China continues to implement an IT-based big data system of market regulation that rewards and punishes individuals and enterprises.
By Paul A. Davies and R. Andrew Westgate
China is currently implementing an innovative approach to monitoring, rating, and regulating the behaviour of market participants through a new “social credit system” (SCS) set forth in the Plan for Establishing a Social Credit System (the Plan). The Plan, first published in 2014, applies credit ratings across social, political, and environmental sectors. For example, a company breaching emissions targets will receive a lower rating (resulting in punitive measures, higher taxes, or other sanctions).
The Plan aims to implement a self-enforcing mechanism for regulation built on big data that monitors and evaluates economic and social behaviour using real-time feedback. The system is designed to incentivise companies to make decisions in line with laws, regulations, and governmental policy targets.
This blog will focus on the application of the SCS to environmental matters.
Establishing the Environmental SCS
In December 2013, several Chinese administrative bodies issued the Trial Measures for Enterprise Environmental Credit Assessment, including the former Ministry of Environmental Protection (MEP, superseded by the Ministry of Ecology and Environment in 2018), the National Development and Reform Commission (NDRC), the People’s Bank of China (PBOC), and the China Banking Regulatory Commission (CBRC). The measures were followed in 2015 by the Guiding Opinions on Strengthening the Construction of Enterprise Environmental Credit System (Guiding Opinions), issued by the former MEP and NDRC, which called for the implementation of an environmental credit system by 2020.
The Guiding Opinions note that the new Environmental Protection Law stipulates that information regarding environmental transgressions by enterprises, institutions, and other production and business operators should be recorded in social integrity files and that lists of offenders should be announced publicly and promptly. The General Office of the State Council “Notice on Strengthening Environmental Supervision and Enforcement” requires the establishment of an environmental credit evaluation system, including blacklisting enterprises that contravene environmental laws and publishing blacklist information.
Collecting, sharing, and publishing corporate environmental credit information will allow relevant departments to co-ordinate supervision and punishment, improve environmental protection through the self-discipline and integrity of enterprises, and establish environmental punishments and rewards/incentives. The required information includes: construction project environmental management; environmental protection permits; nuclear and radiation safety management; sewage charges and environmental protection tax payments. For certain enterprises, the following information may also be required: pollution monitoring; key pollutant discharge unit monitoring; access to and use of special funds for environmental protection; and environmental risk management information.
The system is intended to encourage enterprises to take the initiative in analysing, querying, and addressing their environmental credit records and status, and to rectify existing problems. The Environmental Protection Department will record information regarding prompt rectification and correction of environmentally damaging behaviour.
Rewards/Incentives and Punishment Mechanism
The Guiding Principles establish a multi-departmental rewards/incentives and punishment mechanism to benefit enterprises with good environmental credit, while penalising enterprises with poor environmental credit, in order to ground compliance into the system.
Enterprises with poor environmental credit will be prohibited from participating in government procurement activities. Enterprises with good environmental credit will be awarded preferential environmental pollution liability insurance, while enterprises with poor environmental credit will suffer rate increases.
The mechanism also extends to finance. Enterprises with a good environmental credit rating will receive “active credit support”, while enterprises with a lesser rating will suffer strict loan conditions and will not be granted new loans until rectification measures are implemented to improve environmental standing.
Jiangsu Province Implementation
An example of environmental SCS implementation is Jiangsu Province. According to Jiangsu Province’s Provincial Rules on environmental credit rating, a colour code is assigned to each enterprise on the basis of their environmental credit rating, which ranges from 0 (lowest rating) to 12 (highest rating). The colour codes are green (rating 11 – 12), blue (rating 6 – 10), yellow (rating 3 – 5), red (rating 1 – 2), and black (rating 0).
The Rules dictate that each firm receives an initial score of nine. Depending on the firm’s environmental performance, including the severity of any violations, the environmental credit rating will be raised or lowered. For example, an administrative penalty will lower the rating by one point, while an environmental crime conviction will lower the rating by as much as 12 points.
In December 2015, Jiangsu Province Department of Environmental Protection was the first Chinese province to create a pilot programme charging higher electricity rates to companies with low environmental credit ratings. Under this pilot programme, high-polluting firms with red or black environmental credit ratings are charged an additional RMB 0.05 (0.7 US cents) and RMB 0.1 (1.5 US cents) per kWh. The programme was first enforced in April 2019, based on environmental credit ratings from 2017, against 11 black-graded enterprises and 32 red-rated enterprises.
Jiangsu is also one of the first provinces to charge higher wastewater treatment fees to enterprises with lower environmental credit ratings. In 2018, several cities including Nanjing, Wuxi, and Nantong, began to charge additional wastewater treatment fees of RMB 0.6 per cubic meter for red-rated enterprises, and RMB 1 per cubic meter for black-rated enterprises.
Planning for 2020
The full SCS should be implemented by 2020. Companies operating in China should take notice of the SCS and plan accordingly. Any company that fails to comply with the new system could face punitive measures.
Latham & Watkins will continue to monitor developments in this area.
The authors would like to thank Martin Cassidy for his contribution to this blog post.
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