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Political stability in China comes with little transparency

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Political risk in China is relatively low compared with other emerging markets, but legal and regulatory transparency is a key risk for foreign companies in the region.

“The political risk situation in China is interesting because while there is stability with the one-party system, there is also very little transparency in rules and other aspects of doing business, which make it challenging for a foreign investor,” said Corina Monaghan, New York-based vp of the political risk practice at Aon Risk Solutions, part of Aon Corp.

Transparency is a huge issue in China and is perhaps the biggest single issue for foreign companies, said Andrew Gilholm, Shanghai-based political and security risk analyst for global risk consultancy Control Risks Group Holdings Ltd. For example, corporate filings and accounts can't be treated in the same way as those in the U.S. or Europe, and there are many conflicts of interest within or between companies, buyers, suppliers, etc.

Regulatory transparency is particularly an issue for strategic or politically sensitive sectors like high tech and commodities. Regulations can change quickly, and there can be inconsistency in their application, said Mr. Gilholm.

By emerging market standards, China is a fairly stable and predictable business environment, said Mr. Gilholm. “Many companies are increasingly savvy to operating in China and rarely experience severe problems, unless they get into dispute with a Chinese partner or are involved in a politically sensitive sector,” he said.

China is not a political risk hot spot, with little political violence, business interruption, strikes or riots, said Mr. Gilholm.

However, there has been a rise in political violence in China as the country feels the pain of a recession in the global economy and because of an income disparity between urban and rural communities, said Ms. Monaghan. But actual physical damage to foreign assets appears to be minimal so far, as civil unrest has not targeted foreign businesses, she said.

There has been rising social unrest in China, but it typically remains localized and related to land, labor or environmental disputes, said Mr. Gilholm.

“Widespread civil unrest in China is not likely in the short to medium term, because there are no signs of divisions in the ruling Communist party or the downturn in the economy becoming really destabilizing, two key ingredients for political upheaval,” he said.

China also is relatively low risk for security and crime, said Mr. Gilholm. But while crime rates are relatively low, intellectual property risk remains problematic.

“Chinese authorities periodically clamp down, but piracy and counterfeiting always come back, and industrial espionage is still an issue. (Intellectual property) is still one of the top risks of concern to foreign companies in China,” he said.

There still are many cases of corruption, bribery and gift giving that would not be compliant with international bribery and corruption laws. However, corruption in China is not unusual by the standards of other emerging markets, he said.

Contract frustration is a key issue for companies in China, said Mr. Gilholm. “Enforcing a contract in China can be difficult. Even enforcing a favorable court ruling can be problematic when dealing with certain sectors or with state-owned parties. Companies tend to think twice before entering into a dispute or legal action over a contract if it has a long-term interest” in China.

There are huge discrepancies in legal treatment between courts depending on geographical location, said Mr. Gilholm. For example, courts in Beijing and Shanghai generally operate to higher standards than less-developed cities, and provincial capitals are usually better than, say, courts at a township level.

Investors in China are keen to buy insurance against the risks of political violence and expropriation, said Ms. Monaghan. More recently, there has been interest in buying inconvertibility/exchange transfer insurance, in particular with reports that some companies have had difficulties repatriating dividends or proceeds related to divesting their business in China, due to government interference, she said.

However, political risk insurance capacity in China has been hard to find, said Ms. Monaghan.

“China is the biggest recipient of foreign direct investment, but the supply of political risk insurance has not met the high demand—which has resulted in more expensive capacity,” she said. “Insurers are concerned with their potential recovery after claims are paid, and they contemplate the overwhelming task of dealing with issues like red tape and an opaque system that would be part of the recovery process in China.”