China Corporate Social Credit System (Part 2): how do the ratings and blacklisting work?

In our first article on China’s Corporate Social Credit System we discussed the underlying structure and mechanisms of the Corporate Social Credit System. We concluded that the Chinese Corporate Social Credit System is an instrument to enforce existing and new regulation, where a company’s compliance with this regulation will be formally assessed via the following means:

1. Compliance Records: in case of non-compliance, companies will be blacklisted by the respective government authority.
2. Scale Ratings: all relevant government authorities will have their own scale ratings, based on a detailed list of requirements which companies must meet.

The aim of China’s Corporate Social Credit System is to bring the above two assessment means together through an algorithm that measures a company’s overall compliance. Although the central government is pushing the respective governing authorities to use the publicly available credit information, which is supplemented with departmental industry management data, no comprehensive meta-score for companies is available yet.

At this moment, all respective institutions will form their own ratings and compliance records (which may result in blacklisting). This information is published in public databases for all to see, and based on these ratings companies can incur punishments or receive rewards. In this article, we will further discuss how the scale ratings and blacklisting system works.

Different scale ratings

As discussed before, all companies in China, including foreign companies, will be subject to the Corporate Social Credit System. Data on the companies will be collected via different government authorities, such as the Tax Bureau, Customs Authorities, Environmental Protection Bureau and many others. Based on whether a company complies with the regulatory requirements, companies will be given a scale rating.

Whether a company has a good social credit record is largely determined by four different types of scale ratings:

1. The Comprehensive Public Credit Rating – based on information from the National Enterprise Credit System.
2. Operational Grades – issued by state agencies (Tax Bureau/Customs).
3. Industry Association Grades (Chambers of Commerce).
4. Financial Credit Scores.

Depending on the industry your company is active in and the type of goods/services your company engages in, which rating is most important for your company starkly varies. Because all relevant government departments create their own scale ratings, the central government has developed several centralized databases to publicize available data. Examples of these databases are the following:

• National Credit Information Sharing Platform (NCISP) – Central database, platform integrating local- and central-level government data sources.
• CreditChina – Web portal of the National Credit Information Sharing Platform (NCISP).
• National Enterprise Credit Information Publicity System (NECIPS) – Platform with detailed information on companies records.

How do scale ratings work?

In order to provide a better understanding of how scale ratings work, we will dive deeper into the Comprehensive Public Credit Rating based on data from the NECIPS. Within this rating, companies can be placed in one of four categories:

• 优 （excellent）
• 良 （good）
• 中 （medium）
• 差 （bad）

According to the plans of the Chinese government, the relevant authorities will approach the companies based on the rating they received. Entities which are rated “excellent” or “good” will be encouraged to keep improving their credit history, consolidate and upgrade their credit ratings and continuously improve their credibility and competitiveness.

On the other hand, companies which are rated “medium” will have interviews and special trainings to guide them to pay more attention to credit management, clarify the direction of improvement, and optimize credit status. For businesses whose evaluation results are “poor”, the relevant authorities will conduct a warning interview with the individual in charge and present the reasons for poor evaluation. Furthermore, they will educate the responsible individuals regarding the available credit repair channels and guide them to rectify the poor rating. These reviews will be recorded into the credit record of the NCISP, including refusal and non-conformity of the interview.

To come up with a rating, the authorities have established what is good and what is bad behavior. Companies which are categorized as having good behavior generally follow all existing regulations very well. Examples of this are timely meeting filing requirements, good financial credit, care for environmental protection, no complaints from customers as well as several other factors.

Although behavior leading to rewards is less well defined (admittedly it is harder to quantify), bad behavior is easier to track and define. It includes for example not meeting regulatory requirements, late filing or even criminal offences.

These scale ratings are rather sensitive to violations, as compared to acts of good behavior. Seemingly small violations on reporting requirements such as filling documents late or providing incomplete data will lead to point deductions. Therefore, it is very important to streamline reporting procedures and be well aware of deadlines and accompanying responsibilities within the company to avoid any negative consequences.

How do blacklists work?

Blacklists are an integral part of the Corporate Social Credit System. The blacklisting system can be understood with the “one, two, three, four” generalization: one purpose, two types of standards, triple protection and four kinds of constraints.

The purpose of the blacklisting system is to reduce dishonesty. The main goal is not to punish bad companies, but to reduce dishonest practices via self-regulation. Punishments are part of the Corporate Social Credit System as a means to encourage companies to behave in an honest way without active government intervention.

The two types of standards refer to “direct” and “progressive”, meaning that a company can get backlisted in two ways. Either by committing an offense that directly results in blacklisting, or through cumulative actions that result in a blacklisting. For example, receiving three penalties within two years by the administrative department of industry and commerce (AIC) leads to a blacklisting.

The triple protection means that there are three mechanisms in place to protect companies from the negative consequences. Firstly, there is standard disclosure, which means that the administrative organs publish the criteria for entering the blacklist publicly. This ensures all companies are aware of which actions lead to a blacklisting. Secondly, before an institution blacklists a company, it will give prior notice. The company then has the right to make a statement and a defense. Therefore, rationality and legitimacy of the procedure is guaranteed, and the possibility of mistakes and omissions is reduced. Lastly, the blacklists offer the option of correction afterwards. If the institutions find that a company is wrongly listed or the company files an opposition application, the listing can be revoked by the institution.

The constraints applied once a company is listed can be categorized into four categories; namely 1) administrative, 2) market, 3) industry and 4) social constraints. By imposing administrative constraints, companies will experience hinder regarding government related services, such as extra examinations and difficulty with approvals. Market-based constraints mean being listed can cause them to be restricted in market transactions. Companies will be evaluated when trying to enter into market transactions and partnerships, so a check into the system reveals a listing and the companies will likely miss out. Industry-based constraints mean that industry associations will be made aware of companies within the industry that are blacklisted. Subsequently, the industry will self-regulate and supervise members and if necessary issue warnings, criticism and public condemnations on the listed companies. This would make it increasingly difficult for these companies to do business. Lastly, social constraints work by the naming and shaming principle, causing public opinion to shift on listed companies causing mass discussion and criticism on the company and individuals involved in a social perspective.

In the below table we have provided an overview of the major national blacklists which are currently in place:

Getting on a blacklist

According to a list by the State Administration for Industry and Commerce (AIC), the following behavior gets companies on a blacklist:

• The relevant obligations have not been fulfilled after being listed in the business exception list for 3 years.
• Submitting false materials or taking other fraudulent means to conceal important facts while obtaining company change or cancellation registration.
• Organizing the planning of pyramid schemes, or receiving more than three administrative penalties within two years for facilitating a pyramid scheme.
• Being subjected to more than three administrative penalties within two years for direct marketing violations.
• Being subjected to more than three administrative penalties within two years for unfair competition.
• If the goods or services provided do not meet the requirements for protecting the personal and property safety, resulting in personal injury and other serious violations of the rights and interests of consumers.
• Obtaining three administrative penalties within two years for issuing false advertisements, or publishing false advertisements of goods or services related to consumers’ life and health, causing personal injury or other serious social adverse effects.
• Being subjected to more than two administrative penalties within five years for trademark infringement.
• Other violations of the industrial and commercial administration laws and administrative regulations stipulated by the State Administration for Industry and Commerce, where the circumstances are serious.

Moreover, in general companies are listed as seriously illegal and trustworthy when they do not file their annual report or when they cannot be contacted on their registered address. There are examples where companies got blacklisted for not filing annual reports and this has caused said companies to be unable to open basic bank accounts, be rejected for bank loans, miss out on listing opportunities or lose their AA Customs qualification, among others. In the case of the loss of the AA Customs qualification, the blacklisting could be rectified after filing the annual report, but the loss of the AA qualification could not be reversed.

Conclusion

The goal of the Chinese Corporate Social Credit System is to enforce existing and new regulations. Although the Corporate Social Credit System does not introduce many new regulations, the enforcement of existing regulations will be stricter and more systematic. Where currently companies might get away with slacking on requirements, the full implementation of the system will blacklist these companies or give them a low rating, severely negatively impacting their business.

It is also important to note that past ratings are also taken into account when calculating new ratings. In most cases it is not possible for a company to receive an excellent rating after receiving a poor rating in the previous period. Since negative ratings and blacklist are visible for several years, ending up with a negative credit on the system can affect a company for many years.

In our next article, we will further elaborate on the consequences of China’s Corporate Social Credit System for business. The article will also further dive into the remedies available within
the framework of the Corporate Social Credit System to rectify bad social credit ratings and backlisting.

If you have any further questions about China’s Corporate Social Credit System and how we can help your business avert potential negative consequences due to non-compliance, then please do not hesitate to contact us at info@msadvisory.com or check out our dedicated Corporate Social Credit System Services page.

Our China Corporate Social Credit System Series
Part 1 The underlying structure and mechanisms
Part 2 How do the ratings and blacklisting work?
Part 3 Consequences for businesses (punishments & rewards)

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