October 05, 2020

Multinational Corporations Operating in China: Environmental Challenges and Solutions

Lu Wang and Shengzhi Wang

For most multinational corporations (MNCs) operating in China, environmental protection has become the most significant focus of the corporate social responsibility (CSR) agenda in the past five years. Since its revised Environmental Protection Law was put into effect on January 1, 2015, the Chinese government has initiated intensified environmental enforcement from the central government to the local level. According to China Judgments Online, a national electronic database of published judicial decisions administered by the Supreme People’s Court of the People’s Republic of China (PRC), the number of published criminal judgments for the offense of environmental pollution (Criminal Law, art. 338) has increased dramatically nationwide, from 40 cases in 2013 to more than 2,000 cases each year in 2018 and 2019.

Environmental civil public interest litigation and ecology and environmental damage compensation litigation have become increasingly frequent methods of pursuing environmental justice in China compared with environmental infringement private interest litigation. In 2019, a court ordered an MNC to pay RMB 470 million (approximately $67.12 million) to compensate the local government for environment damage after unlawful wastewater discharge into the Yangtze River. Combined with a separate penalty, the MNC eventually had to pay RMB 520 million (approximately $74.29 million) for the incident, the highest amount in a single environmental case so far in China. See Qiu Haihong, Wastewater Treatment Enterprise Ordered to Pay RMB 520 Million for Concealed Wastewater Discharge and Monitoring Data Forgery; Defendants Sentenced, The Paper, Jan. 6, 2020. But future cases may set new records: On May 28, 2020, the National People’s Congress (NPC), China’s top legislature, passed the first Civil Code in the history of PRC. The Civil Code, scheduled to take effect on January 1, 2021, would for the first time allow claims for punitive environmental damages where a tortfeasor intentionally pollutes the environment in violation of the law and causes serious consequences.

This article analyzes the environmental challenges that MNCs in China face in light of the rapidly changing legal environment. Specifically, we discuss cases illustrating issues related to environmental compliance, supply chain management, and product footprints. We then present a case from Jiangsu, China, where MNCs work on environmental CSR solutions by interacting with their fellow companies, the government, and third-party professionals through a successful local association.

Key Challenges: Compliance, Enforcement, and Supply Chain Management

The Chinese government has dedicated significant efforts to promote its environmental governance. These efforts have included strengthening the rule of law, increasing administrative transparency, reducing unnecessary regulatory burdens, improving fairness and precision in enforcement, and crafting more behavior-oriented policies to encourage compliance and to penalize violations.

These efforts have mixed consequences for MNCs. As the U.S.-China Business Council reported in March 2019, companies welcomed efforts to level the playing field for MNCs that were already operating with strong pollution controls. Notably, domestic companies have been “increasingly held to the same environmental standards” as MNCs. See U.S.-China Bus. Council, Environmental Compliance for US Companies in China 14 (2019) [hereinafter Environmental Compliance].

However, a number of fundamental concerns remain. For example, there are challenges to navigate the increasingly complex regulatory requirements and precisely identify compliance obligations; to weather sometimes arbitrary enforcement, where the authorities have considerable discretion and unclear jurisdictional boundaries; and to manage local business partners, whose expectations and compliance performance may affect MNCs’ business or reputational interests. As China has promulgated more environment laws and regulations, precisely identifying compliance obligations has become a challenge. This uncertainty is the result of several compounding factors.

First, the rules are constantly changing. NPC has intensively enacted and amended environmental laws since 2015, reshaping the framework of China’s environmental law. The Air Pollution Prevention and Control Law was revised in 2015 and amended in 2018; the Water Pollution Prevention and Control Law was amended in 2017; the Law on Environmental Impact Assessments was substantially amended twice between 2016 and 2018; the Environmental Protection Tax Law and the Soil Pollution Prevention and Control Law were respectively promulgated in 2016 and 2018; and the Law on Prevention of Environmental Pollution Caused by Solid Wastes was amended in 2016 and revised significantly in 2020. Furthermore, the State Council and its ministries have been revising the regulations and rules to respond to the above changes. For instance, the lists of solid waste subject to import prohibition or restriction were revised four times between 2017 and 2018. China’s national rules on emission permits were revised three times between 2016 and 2019, and the government is now planning on further revisions.

Most of these changes have moved the regulations in a positive direction, e.g., more reasonable rules, more specific requirements, and less administrative red tape. But the frequent changes also bring extended periods of confusion and uncertainty, as well as high costs for companies as they constantly adjust to new rules (e.g., engaging counsel or compliance advisors).

Second, vagueness in laws and regulations persists; ambiguities and gaps are often filled with either standards or “normative documents.” In China, standards are usually drafted by technical professionals, rather than lawyers. They sometimes conflict with laws or regulations or include inconsistent wording or terminology. “Normative documents” are either policy proclamations or enforcement guidance, which are not subject to the stringent rulemaking process under China’s Legislation Law. Normative documents from local authorities are particularly concerning: They are often not widely publicized and, in theory, do not provide any independent legal basis for administrative penalization. But they often set the tone for local enforcement initiatives, and therefore guide local enforcement actions.

Third, China has not yet adopted a routinely updated, centrally managed, and well-indexed compilation of all its statutory and regulatory rules available to the public. China has no counterparts to the United States Code, the Code of Federal Regulations, or state equivalents. Laws and regulations are promulgated, revised, and repealed with individual decrees or circulars on an ad hoc basis. Locating valid and effective rules is a challenge without commercial databases or professional advisors due to the numerous sources and locations of regulations, guidance, lists, and various other documents issued by many different authorities (i.e., environmental, energy, industry and information technology, marketing regulation, finance, customs, etc.). The central government has been attempting to organize regulations and coordinate policy design. For example, in a March 2020 circular, the National Development and Reform Commission and the Ministry of Justice directed central and local authorities to “promulgate, revise, repeal, and interpret” rules in relation to “green production and consumption,” with the goal of setting up “a fundamental framework” of the applicable laws, standards, and policies by 2025. Opinions on Accelerating the Establishment of the Regulatory and Policy Framework on Green Production and Consumption (Fa Gai Huan Zi [2020] No. 379) (promulgated Mar. 11, 2020).

Fourth, administrative arbitrariness is a problem. Wide discretion for enforcement authorities and lack of clear jurisdictional boundaries result in arbitrary actions. Some local authorities enforce the law overzealously. MNCs in key pollution-control regions (e.g., northern China or the Yangtze River region) have reported frequent environmental and safety inspections from local authorities. See Environmental Compliance, supra, at 6. So-called one-size-fits-all approaches by local authorities result in production suspensions, shutdowns, or relocations across almost all enterprises in a region (e.g., in wintertime, to address poor air quality), regardless of the compliance status of individual companies. Since 2018, the Ministry of Ecology and Environment has issued policy documents to ban one-size-fits-all. Some provinces (e.g., Hebei) have introduced new policies, such as the “environmental credit rating” and “Positive List” system, to foster more targeted enforcement. See, e.g., Hebei Administrative Measures on Enterprise Ecology and Environment Credits (For Trial) (Ji Huan Hui Fan [2019] No. 4).

Conversely, some local authorities lack law enforcement, indirectly favoring noncompliant companies. To address this, in 2016, the central government launched the central environmental inspection campaign, dispatching teams to individual regions to evaluate whether local authorities have properly enforced the law. A “look-back” campaign checks if local authorities continue their enforcement actions after the team from the central government leaves the region.

Chinese authorities have recognized these problems and have been proposing institutional solutions to alleviate them. Environmental authorities in most provinces now have rules on how to exercise discretion in enforcement. Authorities are also proposing rules for exempting de minimis violations.

Unclear jurisdictional authorization is another a problem. Some laws and regulations do not clearly identify the administering authority. As a result, some authorities are averse to taking up novel issues, discouraged by government accountability mechanisms designed to identify authorities that make poor policy or enforcement decisions.

As an example, site contamination investigations are mandatory in certain situations expressly listed under China’s Law on Soil Pollution Prevention and Control, newly promulgated in 2018. See Soil Pollution Prevention and Control Law, arts. 59, 67. The law prescribes mandatory circumstances where site investigation reports must be submitted to environmental authorities for expert review. A question then arises on whether a company may, in order to establish an administrative record of site conditions, file voluntary investigation reports. Local authorities have declined to accept filing voluntary reports, citing that the law provides no authorization for them to accept such reports, leaving companies without a means to legally establish their investigation findings in anticipation of future disputes.

Ambiguities in the laws also cause jurisdictional overlaps and vacuums, i.e., two authorities competing for jurisdiction over a subject matter, or an absence of any authority exercising jurisdiction. Jurisdictional overlap can lead to inconsistent or even conflicting instructions from different authorities.

Jurisdictional vacuums result in no enforcement of certain laws, which can lead to disastrous consequences. For example, Chinese law does not clearly define whether the safety management of waste hazardous chemicals is regulated by the safety authority or environmental authority. The question has been debated in the environmental health and safety (EHS) professional community in China with no clear answer.

In 2019, a major explosion occurred in Jiangsu Province. The explosion was caused by improper storage of hazardous waste. Leaked internal communications from China’s safety and environmental authorities after the incident created a spectacle on social media, as both authorities charged each other with responsibility. The safety authority argued that its regulatory authorization was limited to hazardous chemicals, but not abandoned chemicals that are hazardous waste, which are listed in the National Hazardous Waste Catalogue. The environmental authority countered that its authorization was limited to environmental management, but not safety management, of chemicals that are hazardous waste.

The State Council, in the investigation report of the explosion, harshly criticized both authorities for “merely regulating in a segmented manner based on each authority’s own interpretation; not actively taking one step forward, neither proactive nor responsible . . . [and] exerting no collaborative force to regulate as a government.” The State Council also called for “further refining the safety supervisory and regulatory system in relation to hazardous chemicals.” See State Council Accident Investigation Task Force, Investigation Report for the March 21 Significantly Major Explosion Accident at Jiangsu Xiangshui Tianjiayi Chemical Company Limited 31, 37 (2019).

More recently, the Central Committee of the Communist Party of China and the State Council demanded that environmental authorities bear certain “safety” regulatory responsibility under the existing hazardous chemical safety regulation, whereas safety authorities bear “fall-back” regulatory responsibility for safety issues “when the jurisdiction is unclear.” See Opinions on Comprehensively Strengthening the Work Safety Concerning Hazardous Chemicals, art. 14 (promulgated Feb. 26, 2020). In 2020, a draft proposal of a new Law on Hazardous Chemical Safety proposed that the environmental authority would regulate the safety management of waste hazardous chemicals. See Law on Hazardous Chemical Safety (Draft for Comments for Draft Proposal) (issued by Min. Emergency Mgmt., Jan. 5, 2020) (Ying Ji Ting Han [2020] No. 4), art. 6(4).

MNCs also have challenges managing their local business partners in China. Chinese companies have generally been improving their environment and safety compliance in recent years. However, compliance remains a problem for many Chinese companies, which may not have the resources or the willingness to achieve environmental and safety compliance. This presents supply chain continuity and reputational risks for MNCs.

In 2017, for example, a German manufacturer petitioned authorities in Shanghai to delay an order halting operations of a local supplier that was found to have violated environmental regulations. The supplier was the manufacturer’s sole supplier of a key component. After the petition was leaked on social media, however, the manufacturer quickly released a statement that the issue was resolved after the manufacturer coordinated global resources to “handle the situation.” See Hu Wei, A Common Trouble for Schaeffler, Apple, GM and Other Foreign Companies: Supply Chain Pollution, 2017 China Econ. Wkly., no. 39. The then–Ministry of Environmental Protection later commented on social media that “strengthening environmental regulation is an irreversible trend in China. . . . We recommend that [manufacturers] take [this incident] as a lesson to have a thorough examination of the environmental risks associated with the supply chain, starting from checking and verifying the compliance status of the supply chain. . . .” See Min. Ecol. & Envt, Talking About Production Shutdown: Crisis of Parts Supply Reflects Long-Standing Disregard of Supply Chain Pollution by the Automotive Industry, Weibo, Sept. 20, 2017.

Emerging Challenges: Product Footprints and Compliance

Product footprints—a product’s environmental and safety impacts in commerce—have drawn much attention in China. The government and the public in China have been increasingly more aware and proactive of product footprint issues in recent years. This focus sharpened significantly after the matter of Mr. Cheung Shu-hung and the Lee Der Industrial Company.

Mr. Cheung was a co-owner of Lee Der, a toy manufacturer in southern China. Lee Der supplied toys to a U.S.-based MNC toymaker for more than a decade. In August 2007, the U.S. toymaker launched a product recall after certain toys in the U.S. market were found to contain excessive lead. The toymaker initially claimed that a China-based supplier used an unapproved paint supply. Under public pressure, the toymaker eventually disclosed Lee Der’s name. Despite Lee Der’s corrective action by the time of the recall, China’s quality inspection authority nevertheless banned it from further exporting products.

Mr. Cheung was known as a dedicated and generous boss to Lee Der employees, according to media coverage. After the export ban, he hanged himself in Lee Der’s factory. Austin Ramzy, A Chinese Toymaker’s Mea Culpa, Time, Aug. 14, 2007.

At the time of the Lee Der matter, enforcement of China’s rules on toy product quality was meager for exported products. According to a news report at the time, the local quality inspection authority barely performed routine inspections for toxic levels of heavy metals in toys to be exported. Not surprisingly, the authority enhanced enforcement after the Lee Der incident. See David Barboza, Owner of Chinese Toy Factory Commits Suicide, N.Y. Times (Aug. 14, 2007).

Vehicle manufacturing and emission compliance provides another example of greater focus on product footprint issues. In 2013, Beijing’s Environmental Protection Bureau (EPB) discovered excessive tailpipe emissions from certain vehicles of a Korean carmaker. In 2014, the local authority issued an administrative penalty of RMB 1.35 million (approximately $192,857). See Decision of Administrative Penalization (Jing Huan Bao Che Fa Zi [2014] No. 13) (Beijing Envtl Prot. Bureau Sept. 11, 2014).

Friends of Nature (FON), a well-known Chinese environmental nongovernmental organization, sued the same Korean carmaker in 2016 in an environmental public interest litigation case. FON petitioned the court to order the carmaker to cease selling noncompliant vehicles, arrange vehicle retrofits, pay for environmental harm remediation, openly apologize to the public, and pay litigation fees and expenses.

The case was resolved after a court-hosted mediation. The carmaker agreed to FON’s requests, including paying an additional RMB 1.2 million (approximately $171,429) into a trust fund dedicated to air pollution prevention and control. See Friends of Nature Envtl. Rsch. Inst. v. Hyundai Motors (China) Inv. Co., Ltd., (2016) Jing 04 Civ. First 73 (Beijing 4th Interm. People’s Ct. May 21, 2019).

Amendments to China’s Law on Air Pollution Prevention and Control in 2015 expanded the scope of violations and increased the penalties for mobile source emission noncompliance. They also mandated an “environmental recall program for automotive vehicles.” Air Pollution Prevention and Control Law, art. 58.

As a result, since 2015, legal penalties and recalls in China associated with vehicle emissions have soared. In 2015, a Chinese carmaker paid an RMB 20 million (approximately $2.86 million) penalty for malfunctioning on-board diagnosis (OBD) systems. In 2018, the Ministry of Environmental Protection penalized two carmakers in Shandong for excessive emissions and cheating in emission control devices. One company was fined RMB 31.7 million (approximately $4.53 million); the other was fined RMB 7 million (approximately $1 million). In 2019, a major Chinese carmaker was fined RMB 170 million (approximately $24.29 million) for noncompliant OBD systems on its vehicles. Also, in 2019, a major German carmaker launched an environmental recall of more than 300 imported vehicles due to certain problems with the vehicles’ catalytic converters.

MNCs are also facing increasing enforcement and publicity pressure in China with regard to health risks from their products. In November 2019, the State Administration of Market Regulation issued a new circular on strengthening phthalates inspections in the food industry. See Guiding Opinions on Prevention and Control of “Plasticizer” Pollution in Food (promulgated Nov. 11, 2019). In late 2019 and early 2020, excessive phthalates in baby food, clothing, and mugs triggered sales suspensions or recalls in China by three MNCs. See Qian Yu & Zhou Yingmei, Plasticizer Detected in Olive Oil of La Tourangelle Baby Food, Beijing Bus. Daily, July 16, 2019; Capital Educ., Urgent Recalls Launched by GAP for Excessive Plasticizer That May Cause Child Obesity, Sina, Nov. 26, 2019; Sun Zhicheng, Carcinogenic “Plasticizer” Detected, Mugs Popular Around the World Recalled by Ikea, Nat’l Bus. Daily, Jan. 16, 2020.

It is challenging to manage product compliance in a cross-border supply chain. With more stringent laws, enforcement, and publicity pressure in China, it will only be even more challenging in the future for MNCs.

An Example of MNCs Developing Effective Environmental Compliance Solutions

Under these circumstances, some MNCs have cooperated with each other and the government to improve environmental compliance. China seeks to encourage participation in such voluntary efforts. The new Foreign Investment Law took effect on January 1, 2020, expressly “safeguard[ing] foreign-invested enterprises to lawfully and equally participate in standard-setting.” Foreign Investment Law, art. 15 (promulgated Mar. 15, 2019; effective Jan. 1, 2020). This has been acclaimed as welcoming inputs from foreign investors in China’s promulgation of technical standards.

Suzhou Industrial Park is a prime example of a cooperative approach to enhance compliance amid the rapidly changing regulatory landscape. The park is located in the east of the city of Suzhou, Jiangsu province. The park was established in February 1994, with an administrative area of 278 square kilometers. In 2018, the park achieved a gross regional product of RMB 257 billion (approximately $36.7 billion). In October 2008, several EHS managers working in the park voluntarily formed the EHS Association. The Association was an informal professional “club” at its very beginning. EHS managers meet regularly to discuss the problems arising from their work and exchange ideas. The Association took 10 years to grow into a legal NGO registered with the Suzhou Industrial Park EPB. The Association has more than 60 experts and volunteers, over 1,100 company members, and more than 1,500 individual members. Around 70% of its company members are MNCs, mainly from Europe, the United States, Japan, and South Korea.

Since 2018, the EHS Association has cooperated with the EPB to carry out the three-year Environmental Management Partnership Program (the Program), which aims to help the enterprises improve environmental management through self-inspection and mutual assistance. The Program was awarded as one of 10 innovation cases on ecology and environment protection management by Jiangsu Department of Ecology and Environment in 2019.

The EPB provides necessary (and limited) funding for the Program, and enterprises in the Park can voluntarily enroll. The EHS Association and the EPB cooperate with the enrolling enterprises to carry out self-inspection free of charge and to assist the enrolling enterprises to implement corrective measures. The EHS Association selects qualified persons from EHS managers of its company members for participation in an expert advisory panel to diagnose the problems for the enrolling enterprises. Working groups consisting of experts, EPB staff, and enrolling enterprises conduct on-site inspections, training on environmental protection management, and group discussions to help the enrolling enterprises enhance environmental management.

The EPB has promised that it would not impose administrative penalties for any self-inspection findings under the Program. The Program will annually award outstanding enterprises, EHS managers, and experts to recognize their efforts. The chief officer of EPB personally writes and signs a thank-you letter to general managers whose enterprises are enrolled in the program, expressing his gratitude for their efforts to improve environmental management, which encourages greater corporate participation in the Program.

The Program included 64 enterprises in 2018 and 74 enterprises in 2019. According to an anonymous survey conducted in 2018, 83% of the enrolling enterprises believe that their environmental management has improved significantly. The number increased to 94% in 2019.

Mr. Banghong Ding, the vice chair of the Association, has attributed the success of the Program to three reasons. First, the EPB is willing to promote environmental management of the enterprises, and not completely rely on enforcement. Second, the EHS Association endorses the Program with its expertise and “trust credit” in its members and builds a bridge between the EPB and the enterprises. For instance, the EPB is more likely to distribute its “normative documents” to the enterprises through the EHS Association to allow the EHS Association to add its interpretation to these documents, to make them easier to understand and put into practice. The Ministry of Ecology and Environment intends to promote the Program to other industrial parks nationwide.

However, a survey among the participants showed the main motivation for companies to enroll in the Program is to strengthen their communication with the government. The participants would like to involve the EPB in the Program as early as possible to allow for early rectification. The companies participating in the Program seek to respond proactively and creatively to the changing legal environment.

Meanwhile, the rapid changes in environmental laws require changes by local governments, but local governments also cross the river by feeling the stones. Both governments and the business community therefore need assistance in interpretation and implementation of laws, regulations, and policies from professional third parties. The interpretation of laws and regulations by the professionals (such as law firms, consulting agencies, and industry associations) may help enterprises better implement the laws and reduce the information asymmetry between enterprises and the government. The EHS Association and its partners have played such a role.

As of the completion of this article, China’s COVID-19 epidemic had been gradually alleviated, but challenges remain in the fight against the virus in other parts in the world. On March 3, 2020, the Ministry of Ecology and Environment issued the Guiding Opinions on Effectively Working on the Prevention and Control of Epidemics and the Eco-environmental Protection of Economic and Social Development. See Huan Zong He [2020] No. 13. The opinions called for actively supporting enterprises to resume operations. Some environmental impact assessment requirements were tailored to simplify the process or exempt a variety of projects. Fast-track processes were also set up for those industries related to social livelihood, or that were greatly impacted by the epidemic or are labor-intensive. But the government still expressed its commitment to environmental enforcement.

Balancing environmental compliance and business operations during the epidemic has required more tailored, creative, and cooperative approaches from governmental authorities and companies to ensure that the business community supports society responsibly. These new approaches reflect a change in the government’s emphasis since 2015 on strict enforcement of environmental laws to promote compliance. Coming out of the epidemic, we may be observing a modified governmental approach that tempers strict enforcement with more cooperative collaborations between government and the regulated community.

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Lu Wang and Shengzhi Wang

Ms. Lu Wang is senior counsel with the Sunshine Law Firm in Beijing, China. Mr. Shengzhi Wang is counsel in the Sunshine Law Firm in Shanghai, China. They may be reached at wl@sunshinelaw.com.cn and wsz@sunshinelaw.com.cn, respectively.