A policy change in China has withdrawn public access to corporate records, IFLR can reveal. Hedge funds, and private equity firms with no presence in China, will now struggle to carry out adequate transactional due diligence in the country.
The new policy was introduced by Administrations of Industry and Commerce (AICs) in Shandong and Tianjin provinces as well as parts of Shanghai earlier this year, and was rolled out in Beijing in May. It prevents deal counsel from independently examining and copying the content of a company’s AIC files – a major source of legal material in the due diligence process.
It remains possible, however, to search certain basic corporate information (such as business address, registered capital and business scope) on the AIC website. But only with a proof of claim to the court or the target company’s written permission, in accordance with the Regulation on Review of Company Recording Files.
Officially, the move aims to better regulate the use of company information. Previously domestic lawyers, the police and China’s national security bureau, among others, could undertake company AIC searches. But some smaller firms and sole practitioners had begun misusing this privilege by passing information along to unauthorised foreign and local parties for a fee.
Sources in Beijing believe it is more likely to be a reaction to repeated challenges from research firm Muddy Waters, to publicly-reported ChinaCo financial results, however. There is speculation too that the move was prompted by a recent probe into commercial information provider Dun & Bradstreet amid allegations it violated China’s consumer-privacy laws.
While, China Briefing speculates that the soft handling of the move is indication the Chinese government is concerned about the health of China businesses.
Market participants have branded the move a step in the wrong direction.
One Hong Kong-based private equity firm CEO said the move would hinder his firm’s ability to do business in the country, just as valuations had started to come back. “It’s getting harder to verify numbers from all kinds of businesses in China,” he said. “Fraud is an increasing problem.”
And while many private equity firms will continue to be able to access AIC information with a target company’s approval, many would prefer not to for fear of encouraging collusion between a target and the relevant regulators.
“This vague directive doesn’t help to build trust in any way, it just makes it a lot harder for us to review the recording files of a registered company without such company’s cooperation,” said the private equity CEO. “The AIC previously provided us with full records 95% of the time, that’s now dropped to 50%. It’s a big difference.”
Offshore hedge funds are likely to be the most severely impacted by this, however. As they rarely have buy-in from a company before making an investment, they cannot expect permission from a target company to access their records. They will be forced to rely more heavily on background agencies and research organisations operating in China to source the required information for them.
One in-house counsel at an Asian-focused private equity house said this was not a great moment in China’s regulatory history: “It’s a classic case of China trying to save face in the wake of embarrassing allegations and obvious violations of law.”
Another Hong Kong-based corporate lawyer agreed. “It’s clear authorities in China feel they have been caught out and are reacting by closing ranks, thereby preventing the rest of the world from seeing what’s actually going on,” he said.
“The trouble is this change makes things less transparent at a time when the exact opposite is needed,” he said.
Indeed, one Beijing-based corporate lawyer said the policy went against a World Bank report this month urging countries to move toward greater transparency of, and access to, corporate records as a way to combat fraud. “This is not in China’s best interest,” he said. “It heightens the difference, and continued disconnect, between Western and Eastern approaches and the world’s two largest economies.”
“It will erode investor confidence at time when it’s most needed,” he said.
Private equity firms with a presence in China are unlikely to be too affected by the policy, however. The majority rely on many other sources, and specialist teams, for their due diligence and not just the AIC.
The Regulation on Review of Company Recording Files classifies a company’s files with AIC as ‘machine-readable records’ and ‘paper-based records’. The ‘machine-readable records’ include a company’s basic information such as corporate registration information and penalty records. Under the law, AIC should make machine-readable records publicly-available for access and duplication. The paper-based records, on the other hand, cover all the corporate records filed with AIC. The law only allows the government agencies and lawyers (with a proof of claim to the court) to search and collect paper-based records.
It is possible the regulation will be amended to tighten the public’s review of a company’s files. Market participants, however, hope the policy change will revert in due time as interest from research firms such such as Muddy Waters wanes.