Building a robust and reliable business infrastructure is key to ensuring that China achieves its vast commercial promise. As Bill Parrett explains, the new business infrastructure must be based on two foundations: accountability and corporate governance

It is common wisdom in the business world that China is a country of immense promise. The basic facts are clear. China’s economy is growing at an annual rate of close to 8.5%.

China is the number one country for foreign direct investment. FDI in China topped $50 billion in 2002 – a figure equivalent to total FDI in Russia between 1992 and 2002. Recent projections of the market capitalization of China’s two stock markets – Shanghai and Shenzhen – see their value reaching $2 trillion by 2010, up from the current $450 billion.

All indicators are that China is a major economic player and that the Chinese economy is steadily becoming integrated into the global economy. To continue to sustain current growth and the transformation of its economy, China’s government is committed, among other things, to modernizing its state-owned enterprises (SOEs) as well as supporting the viability of China’s growing and emerging companies in the private sector.

Part of this great transformation is the restructuring and diversification of China’s SOEs. There are some 170,000 of them. Most are small- and medium-size entities with only a local or provincial reach. There are, however, almost 190 large – and potentially global – SOEs that represent assets of over $800 billion.

On October 14 last year, China’s Communist Party’s Central Committee passed a resolution quietly calling on the party to push ahead and clear the way for “diversified ownership” of medium and large SOEs.

This resolution came on the heels of the creation of a new government agency to oversee the portfolio of China’s SOEs, the State-owned Assets Supervision and Administration Commission (SASAC).

Li Rongrong, chairman of SASAC and deputy party secretary, has stated that among his many tasks are the improvement of the accountability and the corporate governance of these SOEs.

Yet integrating these enterprises into the global economy requires more than pursuing sound economic policies. Chinese enterprises of all kinds, including SOEs, need to revamp and modernize their business infrastructure.

The “long march” to modernize the business infrastructure entails sweeping change and transformation across the broad spectrum of Chinese companies. A host of complex internal issues are being addressed. These include business processes, risk analysis, operations, governance, transparency, information technology and human capital – to name just a few.

After a number of trips to China – most recently to attend a symposium on M&A; in China, co-hosted by the SASAC and the United Nations Industrial Development Organization (UNIDO) – as well as receiving, in New York, a top-level delegation from the Chinese Institute of Certified Public Accountants (CICPA), I am more and more convinced that Chinese authorities are committed to modernizing their business infrastructure.

The authorities are acting to improve standards and practices in two key areas of business infrastructure: accountability and corporate governance. Let us consider some recent developments in these areas.

As investors continue to pursue new avenues into China, Chinese authorities are showing a keen understanding of the many dimensions of the concept of accountability. For any enterprise, accountability goes well beyond the balance sheet to assess a business’s performance in the broadest of terms: from business strategy and planning to human resource practice.

It encompasses everything from benefits to abiding by labour laws, from a company’s assets and liabilities to the vision and integrity of its leadership.

The issue is where to begin. From the vantage point of both investors and Chinese authorities, enhancing independent auditing is an important step. Modern audit techniques continue to improve and newer and more exacting methodologies are being developed in the wake of the failures that have tainted financial reporting in the Americas, Europe and Asia in the past few years.

In China, a number of these fundamentals are being progressively put in place. As both China’s premier and finance minister explained at the 16th World Congress of Accountants held in Hong Kong in November 2002, China has done much to improve the standards and training of accountants in the past several years.

Central to these improvements have been the development of Chinese Accounting Standards and the parallel development of a comprehensive Accounting System for Business Enterprises (ASBE) and Accounting System for Financial Institutions (ASFI) – both of which are close to International Accounting Standards.

As it stands, the ministry of finance has announced that all SOEs must adopt the ASBE by 2005. On the training front, the finance ministry has established three nationally accredited schools to provide training and education.

And the process continues. To date, exposure drafts have been published on 32 accounting standards and 16 final standards have been accepted. The certified public accountant (CPA) has become one of the more attractive professional roles in China.

According to China’s finance minister, 600,000 candidates register for the examination for the unified national qualification for CPAs every year. Today, there are some 4,300 accounting firms in China, yet only 71 of them serve listed companies. As standards and training improve, market demands for more and better accountants will be progressively met.

The ministry of finance and CICPA continue to contribute to the global discussion on accounting standards, and the CICPA is undertaking a thorough comparative review of regulatory schemes for CPAs in over a dozen countries.

Beyond encouraging the necessary training and research, it is important for China and the CICPA to be an active participant in helping to set International Accounting Standards. This will send a clear message that China is a serious leader in setting standards not only for itself, but for all companies and investors worldwide.

As former premier Zhu Rongji remarked in his keynote speech to the 16th World Congress of Accountants in November 2002, accountants should “strictly observe the principles of independence, impartiality and fairness and never succumb to unwarranted demands”. While there may be differences of vocabulary, the same fundamental values apply everywhere and to every service performed by a professional services firm – from audit to consulting. More commonly, these core values are described as integrity, quality, objectivity and independence.

The fundamental obligations of integrity and quality call upon auditors and other professionals to answer not just to their clients and their clients’ many stakeholders – but to the investing public as well.

Objectivity requires a disciplined, unbiased and questioning perspective on client issues. It also helps to foster clear analysis and, in that sense, promotes the requisite state of mind among professionals so that they provide answers that stand up to intense scrutiny – rather than obvious, easy, or safe answers.

Finally, independence encourages all professionals to confront the difficult, and sometimes conflicting, interests that surround client issues. And, of course, independence demands that answers be free of any vested self-interest.

These are the cornerstones of professional behaviour, and they are being inculcated among accountants and professional around the world – and in China as well.

Corporate governance is another area in which China is taking important steps. Underlying the improvements in corporate governance is, however, a clear dichotomy. On the one hand, the state wants to improve governance laws to align the SOEs with the best practices of the “modern enterprise system”. On the other hand, continuing state ownership and its inherent lack of independent verification may work against these very principles.

In a number of recent forums, Chinese officials have made clear their determination to face these issues squarely. The issue fundamental to all corporate governance, especially for the SOEs, is to understand ownership rights and interests and who bears the responsibility for overseeing and evaluating management.

Untangling these complex relationships in major SOEs is a necessary prerequisite for restructuring, refinancing, or buying and selling any entity in whole or in part. This, in fact, should become somewhat easier now that the SASAC has been given clear responsibility for the portfolio of the SOEs.

Solid corporate governance will also help management as it invites banks, creditors, shareholders and other stakeholders to clarify issues such as debt obligations or arranging of financial restructuring.

But good corporate governance requires more than just addressing these issues. As the top management of the SOEs and other companies become more proficient in the practices of modern enterprises – and as independent boards and committees begin to oversee management and its role in business planning, strategy and operations – I am convinced that boards must include an “industry expert”.

An industry expert – by which I mean a senior adviser, Chinese or foreign, with considerable experience in a specific industry – can provide important insights and suggestions to corporate management as it weighs the difficult challenges and choices. These challenges and choices may well include a renewed focus on core competencies, which in turn may require the divestment of certain entities.

The issue of SOE debt is immensely complex and the failure of any major bank or enterprise has potentially vast business and social repercussions. From the perspective of managers and employees who have loyally served state-owned enterprises for many years, the notion of restructuring can be daunting. Issues of job security and the need for social insurance are sensitive.

On the other hand, increased efficiencies and effective global alliances can stimulate economic growth and create new jobs – whether in old or in new enterprises. But nothing is smooth or without pain. Consequently, the SASAC and other state agencies are proceeding with caution.

The promise of China, and the many complex business infrastructure issues to be faced, are well beyond what anyone could have imagined some 25 years ago when premier Deng Xiaoping launched China on the road of market reforms.

As he noted in a November 1979 interview: “Modernization does represent a great new revolution. The aim of our revolution is to liberate and expand the productive forces. Without expanding the productive forces, making our country prosperous and powerful, and improving the living standards of the people, our revolution is just empty talk.”

China is fulfilling the revolution by beginning to realize its immense promise, and that is no empty talk. The stakes are very high – not just for China, but for all countries that are, and will be, touched by the evolving Chinese economy. And the economic benefits of China’s success will potentially accrue to all.

As corporate players and leaders, we are called upon to support – and, where possible, participate in – the restructuring of China’s business infrastructure. We are committed to doing our part.

China’s new-found economic vigour will endure only if the necessary transformations are made to its business infrastructure – beginning with a strong foundation of accountability and corporate governance.

Bill Parrett
Bill Parrett is global chief executive officer of Deloitte Touche Tohmatsu.