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China's Social Credit System: overview and implications for businesses

July 15, 2019

In recent times, the Chinese government seems to be picking up the speed of economic and legal reforms in the country. However, from a historical perspective, China has faced great problems in ensuring legal and regulatory implementation, enforcement and compliance due to the large size of China. This issue is well-illustrated by the Chinese saying "山高皇帝远" (shān gāo huángdì yuǎn), meaning "the mountains being high, and the emperors far away". As a result, the Chinese authorities have explored various regulations and tools to support the development of the market economy, whilst simultaneously easing enforcement. One program which gained particular attention in Western media is China's so-called Social Credit System.

 

China's Social Credit System is a system designed to regulate the behavior of both individuals and businesses active in the Chinese market with incentive and punishment schemes. According to the China's State Council (14 June 2014), the aim of China's social credit system is "... allow the trustworthy to roam everywhere under heaven while making it hard for the discredited to take a single step". For the implementation of China's social credit system, a vast amount of data is collected in order to create a comprehensive database of all those who live in, or are citizens of, the People's Republic of China (including foreigners) as well as companies active in China.

 

In this article, we aim to provide a comprehensive overview of the Chinese social credit system including the purpose of the system, its current state, the implications for individuals and businesses as well as the future implementation of the social credit system.

 

 

The purpose of China's Social Credit System

At first, the aim of the Chinese social credit system was to support the development of the market economy. The Chinese term for Social Credit System is "社会信用体系" (shèhuì xìnyòng tǐxì). Here, the Chinese word "信用" (xìnyòng) can be translated as both "credit" in a financial sense as well as "trustworthiness" or "sincerity". 

 

Therefore, the intent of China's Social Credit System was to create a system to increase compliance of both individuals and business with laws and regulations. This system would also allow for increased monitoring and create incentives for compliance by introducing clear and enforceable punishments.

 

Over time the social dimension of the Social Credit System further developed. The idea of the system was to create various incentives, both positive and negative, to ensure individuals and businesses would act in a desirable way without government intervention.

 

The 2014 Planning Outline for the Construction of a social credit system sets out the following targets for the Social Credit System:

  • Increase transparency, lawful administration and build trustworthiness in Government Affairs.

  • Increasing Commercial Integrity to support the market economy.

  • Increasing Social Integrity of the wider population.

  • And boosting enforcement and credibility for the country's Judicial System.

 

What does the Chinese Social Credit System look like?

As mentioned before, China's social credit system consists out of a variety of incentive and punishment schemes. This means that there is not one social credit system, but there are actually several different systems working simultaneously at both the national and local levels.

 

At the core, the national government runs several blacklists for both individuals and companies. If an individual or company is placed on a blacklist, this can have vast consequences. The principle behind these blacklists can be defined as "the joint punishment system", whereby failure to comply with the law in one area results in restrictions being imposed everywhere.

 

A second feature of the blacklist system entails that the list of offenders will be published and accessible. This adds the element of public shaming, or in the Chinese this can be referred to as the phenomenon of losing face ("丢脸" diūliǎn). As a result, individuals will feel social pressure to comply with laws and regulations in order to avoid being placed on a blacklist.

 

It is important to understand that the blacklist system does not involve a social credit rating or a social credit score. In general, you are either on or off the blacklist; and the system does not (yet) use Information Technology to categorize individuals or companies.

 

These blacklists have already been used for a significant amount of time. We have already come across companies whom were blacklisted for for example the use of a fake office on their Business License. Subsequently, the company has to rectify their mistake in order to be removed from the blacklist. We have already assisted companies to become more compliant with Chinese regulation and assisted in their removal from the blacklist.

 

In addition, it is worthy to note that the blacklist system is applicable to those individuals residing in China, which would mean they are also applicable to foreign individuals. It is unclear how this system would apply to for example tourists, but one can assume that also a foreign individual who works and lives in China (i.e. more permanently resides in the country) is subject to this system.

 

Social Credit Scoring Systems

Currently, there is no social credit scoring system at the national governmental level. However, at the local level there are some cities and regions that are experimenting with a scoring system. For example, the county of Suining introduced a credit program, which gave individuals a score of 1000 points. Subsequently, the score would be lowered because of bad conduct. Depending on the score, the individual could experience certain preferences or face increased scrutiny from authorities. However, this scoring system was eventually discontinued.

 

The most famous examples of social credit scoring systems for Western media are "private social credit systems". In early 2015, the People's Bank of China selected a number of private businesses to develop a personal credit rating system. Of these private social credit systems, Sesame Credit (which was developed by Ant Financial Group, an affiliate of Alibaba), is probably the most famous.

 

Sesame Credit was originally developed to support Alibaba in the eCommerce business. The function of Sesame Credit here is twofold, 1) the scoring system assesses the creditworthiness of individuals and 2) the scoring system brokers trust between buyers and sellers. These two functions were essential to Alibaba as they had to develop their own payment system, due to the absence of an external mobile payment system.

 

In addition to the traditional credit scoring system, Sesame Credit is supplemented by a loyalty scheme. For example, individuals with a high Sesame Credit score can enjoy a waiver for deposits for certain services.

 

Sesame Credit calculates a score between 350 and 950 points based on data in five major categories:

  1. Credit history;

  2. Behavioral trends;

  3. Meeting agreements and making payments on time;

  4. Quality of personal information provided (used to verify an individual - i.e. you are not a robot);

  5. Social relationships;

 

Implications for Businesses

By now, it should be understood that the social credit system consists of both positive and negative incentives. Once an individual is placed on the blacklist, they will subsequently be penalized. These restrictions and punishments are also applicable to businesses in China (and their senior staff/management). According to the Memorandum of Understanding about the Obligations for Party and State Bodies in the Joint Punishment System (National Development and Reform Commission, 2016) these may include the following:

  • Restricting economic activities (limiting access to finances and obtaining permits);

  • Rejected from receiving government subsidies;

  • Additional restrictions in specific sectors (e.g. the food, pharmaceutical and chemical industries);

  • Negative status for customs procedures.

  • Being barred from purchasing real estate/land-use rights.

  • Restricting consumption of conspicuous products/services (e.g. travel on high-speed trains and civil aircraft) - notably, for businesses this may affect senior staff/management.

 

In practice, this may introduce significant red tape and barriers to market entry for foreign firms as these businesses may be denied specific licenses or permits required to carry out their business. These companies may also be subject to higher taxes, however, this is unclear at this moment.

 

For businesses and legal persons, it was historically difficult to enforce punishment for blacklisted businesses as the Company Business License would have a different number for different government authorities. However, since the introduction of the Five-in-One Business License ("五证合一" wǔ zhèng héyī) the Business License, Organization Code, Tax Certificate, Social Security Bureau Certificate and the Statistics Bureau Certificate were integrated into one.

 

The introduction of the Five-in-One Business License has enabled the government authorities to connect data sources. This data is derived from 1) records held by government agencies (e.g. tax or environmental bureau), 2) court judgments, 3) information regarding criminal and administrative punishment and 4) financial information. However, these data sources are increasingly supplemented with other sources, and many foreign businesses fear this may favor domestic Chinese businesses or may be used in the context of for example a trade dispute (i.e. the China-US Trade War).

 

A business can review whether their company is currently on any national blacklist via the website of the National Enterprise Credit Information Publicity System (please click here).

 

Looking Forward

China's social credit system is set to be implemented starting from 2020. However, it remains to be seen how the social credit system will affect foreign businesses in China in comparison with domestic Chinese businesses. In addition, we will have to further await announcements how China's social credit system will be implemented on the national level, and whether we will see further integration between the Chinese authorities and private social credit scoring systems.

 

If you have any further questions about China's social credit system, then please do not hesitate to contact us at info@msadvisory.com or check out our dedicated Corporate Social Credit System Services page.

 

Want to know more about the system? Read our mini series!

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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