Cracking the code in China

Infrastructure development remains a top priority for the Chinese government, which has long recognised that a modern economy runs on reliable road and rail networks, electricity supply, and telecommunications.

Encouraged by the government, an increasing number of domestic private and foreign investors have become involved in infrastructure investment. As a result, various issues, some with unique Chinese characteristics and others of a more general nature, have emerged.

The legal view

Market entry

The Chinese government outlines market entry barriers through the Catalogue of Industries for Guiding Foreign Investment. In general, the Catalogue encourages foreign investment in infrastructure, with a few notable restrictions. The Catalogue also provides required shareholding structures in certain industries where foreign investors require a majority Chinese partner to undertake infrastructure projects.

Land procurement

According to Chinese law, the state or collective groups in rural areas own all the land. Legal entities or individuals can procure commercial land-use rights from the state (or the collective groups with more stringent conditions). Each procured land-use right will have a validity period, the length of which will depend on the nature of the land and the method of procurement, though this tenure tends to be not longer than 70 years. In addition, China has a strict system of land-use planning.

The Chinese government has overall responsibility and control for land-use planning, regardless of the ownership nature. Land is classified into different categories of usage, such as commercial, manufacturing, farming, forestry, and others. Land falling into one category is not allowed to be used for other purposes. Furthermore, land designated for farming is not allowed to be used for any other purpose unless complicated special approval formalities are undertaken at the provincial government level or higher.

Given the complex ownership and usage planning systems, there are cases where local governments have not actually been authorised to sell or grant land-use rights; or where there were substantial project delays due to complicated approval formalities around the sale or granting of land after the procurement/concession agreement had been executed. There have also been cases where the land foreign investors procured turned out not to be fit for the original intended use.

Securities for financing

Infrastructure projects require comprehensive security arrangements for project finance, and often the real estate assets will be the main form of collateral. The Chinese Property Law and real estate registration practices have been found to be too inflexible to fully satisfy the security requirements of an infrastructure project. These impracticalities should be considered and addressed at the time of negotiating concession agreements and other project documentation.

Government guarantees for operation risks

We have seen in some foreign BOT (build, operate, transfer) highway development cases the need for guarantees from local governments. These examples include highways being overused and excessively damaged or local planning meaning traffic volumes were unable to reach guaranteed levels. Foreign investors should address these issues as much as possible in advance and seek sufficient guarantees from the host governments.

The effects and contents of government guarantees should be reviewed in advance. These issues are universally the same, but foreign investors should also consider the historic performance of the host government in honouring previous guarantees.

The insurance view

Some things are not so different

There are not many scenarios the insurance industry has not seen before. China, as with any market, has its own regulations and nuances, but many of the issues companies face – in the infrastructure sector or otherwise – are the same in other markets…just on a much larger scale.

Key areas of risk assessment

Liabilities: A feature of the Chinese business environment is the diverse supply networks. Often these networks are made up of small companies who can’t afford or find product liability insurance. As a result, the product liability risk is often taken on by the brand owner and retailer, not the original supplier.

The insurance market now supports brand Owner & Retailer sponsored schemes where groups of small suppliers can access affordable product liability insurance. The brand owner or retailer’s own premiums can reduce as a result, in a win-win circumstance of increased cost-effective cover for small suppliers and reduced costs and risk for the retailer or brand owner.

Business continuity

The same business continuity issues apply in China as they do everywhere else, except on a larger scale. If China is a supply base, typically companies use a range of suppliers, sometimes as many as a thousand. While this high number provides choice in the event of non-supply by one company, this is not always the case where highly specialised suppliers are used.

Companies need to assess their supply base from both quality and quantity perspectives. This includes understanding the upstream supply chain from the companies they source from. The melamine-contaminated milk powder scandal a few years ago demonstrated just how far faulty (and in this case toxic) products can get, even with quality checks in place.

While food security and quality is a particularly high-impact risk, it does demonstrate how a single bad supplier can have a catastrophic impact on a business in China.

Given the variability of public emergency services, business continuity plans are also particularly important as a company may need to be self-sufficient for longer than in other markets.

These issues have an impact on companies’ business interruption insurance, particularly the indemnity period for loss of profits. How long would it take to get the business up and running and restore profits? From experience, companies often vastly underestimate the time taken to restore their business and, as a result, tend to under-insure.

Health and safety

Health and safety standards and regulations can be variable. Companies need to rigorously set and enforce their own standards. These need to be conveyed to insurers along with supporting incident and claims data to ensure that the company’s investment is reflected in insurance ratings and premiums.

Contract risk analysis

Contracts create specific risks depending on what the company’s position is. If you are the main client then the master contact needs to be worded to ensure that contractors’ own liability is clear. Likewise, as a contractor or sub-contractor, the owner of the master contract might expect you comply with their contract, not your existing contract.

If you are the owner of the project it is important that the liabilities of the sub-contractor are clear within the master policy and that liability doesn’t reside with the master policy.

Using a broker to read the contracts and understand how the project contract relates to your existing insurance is important to understand the liabilities you are accepting and how they relate to your existing insurance cover.

Conclusion

The issues mentioned above are only part of the risk paradigm surrounding infrastructure projects and general business operation. In China, as in any international market, foreign investors can address and resolve these issues to successfully allocate risk between foreign investors, their local partners, sub-contractors, their insurers, and local governments.

*Peter Jackson is head of sales for Lockton in the Asia region. Ronin Zong is of counsel at Wikborg Rein’s Shanghai office and is part of the firm’s shipping offshore practice.