As Christmas is approaching, many children might be wondering whether they’re on Santa’s naughty or nice list. Meanwhile, as China’s corporate social credit system is rolled out, companies in China are asking themselves whether they’re on any of 42 national-level naughty lists or one of eight nice lists. 

At the end of 2020, the planned first phase of development of China’s corporate social credit system is wrapping up. Announcements that will shed light on the next phase are expected by the end of the year.

A report by China-based policy research firm Trivium released last week provided one of the most level-headed and comprehensive looks into the emerging regulatory technology yet. Below, here’s what we learned from it:

  • Bottom line: Corporate social credit isn’t as complicated—or exotic—as it sounds: It’s a giant corporate registry, with consequences for records of non-compliance. The system is still being rolled out, but large parts of it are already operational, and accounts for a wide array of corporate activities. There is little indication of discriminating against foreign companies, but government officials have indicated global ambitions for this regtech innovation, with implications for financial markets. 

A brief timeline

According to the report:

  • 1999: A research team at the Chinese Academy of Social Sciences proposes “The National Credit Management System” as a solution to bad market behaviour.
  • 2000: The development of a social credit system is discussed at the annual meeting of China’s legislature. 
  • 2002: An updated version of the 1999 paper states that credit—perhaps best understood as trustworthiness—is key to a healthy economy and to socialist society as a whole. The revamped paper also examined US credit regulations and financial risk assessments. 
  • 2003: Shanghai launches social credit pilot. 
  • 2014: The government officially starts working on the social credit system, and creates a 15-year plan for its development. 
    • The creation of blacklists and their opposite, redlists, is formalized, as well as punishment mechanisms. 
  • 2015: The State Council approves the construction of a national unified social credit system for legal persons, including companies. Business registration numbers are replaced by so-called the Unified Social Credit Identifier, a unique number that ties every company to its corporate social credit record.  
    • This sets the legal basis for the rollout of the corporate social credit system. 
  • 2016-2018: Most blacklists and redlists are created. 
  • 2019: The State Council urges regulators to ramp up implementation of the SCS and ties the system to algorithmic regulation. 

Real problems: The Trivium-USCC report writes that the social credit system began as a response to real problems with compliance: companies frequently ignored court judgments, and even if companies faced consequences the individuals behind them could simply move on and start new companies. The 1999 treatise that first proposed the CSCS complained that a large portion of contract violations are not persecuted and swathes of violators go unpunished. 

  • The system was designed to name, shame, and punish companies with a history of bad behavior—and individuals running those companies.
  • To this day, the largest blacklist in China is the Supreme Court’s list of court defaulters.

READ MORE: INSIGHTS | Social credit: A roadmap for a sincere and virtuous marketplace

A librarian’s dream

At its heart, the CSCS is a massive record-keeping system that brings together company information from different government agencies, as well as some non-government organizations. 

The data: Every company has a folder, tracked by a unique identifying number, in which an assortment of data is stored. 

  • The folder contains basic facts about the company, such as equity information, annual reports, corporate structure etc. 
  • Different government departments from all levels of government contribute additional information: records on taxation, personnel (including how many Party members work for the company), judicial, and compliance of all sorts, from markers of anticompetitive behavior to violations of environmental standards.
  • Information from government agencies is the foundation of a company’s record. As of 2016, it contains over 400 categories, but this list could be updated in the near future, Trivium said. 
  • Authorities also encourage non-government entities, such as private firms, industry associations, and consumers, to contribute data. This part of corporate social credit is “vague and poorly defined,” and its scope is ambiguous, Trivium said. 
  • “In most cases, participation is voluntary,” Kinzius said, adding that it’s mostly related to what the government wants to build on top of the CSCS. 

Access: Much data collected by the system is made public through online credit platforms, such as the publicly run Credit China and the private Tianyancha.

  • About 75% of data collated from government agencies is meant to be shared publicly, Trivium calculated. The National Development and Reform Commission (NDRC) has created an online platform where the information is public, Credit China. 

Work in progress: But data integration between agencies is incomplete, limiting the reach of the national platform, said Luisa Kinzius, project lead at Sinolytics, a Berlin-based consultancy that helps foreign companies navigate Chinese policies (and which authored a August 2019 CSCS report with the European Chamber of Commerce in China). 

  • One reason is that much information trickles from the bottom up, from local governments to the national platform, she said. 
  • The CSCS is “a bit like a jigsaw puzzle,” Kendra Schaefer, lead author of the Trivium report and head of tech policy research at the firm, told TechNode: , “The parts that are done are launched as they are completed, and upgraded on an ongoing basis.”
  • Trivium found that 89% of blacklist records from the customs authority are on the publicly available Credit China platform, compared to 25% of Ministry of Transport records, and 20% of Ministry of Industry and Information.
  • The Trivium report said that Shanghai is leading in system completion. At the end of 2018, the local government had centralized data from 88 government agencies on 11.3 million enterprises.

Carrots and sticks

The CSCS doesn’t just keep records—it also creates incentives for compliance. Among the data on the platform are two systems to reward and punish companies: black- and redlists, and scores.

Lists: Government agencies can place companies on blacklists—or their opposite, positive “redlists”—as punishments for breaking rules, or rewards for good behavior. If a company ends up on one of these lists, it will be noted in its CSCS record.

  • Blacklists are more developed than redlists, Kinzius said. The “bigger focus” is detecting violations, she said. 
  • But the redlists show “a new way of thinking about compliance” in that overcompliance can have positive consequences, she said. 
  • The lists come with cross-agency disciplinary actions. Some authorities have made deals so that a violation of one regulation can lead to punishments from a range of agencies.
  • A company that ends up on the Ministry of Agriculture’s naughty list for violating agricultural regulations will face 25 punishments across different sectors, Trivium said: the Ministry of Natural Resources might restrict its use of government land, while the People’s Bank of China and the Securities Regulatory Commission might stop it from issuing stocks and bonds. 
  • A logistics firm that is on the Ministry of Transport’s good list will have access to 63 rewards: from fast-tracked licenses for imports and exports from the Ministry of Commerce, to preferential access to financing from the PBOC, the report found. 

Personal liability: The CSCS links the behavior of key personnel to the company’s records; they might be punished if the company is blacklisted, and the company’s record is affected by the personnel it hires. But these linkages only exist in “very specific areas,” in part because the personal social credit system is not as advanced as the CSCS, Kinzius said. 

  • To get on the Ministry of Emergency Management’s redlist, the company’s legal representative and top level management must not have any record of violations in the last three years, Trivium said. To get a good customs score, key personnel must not have criminal records, Kinzius said. 
  • One US company was barred from participating at a trade expo because senior staff was blacklisted for legal violations unrelated to the company, Trivium told TechNode. 

Grades: The corporate social credit record also includes several kinds of ratings, calculated using government data available on firms’ files by different local and national agencies, as well as some non-governmental entities. These include both letter grades and numerical point scores.

  • Compliance grades score the extent to which firms’ abide by regulatory standards. Broadly speaking, the analysis is automated but data collection isn’t, Kinzius said. 
  • Getting the lowest or highest grade can lead to the same consequences as being on one of the lists, Kinzius said. Being second worst might also bring on sanctions, and so on, she said. 
  • Some are national, such as the score of companies building waterways and roads, compiled by the Ministry of Transport. Others are generated by local authorities, such as systems to grade hospitals, the report by Trivium said. 
  • Agencies also grade companies based on the quality of the goods they produce. Many of these are compiled by industry associations based on government data. 
  • Financial credit scores are granted by licensed credit rating agencies. 

The GPA: The NDRC has promised a unified “comprehensive credit evaluation” that rates a company’s overall social credit profile from poor to excellent. The evaluation is said to take into account compliance, quality, and financial scores. Officials haven’t clarified exactly how it is calculated. 

  • The NDRC said in September 2019 that 33 million companies (in Chinese) have a Master Grade. Most of these scores are not public yet.

How far along?

It’s used for, well, credit: As of 2014, corporate records are used to supplement financial data in lending risk assessments, particularly for small and medium enterprises (SMEs). 

  • In 2018, the NDRC and China’s banking regulator launched an initiative to encourage the use of CSCS government data when assessing lending risk for SMEs. 
  • The 130 licensed credit rating agencies that rate corporate bonds and debt instruments are encouraged to align their assessment with government data. 
  • The PBOC’s “second generation” personal credit reports for individuals include CSCS government information, which could affect entrepreneurs’ ability to take out loans when starting a new business, Schaefer said. 

Localization: Provinces and province-level cities are responsible for legislation on the local level, developing data collection infrastructure, and coming up with rewards and punishments. 

  • This trickle-down legislative process has proved problematic in a project that requires a high degree of inter-agency coordination, Trivium said. 
  • “All the local authorities tried to make their own blacklists” Kinzius said, “Now the government is quickly trying to get back control at the central level” so that the blacklisting can be standardized and only happens in severe cases. 
  • Local governments have tried to leverage the system in ways that the public and the central government thinks lie beyond its intended purpose, the Trivium report said. 
  • In April 2019, the government of Zhejiang announced plans to use the social credit system to penalize job-hoppers. There was public outcry in response and the plan was eventually dropped. 
  • Beijing is working to rein in (in Chinese) provincial autonomy as it relates to the CSCS. 

A huge legal project: Corporate social credit requires a massive legal undertaking: Hundreds of laws must be updated to link to the CSCS. 

  • The legal basis for the CSCS, including data aggregation, blacklists, redlists, and the resulting rewards and punishments has been broadly defined on a national level, but details are still being hammered out.
  • Out of China’s 33 provincial-level units, 14 have drafted or finalized regulation for collecting and managing government data for the CSCS, Trivium said. 

Next steps: The CSCS will continue being iterated in the next few years. The plan outlined by the State Council in 2014 aimed to have established the foundation for the corporate credit system by 2020. Progress has been made, although the system is not complete. 

  • Premier Li Keqiang recently outlined a vision for a “Differentiated Supervision System” which will process data from the CSCS to create predictive regulatory risk estimates wich will then inform regulators’ behavior, Kinzius said. 
  • Kinzius expects an update on this phase of the CSCS development in the next few weeks. 
  • The next step to the CSCS will integrate more data coming from non-governmental sources like industry associations, she said. 

Global implications

Discrimination? A January report by the US Congress Research Service identified corporate social credit as a “major concern” to Washington. The system could be used to align US citizens and companies with Beijing’s interests and expand China’s influence overseas, it said. 

  • The current policy framework and implementation of the CSCS doesn’t discriminate against foreign companies, Trivium said. Google and FedEx have been blacklisted for tax violations, but so have 1,391 state-owned enterprises, Trivium said.  

Tightened control? While the system is not targeting foreign companies, it does create incentives or foreign companies with Chinese operations to toe the government’s line on political questions, Trivium wrote. 

  • In 2018, numerous foreign airlines changed their websites to list Taiwan as the same country as China after the Ministry of Aviation threatened to blacklist them. 

Leading regtech? China is a first mover in this use case of regulation technology, and, some government officials have expressed an ambition to take the CSCS global. 

  • As the system is refined, and especially its algorithms, it could be sold or imitated by other countries and eventually “could underpin a shift towards a Chinese-led model of urban regulatory frameworks,” Trivium said. 

Taking on the US: Some members of the government see company credit ratings as an area of strategic competition where the US currently reigns supreme. They have expressed a goal to create a competing credit model, like the CSCS, Trivium said.

  • Currently, the big three credit rating agencies are US-based; S&P Global, Moody’s, and Fitch, which gives the US an advantage in international financial markets. This view has been expressed by policymakers such as China’s Finance Minister in 2016, Lou Jiwei.
  • “Under the all-round opening up of international competition, [control over] credit standards … is also an important area of competition between countries, and is a manifestation of national soft power,” (Trivium’s translation), Wu Weihai, member of the NDRC’s International Cooperation Center member, said in a 2017 publication. 

At its core, the CSCS is not such an exciting concept: it’s a massive filing cabinet. Companies have already felt its consequences, but the full extent of its scope is yet to be determined. Authorities continue developing it and have not been clear on what the endgame is. 

LISTEN MORE: China Tech Investor podcast: China’s social credit system—everything you know is wrong with Kendra Schaefer

Eliza Gkritsi

Eliza was TechNode's blockchain and fintech reporter until July 2021, when she moved to CoinDesk to cover crypto in Asia. Get in touch with her via email or Twitter.