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Chinese companies going global: Know Your Customer to reduce third-party risks

Thomas Kim  Chief Legal Officer & Company Secretary / Thomson Reuters

Thomas Kim  Chief Legal Officer & Company Secretary / Thomson Reuters

Chinese companies are expanding their boundaries in search for new business. As they enter new markets, they'd do well to pay attention to the challenges raised by Know Your Customer and third-party risks.

Over the last few years, China has taken huge strides to become a major global financial player and a center for international trade. To further support this development, the government has taken proactive measures to encourage Chinese companies to expand to foreign markets, trade with other countries, and set up overseas operations.

There is no better example of this than the Belt & Road initiative, a massive program launched by the government to revive historic trade ties that China had with other nations across the globe. As part of the Belt & Road, the government has made significant investments in building infrastructure along the ancient Silk Road, linking it with Europe and Africa. According to Thomson Reuters data, Chinese acquisitions along Belt & Road countries reached a record high in 2017 of US$46.1 billion.

As Chinese companies expand their global footprint, they need to be mindful of the challenges and risks of operating in foreign markets so that they are in compliance with the laws and regulations of various countries.

A tourist junk sails past the 118-story-high skyscaper International Commerce Centre (ICC), the highest building in Hong Kong,REUTERS/Bobby Yip
A tourist junk sails past the 118-story-high skyscaper International Commerce Centre (ICC), the highest building in Hong Kong,REUTERS/Bobby Yip

Increasing compliance challenges

This international expansion has led to Chinese companies integrating with the global economy, with their supply chains becoming more complicated and geographically diverse. While this growth has created many opportunities, this expansion has also created its own challenges, which must be monitored and managed. One such challenge is ensuring water-tight Know Your Customer (KYC) compliance and third-party risk management.

Non-compliance is not an issue that affects Chinese companies alone. Non-adherence to KYC norms has affected many large global companies as well, especially in the financial services space, where some have incurred huge penalties from regulators and governments around the world.

For example, a large German bank was recently fined millions of dollars for sham trades. The bank was criticized by United States and UK regulators for not knowing the customers involved or the money source for the trades. Similarly, a UK bank was fined by U.S. authorities for failing to maintain an effective program against money laundering and its failure to conduct basic due diligence on some of its account holders.

Chinese companies need to ensure they are compliant and do not face such issues as outlined above, they need to be cognizant of several related challenges that they are likely to face, such as:

  •  Inter-regional legal issues: As Chinese companies go global, they have to operate in countries with their own unique business environments and legal systems. In such cases, Chinese companies may encounter situations of asymmetrical information when dealing with their clients, partners, and their third-party suppliers, exposing them to risks arising from absent critical information.
  • Limited understanding of the local laws: Some Chinese companies may have only partial knowledge or understanding of relevant local laws, which may make it more challenging for them to grow their business across borders. Violation of local laws due to ignorance not only leads to financial loss, but also to a negative impact on the reputation of corporations. Needless to say, it exposes them to fines or other sanctions in those countries.
  • Steep costs due to fragmented information: Companies have to put in a lot of effort to filter and identify the high volume of business information which is beneficial and relevant to them. This creates high cost burdens.

As a member of the Financial Action Task Force on Money Laundering, (FATF) China will receive mutual evaluation from FATF in 2018. Although banks are the main target for the evaluation, there is no doubt that enterprises will inevitably be faced with additional pressures transferred from the banking sector. For instance, companies will receive stricter review of their financing when expanding internationally to make sure there are no connections to potential third-party risk such as illegal transactions, money laundering or terrorist financing. Accordingly, this will increase the cost for companies to improve their enterprise workflow and risk management capabilities.

National flags of U.S. and China wave in front of an international hotel in Beijing February 4, 2010. REUTERS/Jason Lee
National flags of U.S. and China wave in front of an international hotel in Beijing February 4, 2010. REUTERS/Jason Lee

Polarized risk awareness

In the face of increasing compliance pressures, it is critical to note that there may be polarized attitudes toward risk awareness among companies. State-owned enterprises and large financial institutions that joined the outbound investment wave at an early stage have already formed robust compliance risk awareness. Many of these large institutions have established sound compliance management systems, recognizing that the price they pay for building these systems is an investment for the future and this investment could make a difference for the organization’s long-term development.

In contrast, many privately-owned businesses have not yet realized the value, benefit or importance of building their own compliance systems.  These businesses are passively responding to government regulations overlooking the value of corporate compliance and in turn missing out the benefits of having a sound compliance system.

Even though not all businesses have yet fully realized the importance of building robust risk-management systems, the situation is improving. With evolving technology, most Chinese companies have begun laying a foundation to have a thorough KYC process in place and address third-party risk.d

Leveraging technology can go a long way in making the process of KYC thorough, hassle-free and fast, reducing on-boarding time and cost, increasing compliance and facilitating smooth business operations. There are several platforms in the market that provide end-to-end KYC management solution, from initial screening, due diligence to on-boarding. This includes screening financial data, aggregating news to check for any history of fraud, leveraging connected data to unearth relationships and flagging off politically exposed people. Having a single KYC resource eliminates duplication, facilitates communication and reduces operational costs thereby improving efficiency.

Need for immediate action

To wade through these challenges, companies must not only have a comprehensive understanding of the business environment, but also strict KYC checks in place to minimize third party risks. This is especially important in today’s environment where globally, lawmakers are getting more stringent in their application of the laws, holding organizations responsible not only for their own actions but also for the actions of third parties who may be customers, suppliers, vendors and partners.

While most companies have a KYC process, it is rather primitive in many businesses and limited to the collection of a few documents. To ensure a thorough KYC regime, companies must transition from just Know Your Document (KYD) to Know Your Customer (KYC).

Chinese companies should also invest in sensitizing and training their employees on risk awareness and management. This will contain potential risks and help avoid penalties and damage to corporate reputation.

In summary, as more and more Chinese companies ‘go global’, trusted information, making sense of the data patterns and unleashing the power of connected data can go a long way in driving effective KYC and help corporations mitigate risks and conduct business in a smooth and compliant way.

A version of this article originally appeared in China Investment. 

People walk after the rain along the Bund near the Huangpu River near the coastal area of Shanghai. REUTERS/Carlos Barria
People walk after the rain along the Bund near the Huangpu River near the coastal area of Shanghai. REUTERS/Carlos Barria

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