Intensifying business risks in the People’s Republic of China (“PRC”) and Hong Kong have prompted some premature calls for foreign investors to depart those markets altogether – most notably in a recent Wall Street Journal article, which created consternation in the business community.

However, the harsh reality is that most foreign companies, as legacy investors, simply cannot withdraw at short notice, and nor would doing so be wise, given that most operate in uncontroversial sectors. Despite a media narrative to the contrary, it is not (yet) unpatriotic to make shoes or power tools in China.

Even so, boards should know that increasing pressures on companies mean that doing nothing to mitigate risks is no longer an option. Executives must face up to these challenges, or leave corporate interests exposed.

An economic tempest

One obvious problem is economic. The prospective insolvency of China Evergrande Group and the default of Country Garden Holdings, both major developers, have highlighted the dire plight of the Chinese property market – and the prospect that financial contagion may spread.

A run on the Bank of Cangzhou in China’s Hebei province in mid-October 2023, albeit a small example, and the much more significant plight of trust company Zhongzhi Enterprise Group, illustrated fears that more financial instability could follow. Such contagion could derive from links between property companies, trust businesses, and private wealth and life insurance firms.

For now, the Chinese authorities are appointing state-owned entities to handle the insolvencies, allowing some fiscal relaxation, and adopting measures to boost the stock markets. Beijing may yet succeed in stamping out the fire, if at the expense of much-needed “creative destruction”.

Even so, the PRC economic outlook is at its worst in many years, with deflation worsening, youth unemployment at a high, and statist (or erratic) policymaking impinging on the private sector. The quiet exodus of talented foreigners and locals seems to continue, and many small- and medium-sized businesses have folded or have left.

Political headwinds

The second challenge is political. Calls from the US (and European states) for companies to “de-risk” are intensifying. Washington seemingly hopes to diminish Chinese sway over the “commanding heights” of the next generation economy.

US trade and export control restrictions, especially on high-technology sectors, such as semi-conductors, artificial intelligence, and electric vehicles, have been especially prominent in this context.

In response, China has adopted its own measures, such as controls on exports of gallium, germanium, and graphite, the adoption of an anti-sanctions law, and the drafting of an “unreliable entity list”.

Of further note has been Chinese action against foreign consulting businesses, with the arrest of staff at an American due diligence firm, investigations into expert network provider Capvision, and the passage of data protection and anti-espionage laws.

Unfortunately, the risk of an escalatory “tit-for-tat” is real, notwithstanding some recent diplomatic bonhomie, and a possible upcoming meeting between US President Joe Biden and Chinese Communist Party (“CCP”) General Secretary Xi Jinping in November 2023.

After all, the US continues to tighten restrictions on semiconductors, and may yet take targeted action against Hong Kong, given unconfirmed allegations of the use of local companies to circumvent restrictions on exports of chips to Russia.

Not all in the same boat

Of course, different businesses face different threats. Those in sectors subject to US export controls or sanctions are more at risk than are more mainstream businesses. Those from European states or Japan may face fewer challenges than those from Australia, Canada, and the US.

Indeed, SVA has noted that many companies, such as those in financial and professional services, manufacturing, textiles, real estate and consumer goods, face long standing problems that are rarely strategic or overtly political.

Rather, these foreign businesses may still need assistance with workaday problems such as fraud, corruption, intellectual property theft, staff defections, or asset searching and litigation support.

Alternatively, they may need SVA’s help in scaling back or de-risking – if that is the path chosen by headquarters – or in identifying risks in potentially just-as-challenging jurisdictions in Southeast or South Asia.

The challenge, though, is that many of these foreign companies are legacy investors, and often they are heavily reliant on China for inexpensive production or a major portion of sales. Many firms cannot simply up and leave at short notice. There is simply too much at stake for these companies.

Such is true, too, for many states at an aggregate level; a vast amount of foreign investment – a classic national interest – is now at play. The economic havoc arising from a sudden withdrawal from the world’s second largest economy would be vast.

SVA is active in supporting foreign companies in this context, by providing consulting and advisory services. Boots on the ground are necessary to do so, and SVA remains headquartered in Hong Kong, unlike some firms that have heeded the exit narrative.

How should boards steady the tiller?

The commercial outlook in the PRC and Hong Kong has worsened, then, but investors should not panic. Neither, though, should they bury their heads in the sand – a lot has changed, and more change is to follow.

In particular, the risk of a sharp deterioration in the business climate, perhaps in response to an incident over Taiwan, a conflict in the South China Sea, or a new round of sanctions, is real – and growing.

Boards should recall that many companies effectively lost their entire Russian units immediately after the invasion of Ukraine in February 2022. Political risk analysis, a key SVA service, has never been more important.

SVA believes that boards should act nimbly to protect their interests, with measured key steps, which might include, but not be limited, to:

• Companies should carry out independent strategic appraisals, so as to gain a firm understanding of the threats and vulnerabilities in question. Such assessments should consider geopolitical risks, of high- and low- order, alongside commercial and more workaday concerns, and ask what structural or operational changes to make in response. What seemed unlikely even a year ago is now coming to pass. This is a key SVA service; we have provided advice to numerous foreign multi-national companies on such issues in recent years.
• Manufacturing businesses should, once again, re-examine their supply chains. The recent pandemic provided some sense of how to deal with stoppages, but companies need now to examine any reliance on key inputs, especially those from China. Such assessments should consider how to adjust or diversify supply chains, whether moving elsewhere will reduce dependencies, and what and where the key logistics chokepoints might prove to be.
• Boards should consider the exposure of plant and personnel in the event of a rise in tensions. Executives or staff may find themselves at risk of regulatory action or arrest, for instance, or plant and workers may become targets of protests, boycotts, or strikes. A regional conflict could prove especially challenging for shipping or aviation businesses.
• International companies should consider how to handle their local teams with diplomacy and dexterity, mindful of the divisive context, the worsening outlook, and the need to ensure staff look beyond immediate loyalties. Leaving a local team in charge may result in loss of control, but nor can foreign management act without consideration of local sensibilities.
• Treasury departments should appraise the integrity of payment systems, taking account of how intensified capital controls or restrictive banking regulations could affect transfers or access to working capital. Similarly, boards might examine whether restructuring entities, the raising of debt, or the use of financial options or insurance could protect interests – perhaps by shifting assets and liabilities into different entities or jurisdictions.
• Companies should examine information technology systems, not only in the light of conflicting data rules, but also with an eye on possible separation into stand-alone units. Systems integrated across borders may pose an acute vulnerability as tensions rise. Equally, companies should examine whether reliance on certain server locations, cloud storage systems, or software providers amounts to a vulnerability.
• Companies should assess whether communications systems might retain integrity in any crisis. The adoption of coordinated planning and training of teams across separate business units should ensure that communications breakdowns do not disrupt business operations unduly, and may minimise any loosening of ties between business units over a longer period of autonomous operation.
• Boards should examine the structure and status of crisis management departments. A traditional reliance on a press relations lead may no longer be appropriate. Rather, fusion with security departments, supply chain teams, IT and others may make more sense. Moreover, crisis management teams need to have access to senior decision makers. SVA staff serve on such teams, and provide advice in emergency and simulated situations.
• Legal departments should examine existing contracts and insurance policies, to ensure that they take account of actions that might hitherto have been ignored, or have deliberately been carved out, but which are now genuine risks. Many insurance policies distinguish between war risk, political violence, and terrorism, for instance. Labour contracts are also of note, as local staff may come under pressure not to work for companies from particular jurisdictions.
• Regulatory risk will require closer attention, as investors can no longer assume supervisors will act with good faith. Companies should thus refresh prior due diligence work, on an independent basis, given that the world has changed, and assuming that a reasonable judgment of five years past could now prove a liability. SVA provides in depth Investigative Due Diligence services across Asia.
• Companies should watch closely for fraud. Economic pressures and, perhaps, perceived differences between local teams and head offices will add to the risks of financial crime. Executives should strengthen mechanisms to monitor transactions, and should establish sounder audit and documentary trails (in retrospect, if need be). Relying on auditors to detect fraud is an unsound strategy. It is unlikely that there will be an outbreak of honesty in 2024.
• Companies should act cautiously in “de-risking” – especially when reacting to political rather than actual situations. A close assessment of how best to scale back is important, so as not to anger local partners or provoke a nasty response, as is gaining a full understanding of alternative jurisdictions or counterparties. Acting impetuously may prove harmful.

All told, the outlook for business in mainland China and Hong Kong has undeniably become riskier.

However, investors need not flee the market, and can still protect their interests, provided they act nimbly to do so, and do not bury their heads in the sand.

Undoubtedly this is a difficult time for foreign business, but there is also opportunity in danger, and Hong Kong, although much changed, remains a critical hub for supporting foreign business in China.

With 40-years of operations in Asia, SVA has considerable experience in helping clients move swiftly to seize opportunity, and in mitigating risks as they do so.

SVA www.stevevickersassociates.com is a specialist risk mitigation, corporate intelligence and risk consulting company. The firm serves financial institutions, private equity funds, corporations, high net-worth individuals and insurance companies and underwriters around the world.

SVA has three core lines of business, which are: Business Intelligence and Political Risk; Corporate Investigations; and Special Risk and Response. SVA also has a dedicated crisis management team which, for our retained clients, stands ready to assist companies during crisis situations.