China: No More Exceptions

Last Updated: 4 September 2008
Article by Melinda Xie and Andrew Halper

Originally published in Eurobiz Environmental Law Briefing, May 2008

As the Chinese government gets tough on cleaning up the environment, multinationals face more stringent scrutiny

This is a true but not exceptional story, set in an industrial park in a medium-sized costal city in China, where a Fortune 500 multinational chemical company has been under heavy pressure over environmental issues affecting one of its plants. The company is faced with a stark choice – either invest several million euros to improve the plant's waste water pretreatment facilities, or close the plant due to its failure to meet the compulsory discharge standards recently introduced in the province.

This predicament could not have been anticipated. Two years ago, when the firm first came to the industrial park, the local government entered into a framework agreement with it, allowing the company to discharge waste water with a COD (chemical oxygen demand, a main index of water pollution) concentration of 1,000 parts per million. Although the applicable national major pollutants discharge standard for COD was 500ppm, the local government reduced the standard to encourage foreign investment, and this was encouraged and approved by the provincial government. However, in early 2007, the local government started to strictly implement the national major pollutant discharge standards.

After prodigious efforts spent lobbying the local authority, the company obtained written confirmation of a two-year grace period allowing it to continue to apply the old standard until the end of 2009. However, the waste water treatment plant in the industrial park now refuses to accept any effluent from the company if the COD concentration is above 500ppm. For this firm, investment in environmental protection facilities to bring down the COD concentration is not economically viable unless the total production capacity is increased – but that was not part of the original business plan.

It is not only in one industrial park, or in one province, that the Chinese government is tightening its environmental policies. Rather, this is a nationwide campaign aimed at responding to the severe environmental situation in China and increasing pressure from the international community and the Chinese public.

As a country that generates 83 percent of its power from coal, China is the planet's largest emitter of COD and sulphur dioxide (SO2). Some experts are already reporting that China has replaced the United States as the largest carbon dioxide emitter. The World Bank's 2006 Development Indicators showed that China had 16 of the world's 20 most polluted cities. A 2007 World Bank report estimates that the cost of air and water pollution in China is between 3.5 and 8 percent of GDP.

Getting serious

Rapid economic development and a steep increase in the urban population has caused a serious threat to the sustainability of the Chinese economy, and as the PRC Government is painfully aware, also risks endangering political and social stability.

The Chinese government now seems unprecedentedly determined to tackle the country's environmental problems. In its 11th Five-Year Plan, the government vowed to bring down SO2 and COD emissions by 10 percent by 2010, and to reduce energy consumption per unit of GDP by 20 percent by 2010. However, due to lack of strong implementing measures in the first year of the plan, the Chinese government failed to meet its target. Now, following this failure, the government has put in place more vigorous measures in order to meet its ambitious targets.

Previously, GDP growth was the only economic indicator used to judge officials' performance. An investigation conducted last year by the State Environment Protection Administration (SEPA, which was upgraded to the Ministry of Environmental Protection in March of this year) of some 126 industrial parks in 11 provinces showed that nearly 90 percent of these parks were not complying with environmental regulations. Regulatory breaches included officials approving projects beyond their proper powers, lowering environmental impact assessment grades, and failing to implement the "three simultaneities" rules, which require environmental protection facilities to be designed, constructed and put into operation simultaneously with the main body of a construction project.

More recently, however, officials are showing signs of increasing commitment to meet their energy-saving and emission-reduction targets. In 2007, the authority of some cities and industrial parks to approve new projects was suspended by SEPA, and they were ordered to rectify irregularities. In November last year, the State Council issued a series of rules regarding the so-called "Three Major Systems" (ie a scientific indicator system, an accurate monitoring system and a strict assessment system for energy saving and pollution reduction).

According to these rules, the officials and heads of some 1,000 major enterprises will not be allowed to participate in any awards competitions, and may have to personally assume administrative liabilities imposed by the state supervision authority should their enterprises fail to meet energy-saving and emission-reduction targets. This rule has gained considerable publicity as for the first time, performance of officials and enterprises leaders is being linked to environmental protection.

The price of non-compliance

A number of new regulations and standards have been rapidly promulgated. The new foreign investment catalogue issued by the Ministry of Commerce has strictly limited market access for heavily polluting, energy-intensive industries. More recently, SEPA issued a list of 114 highly polluting, high-environmental-risk products across six industries. Once the relevant ministries have endorsed the proposal, products on the list will have their tax refund cancelled and related processing trade banned. Some provincial governments have even issued more stringent waste discharge standards to meet their respective emission-reduction targets.

Nowadays, a project application report will not be reviewed by the approval authority until an environmental impact assessment has been approved. For chemical companies, a safety assessment must be conducted and approved by safety production authorities before an application can be made for project approval. In addition, public sentiment has taken on significant importance in the environmental impact assessment process. Many projects have been suspended or even withdrawn due to pressure from the local community.

For a long time China's regulatory environment has imposed low costs on the violation of environmental regulations, which amount to a license to pollute rather than a significant discouragement to violating legal standards. Enterprises often switched off the operation of environmental protection facilities simply because they only needed to pay small penalties for noncompliance. This, however, will no longer be the case.

The newly revised Water Pollution and Control Law, which will go into effect on June 1, has imposed much larger penalties on companies who violate waste water discharge rules. Discharge of water pollutants that exceed the national or local standards or the quota for control of total discharge of major water pollutants will now be subject to a penalty of between two and five times the pollution discharge fee, an increase from the old penalty of one to two times. Companies that cause water pollution accidents may face a penalty up to 30 percent of the direct losses caused by the accident. Individuals who are responsible for these accidents may face a fine up to 50 percent of the income received from their companies in the previous year.

A changed landscape

Theoretically, the chemical company we examined at the beginning of this article could make an arguable case that the local government should be bound by the framework agreement. However, in practice, few foreign-invested enterprises (FIEs), anxious about potential impact on their governmental relationships, will dare to bring this sort of dispute before a PRC court. So the question for FIEs is: How can they cope with increasingly more stringent environment scrutiny in China?

Paying due attention to environmental compliance is of ultimate importance. With the tightening of policy-making and enforcement, past environmental failings may be disinterred with the result that FIEs become exposed to significant liabilities. Historically, many foreign investors relied on their Chinese partners to deal with the government approvals and regulatory compliance issues. However, this is a potentially dangerous approach, for Chinese partners may have a limited understanding of these issues, since in the past they could often avoid or at least soften the approval procedures by establishing and nurturing close relationships with officials.

Building and maintaining good relations with the local community is as important as building relations with authorities. The Environmental Impact Assessment Law requires public participation, but it contains no specific provisions regarding the method, scope and degree of solicitation of public opinion on a proposed project. However, lack of public participation or lack of sufficient public participation may endanger your project. Maintaining a good relationship with your neighborhood and presenting your project in a transparent and well-structured way will help mitigate the negative impact from the public. Moreover, an environmental scandal in China will quickly result in negative publicity back home, and can of course also have an impact on share price and investor confidence.

It is important that FIEs are advised by advisors with in-depth knowledge of local compliance. We have seen companies that, having engaged sub-standard environmental impact assessment advisors, have experienced severe problems due to the resulting report's poor quality.

Good environmental experts and legal counsel will help you to bridge international best practice and local requirements. Getting all of your people on the same page in terms of local environmental compliance, and taking an informed and responsible approach in dealing with environmental issues in China, especially from now on, is an investment that all prudent FIEs should be making.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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