retain and cultivate talent, Xie Chenyang says that Foxconn Industrial Network, which has nearly 100 legal professionals, will initiate an employee stock ownership plan involving a maximum of RMB2 billion and 12,000 employees.
However, in some cases the company’s dedication to its personnel is curbed by limitations to objective conditions. “Our company has little advantage in terms of geographical location,” says Zhang Jiangbo, legal director at Huayou Cobalt. “Consequently, its ability to attract and retain talent is limited.” Huayou Cobalt’s headquarters is located in the Tongxiang Economic Development Zone of Zhejiang province.
Echoing the importance of geographical positioning, Xu Jie, at Junzheng Logistics, says that although the group enjoys a global presence, with various service offerings, it has decided to assemble all legal personnel – regardless of whether they are specialised in dispute resolution, insurance claims, corporate governance, compliance or contract management – in the head office.
“On such a larger platform that provides both legal service and governance, our legal staff will find their fields of view significantly broadened,” says Xu. “If we are to divide the legal talent between the head office and branches at this stage, our colleagues in branches will inevitably have a difficult time locating the head office’s boundary of risk control, or envisioning their long-term career development from a higher vantage point.”
Within the head office, legal staff take on managerial functions on top of providing legal assistance to other departments, which allows them to identify concealed risks in daily operations and, in turn, apply this valuable experience to bettering their legal offerings, says Xu.
“This effectively prevents legal counsel from becoming a detached function within the company,” she concludes. “Instead, it plays a managerial role that originates from, attaches to, and finds roots in business activities.”
According to the legal head of a leading Chinese internet TV operator, its IP and legal department leans toward flat management. As the team is limited in its number of staff, management has opted to concentrate on three keywords – focus, overlap, and intersection – under which one staff heading a certain business module will also be required to provide support to one or two other modules.
In response to the constant inflow of new business, Chenxifunds regularly organises internal sharing and discussions of legal relationships and regulatory focal points, says Zhao Li. However, in terms of non-performing assets, for which the team had little prior litigation or arbitration experience, the team engaged the services of external counsel. This, according to Zhao, also helped the in-house team quickly gain practical skills.
With mounting compliance pressure driving up the need for legal services, effective co-operation with law firms makes up a hefty piece of the puzzle.
“Efficient co-operation with external counsel, on one hand, is about clarifying the scope and requirements of the task so lawyers can direct their legal services to hit the right spot,” says Wang Xiaojing, of China Nonferrous Mining Corporation. “On the other hand, it is about timely communicating the company’s main concerns and demands with the lawyers so the results can better match with the company’s needs.”
According to our recently conducted market research survey with in-house counsel, dispute resolution, compliance management, data compliance and intellectual property are among the practical areas where external legal counsel are most heavily sought after.
“Legal service providers should focus on expertise and team development, rather than price competition,” says Wang Dingxian, of State Grid.
To Xie Chenyang, mutual understanding and respect is the optimal path to benefitting both the enterprise and the law firm, and selection of law firms should be based on the actual needs and shortages of the specific project. “Choice should be made based on the partner’s competence in the required field and suitability to the company’s needs,” he says. “It is not advisable to place too much stock in the law firm’s reputation or scale.”
The above-mentioned legal head at the internet TV operator believes that the quality of legal service is the core of a healthy, sustainable co-operative relationship between a company and external counsel, but the internal-external counsel relationship is far from a simple matter of one-sided “give and take”.
“While quality of legal service is most directly related to the external counsel’s expertise, the ability to receive those services in a professional, compatible manner, and timely communication on both sides, are no less important,” she says.
LOOKING AHEAD
With the pandemic back under control, and major commercial hubs shaking off the rust from lockdowns and resuming their busy schedules, many businesses in China are looking at the second half of the year as a hopeful period of stabilisation and recovery.
The general outlook on the future of China’s legal service market, according to our survey, remains largely optimistic, with a modicum of caution.
Zhang Jiangbo, of Huayou Cobalt, credits his positive views to the fact that “China will look to its vast array of homegrown legal practitioners for economic development, as will Chinese companies for global business expansion”.
Also emphasising growing market needs, Wang Xiaojing, at China Nonferrous Mining Corporation, says: “Under the current economic status and compliance requirements, Chinese companies will have a growing need for legal services, including state-owned enterprises entering a critical stage of wider reform.”
Cheng Jiejiya, at Hangzhou International Airport, maintains an overall positive forecast, but cautions that China’s market remains in want of discipline-specific legal talent.
Xu Jie, at Junzheng Logisitics, compares China’s current legal services market to a recent graduate with a promising future. “In China, the subjects of legal services are quickly becoming aware of their need for legal services, which will unlock considerable market potential,” she says.
On the increasing portion of compliance in legal offerings, she concludes: “The flourishing of the legal services market manifests not only in the burgeoning number of clients, or the maturity of those clients, but also in the growing sophistication of the service itself.”
