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Focus: The Environment

Who's Cleaning Up This Mess?

Rising environmental awareness is affecting business in China

by Charles R. McElwee II

The consequences of 20 years of China's "produce now, clean up later" growth model fill today's headlines. Beijing's new skyscrapers are shrouded in smog and sit on a depleted aquifer. China's rivers—when they flow at all—run black and red, and thousands of acres of once productive farm land have turned into desert or been contaminated with hazardous wastes. All layers of Chinese society now realize that an environmental crisis exists. Private citizens, the press, and some segments of the PRC government are demanding that something be done. Though PRC officials are still contemplating what that something will be, some of the ways that rising environmental awareness in China will affect foreign-invested enterprises (FIEs) are clear.

Quick Glance

China's government, people, and media are all paying more attention to the environment.
Foreign companies must do more than merely comply with environmental regulations, or they may find themselves the center of unwanted attention.

New environmental laws and regulations

China has already enacted a comprehensive set of environmental laws. The statutory scheme is not perfect, however. For instance, penalties for noncompliance with some of China's environmental laws are so low that it is often cheaper not to comply and pay fines than to undertake the actions necessary to meet the statutory mandates. In other instances, companies have disregarded statutory requirements because the PRC government has not yet issued implementing regulations. But China's lawmakers cannot be entirely blamed for the current state of the environment; China's law enforcers—and the lack of a compliance ethic among Chinese businesses—are the chief culprits.

Though China lacks environmental enforcement—not environmental laws—the PRC government apparently views the promulgation of more laws and regulations as a big part of the solution. The pace of legislative and regulatory activity in China's environmental arena has increased dramatically over the past two years (see Table). Numerous agencies, in addition to the PRC State Environmental Protection Administration (SEPA), are churning out ever-stricter regulations and standards in the name of environmental improvement (see PRC Environmental Regulators). Every aspect of operating in China now has some environmental component: from making a corporate acquisition, buying property, designing a facility, or selling a product to dealing with products on a post-consumer basis. Simply building a plant that will make or use hazardous substances (which are broadly defined in China) can require five separate permits. Keeping up with this barrage of new laws and regulations can be the biggest environmental challenge that FIEs in China face today.

Many of the new laws reflect the shift that has been taking place in China's national environmental policy over several years. Given the country's high economic growth rates, China will be unable to significantly reduce total pollutant discharges in the future by simply enforcing the end-of-pipe regulations that have traditionally formed the backbone of its environmental regulatory system. For example, even if all existing coal-fired power plants complied with China's current sulfur dioxide (SO₂) emission limits and cut their emissions by 10 percent, total year-on-year SO₂ emissions would still rise if new coal-fired generation increased at an annual rate higher than 10 percent.

In an attempt to change this bleak reality, China has shifted its environmental regulatory model from "command and control" (where the control component was often ignored) to "sustainability," or, as it is known in China, "the circular economy." This model relies more on EU and Japanese precedents than on the less-developed US "sustainability" concept. China took its first significant step in this direction when it passed the Clean Production Law, which took effect in January 2003. This law requires companies building or upgrading a production line to replace hazardous raw materials with non-hazardous ones in its products and adopt prduction processes and equipment with high resource utilization rates and little pollutant generation. Where economically and technically feasible, facilities must recover and use their own production wastes and waste heat or transfer these wastes to other facilities or persons with the ability to use them. Articles 27 and 28 of the law impose post-consumer recycling obligations on companies with products listed in a compulsory recycling directory and require companies that use or discharge toxic or hazardous materials to conduct periodic "cleaner production audits."

The PRC National People's Congress reviewed the draft Circular Economy Law in September 2007. The law, which may pass in 2008, aims to significantly reduce production-and consumption-related waste by promoting recycling and the reuse of materials; it will reinforce and strengthen the requirements of the Clean Production Law and impose several new sustainability requirements on companies. According to the draft law, such requirements include implementing water-saving plans; adopting advanced water-saving technology, processes, and equipment; and employing advanced recovery technology and equipment to achieve a comprehensive utilization of residual heat and pressure from the production process.

Finally, China has set ambitious energy efficiency goals and has enacted legislation (including recent amendments to the Energy Conservation Law) to achieve these goals. China wants to increase energy efficiency per unit of gross domestic product by 20 percent from 2005 to 2010. The results to date have not been particularly encouraging (the yearly reduction targets were not met in 2005 or 2006), but the central government has confirmed that it will not rescind the goal. In fact, central government officials are eager to push local officials to comply with the energy efficiency goal. Beijing believes that energy efficiency can be achieved without sacrificing ecnomic growth and can help moderate China's growing reliance on imported oil. Consequently, meeting energy efficiency improvement targets has become an important component in the factors used to evaluate local political leaders, and energy efficiency mandates are finding their way into many regulations and policies.

Enforcement

If one factor had to be identified as the cause of China's environmental crisis, it would be lax enforcement of the existing environmental laws—the practical manifestation of the "clean up later" policy. Over the past two years, central authorities have repudiated the clean up later model and demanded that government agencies at all levels get tough on polluters. Actions to back up this rhetoric have been tentative to date: Certain environmental metrics (SO₂ and chemical oxygen demand) have been added to the criteria used to evaluate local political cadres, SEPA has set up regional offices to increase national oversight of local environmental officials, and bank loans in certain sectors have been tied to proof of environmental compliance. Though the central government's steps are encouraging, they are likely to produce only slow, incremental, and geographically uneven increases in local enforcement levels; China's more economically developed coastal regions will generally be stronger enforcers than lessdeveloped western regions.

Western companies that invest in China usually subscribe to corporate social responsibility principles that require them to comply with the environmental laws and regulations of the countries where they operate, regardless of whether those laws are enforced. Thus, improved enforcement should not significantly affect the China operations of most FIEs. Anecdotal evidence suggests that FIEs are sometimes the first targets when local officials feel the need to show they are "getting tough" on polluters, however.

On balance, whether stronger enforcement efforts in China increase costs for an FIE probably depends on whether its operations in China are primarily engaged in supplying the domestic market or in exporting products. FIEs that supply the domestic market often welcome efforts to achieve more universal compliance because such efforts help level the playing field by ensuring that domestic competitors pay their share of environmental compliance costs. For exporters, to the extent that environmental compliance raises costs in China generally, it could result in higher costs of materials or products purchased from Chinese suppliers.

Power to the people

Government actions make up only half of the effort to improve China's environment today. Ordinary citizens and the press have also entered the stage as major actors, and their effect on environmental operations in China can be significant.

In the last few years, citizens have protested against pollution sources that acutely affect their health or livelihoods. These protests, some of which have taken the form of civil disobedience, are generally aimed at state-owned enterprises (SOEs) and reflect, at least in part, the public's frustration with its inability to achieve effective redress through formal channels. In fact, citizens can employ several legal mechanisms to stop harmful pollutant discharges and obtain restitution for past harm. Though these mechanisms may be ineffective against politically powerful SOEs, they may be effective against FIEs.

For example, in China, individuals injured by solid waste can seek recovery of their damages in a lawsuit where the burden of proof is placed on the defendant—the generator of the solid waste. In other words, to avoid liability in China the defendant must prove that there was no connection between its solid waste and the plaintiff's injuries. (This contrasts sharply with US environmental tort jurisprudence, where the burden of proof lies with the plaintiff.) Moreover, several of China's environmental statutes provide a cause of action similar to a private nuisance action in the United States. These actions are of particular concern to facilities that were initially constructed in relatively unpopulated areas but are now in the path of encroaching residential developments.

While many of the civil protests in China to date have involved existing polluting facilities, some protests herald an incipient NIMBYist ("not in my backyard") attitude on the part of the Chinese public. For instance, in spring 2007, thousands of street demonstrators in Xiamen, Fujian, protested against plans by a private entity to build a new petrochemical plant in an industrial zone near the city center. Although the government strongly discourages such protests, it has recently encouraged, through new SEPA regulations, greater public participation in the environmental impact assessment process, which is required before constructing projects in China. Consequently, when building a new facility or expanding an existing one, companies should engage and seek to address the concerns of neighbors, who are becoming newly emboldened and empowered stakeholders.

Like many other countries, China publicizes the names of entities that violate its environmental laws; generally, China's local environmental protection bureaus release the information. In 2007, the Institute of Public and Environmental Affairs (IPEA), a nongovernmental organization with ties to SEPA and other government organizations, published lists of companies that reportedly violated China's water pollution law. Although the number of US companies on the list is small (less than 1 percent of the total) and the violations ascribed to them mainly involve temporary problems such as equipment malfunctions or other one-off events (not systematic flouting of China's environmental laws), these companies, along with a handful of other multinational corporations, have been singled out by the domestic and foreign press.

This focus on FIEs by the Chinese press has increased in intensity in recent months, in part as a reaction to the perceived unfairness of foreign press reports that have highlighted recent lapses in food and product safety by Chinese companies. As a result, the notion that FIEs are no longer models of environmental citizenship is gaining traction in China. Leading Chinese environmentalist and IPEA Director Ma Jun said in an August 2007 Environmental Leader article: "These enterprises are serious towards environmental protection at home, but their Chinese subsidiaries here seem to have slackened their efforts."

An even more troublesome proposition that is attracting Chinese and foreign believers attempts to blame a large part of China's environmental degradation on US consumers (or at least the companies that sell to these consumers). Andy Xie, former chief economist for Morgan Stanley, summarized the argument in the Wall Street Journal Online last summer: "Prices in the US are artificially low. You're [US consumers are] not paying the costs of pollution, and that is why China is an environmental catastrophe." The logical contortions required to produce such an argument are breathtaking, but even if one subscribes to the premises, the conclusion is patently false. According to Xie's own estimates, only "about 20 to 30 percent of China's water pollution comes from manufacturing goods that are exported." The total share of these exports bound for the United States fluctuates between 20 to 25 percent. Using the highest numbers in each range, US exports account for, at most, 7.5 percent (25 percent of 30 percent) of China's water pollution—hardly enough to bear the blame for China's national catastrophe.

Keeping up with developments

These are interesting times in China's environmental development: New laws and regulations are being promulgated at a breakneck pace, sustainability concepts that are more developed than those in the United States are gaining ground, new construction projects may face increased opposition from a newly empowered populace, and established facilities may be the targets of tort or nuisance lawsuits. FIEs operating in China have lost their "shining knight" status on the environmental front, and their environmental performance is now under a microscope. Given these factors, the China-based environmental function of an FIE must be as sophisticated and well-funded as its US equivalent (see Environmental Compliance Strategies). Failure to keep pace with China's quickly shifting environmental landscape can prevent an FIE from fulfilling its corporate goals, land it in a Chinese court, or cause its corporate name to be featured in an unflattering headline.

China's Major Environmental Laws and Regulations
Law/Regulation	Effective Date
Environmental Protection Law	1989
Law on Prevention and Control of Environmental Pollution by Solid Waste	1995; amended 2005
Law on Prevention and Control of Atmospheric Pollution	1995; amended 2000
Law on Prevention and Control of Water Pollution	1996
Law on Prevention and Control of Pollution from Environmental Noise	1997
Energy Conservation Law	1998; amended 2008
Regulations on Labor Protection in Workplaces Where Toxic Substances Are Used	2002
Impact Assessment Law	2003
Clean Production Law	2003
Renewable Energy Law	2006
Administrative Measures on the Control of Pollution Caused by Electronic Information Products (also known as China's RoHS)	2007
Regulations on Waste Electrical and Electronic Equipment	Forthcoming
Circular Economy Law	Forthcoming
Sources: Charles R. McElwee II; China Law & Practice, April 2007

PRC Environmental Regulators

The PRC State Environmental Protection Administration (SEPA) is China's top environmental regulator. In 1998, it was upgraded into a full ministerial-level agency, but not given cabinet status. SEPA has less than 300 employees at its Beijing headquarters and only 2,200 total employees on its payroll. (Local environmental protection bureaus [EPBs], which are not on the SEPA payroll, have additional staff.)

Except for high-profile matters, SEPA is not directly involved in enforcing environmental regulations or in issuing permits to regulate pollutants. Such tasks are handled by EPBs, which exist at the provincial, municipal, county, and township levels. Though they take direction from SEPA, the local EPBs are funded, and thus controlled, by local government authorities.

—Charles R. McElwee II

Environmental Compliance Strategies

To manage environmental compliance efforts effectively in China, foreign-invested enterprises (FIEs) should consider taking the following actions.

Assume responsibility for the environmental impact assessment (EIA)

FIEs undertaking a project in China with a local joint venture (JV) partner should take responsibility for arranging the EIA, because the local partner may not have all environmental impacts adequately assessed or may use unpalatable means, by Western standards, to obtain regulatory approvals. These actions can cause delays in project approval or potential problems in subsequent plant operations. The EIA should be performed correctly in the first instance, and all applicable approvals and permits should be obtained based on a full review of the project's environmental impacts.

Employ a China environmental manager

FIEs should also employ a China environmental manager who reports directly to the global headquarters' environmental or environmental health and safety department. The manager should be responsible for all China operations—across business groups, product lines, and business types (such as wholly foreign-owned enterprises and JVs). Simply staying abreast of China's rapidly changing regulatory regime can be a full-time job, and creating a corporate-level position responsible for environmental compliance will free each plant or business line from the task of creating its own environmental-knowledge base and developing its own environmental management system. This manager should coordinate with the company's local government affairs department to ensure that all applicable regulatory developments are tracked.

Closely monitor plant-level compliance efforts

FIEs would also do well to implement a mechanism to ensure that plant-level environmental personnel fulfill their environmental responsibilities and report the results of their efforts to the China environmental manager. This can be accomplished by defining a number of performance outputs, such as daily wastewater monitoring reports, derived from the responsibilities of each individual in the environmental compliance chain. A number of contractors provide environmental reporting software tailored for China.

Audits of environmental performance at all facilities should be undertaken on a regular basis. An environmental audit is a systematic check to establish whether all activities are being carried out in accordance with the environmental management system. Audits—performed either by internal teams or outside auditors—should cover both local and corporate-wide environmental standards.

Get employees involved and keep the neighbors happy

Companies must develop training programs to ensure that all staff comply with environmental standards. Training must occur across all levels of the organization, from senior management to the staff responsible for the daily operation of pollution-control equipment. For US-listed corporations, training should include the applicable provisions of the Foreign Corrupt Practices Act (see the CBR, November-December 2006, The Foreign Corrupt Practices Act Dilemma).

Companies should encourage all employees to become involved in environmental management, compliance, and innovation. Experience has shown that a significant amount of environmental innovation originates with "shop floor" employee recommendations.

Though plants that flout environmental regulations run a high risk of conflict with their neighbors, plants that operate within permit limits may also find that their neighbors do not like the smells coming from the plant. Unless these issues are resolved they can lead to lawsuits—where compliance with the applicable law is not necessarily a defense. Companies should cooperate with neighborhood groups to address any concerns they may have before conflicts escalate into formal complaints to regulators or lawsuits.