Beijing Bolsters SOE Reform Blueprint, Impact Yet to be Seen

September 16, 2015

Stephanie Henry, Owen Haacke

The State Council’s long-awaited framework for reforming China’s state-owned enterprises (SOEs) marks limited progress on areas of SOE reform such as mixed ownership, asset management, and SOE classification. Some have reported that reforms are “tepid” because they do not make a bolder move towards privatization or a stronger market orientation for SOEs, in line with the goals laid out at the November 2013 Third Plenum. However, the content of the plan—known as the Opinions on Comprehensive SOE Reform—is largely in line with previous less ambitious signals from regulators that they would focus on improving efficiency and management for SOEs that would remain firmly under government control.

China’s SOE system has long been a target of reform efforts, though internal government debate on the role of the market and the scope, pace, and scale of economic reform have slowed any significant progress on SOE reforms. Indeed, this framework itself has been rumored for an imminent release since 2013. Part of the challenge in implementing true SOE reform is the large number of SOEs: according to media reports, the central government manages more than 110 SOEs, while local governments oversee nearly 25,000. SOEs persist in a wide range of sectors, including many sectors deemed of vital importance to China’s economy: oil and gas, steel, aviation, automotives, telecommunications, and financial services. These vested interests are a strong internal advocate for the continued role of SOEs in the economy.

The latest Opinions aim to address SOE inefficiencies and mismanagement problems, as well as the failure of SOEs to respond to market influences. The Opinions outline several goals to address these issues and improve SOE performance, include limiting government intervention, promoting anti-corruption efforts, promoting private investment, improving market responsiveness, and separating management from ownership. However, the Opinions contain few implementing details, leaving major questions about how regulators like the State-Owned Assets Supervision and Administration Commission (SASAC) and its provincial counterparts will move forward.

SOE classification

SOE classification—dividing SOEs into those that should operate largely on competitive terms and those that should not because they sit in strategic, monopolistic, or public service sectors—is one area that has long been rumored as a potential component of SOE reforms. Companies are interested in this work, as it could enable government agencies to allow—or even require—competitive SOEs to operate more as market entities.

The final plan does include a scheme to separate SOEs into “business SOEs” and “public service SOEs,” a division that is quite different from earlier pilot reform plans. Business SOEs are defined as for-profit commercial entities that operate in line with market demand. These SOEs are directed to implement shareholder system reforms and are encouraged to go public under this framework. Public service SOEs will be dedicated to public welfare and, given this status, will likely not be subject to market-based SOE reforms. According to the Opinions, SOE shareholders will have the right to suggest how a SOE is classified, and local governments will have the authority to review the investors’ proposed classification, along with their justification for that determination. The State Council notes that this distinction gives the central government a broader ability to design and implement reforms to the SOE system.

Notably, the Opinions also classified business SOEs into two groups: business SOEs in competitive industries and business SOEs operating in areas deemed important to Chinese national security, which may include sensitive sectors like energy, telecoms, and transportation. The State Council has already identified more than 50 SOEs operating in key sectors—including petroleum, civil aviation, shipping, telecommunications, coal, agriculture, and high-tech—that are deemed essential to the economy. It is unclear if these sectors will automatically fall directly into the national security classification outlined in the new framework. According to the Opinions, factors by which the government will assess a business SOE classification are broad, lacking specific criteria.

While SOE investors have some input into how a SOE is classified, little detail is provided on how local governments will review the investors’ proposed classification and make a final determination. USCBC conversations with Chinese think tank experts in recent weeks indicate that SOEs in key sectors such as those listed in the previous paragraph are likely to retain their role in the economy. The Opinions also lay out ownership rules for public service SOEs, stating that they can be wholly state-owned proprietorships, franchises, or other state-owned investment structures—indicating a broad range of SOEs could fall into the public service category.

Management independence v. stronger party role

SOE governance and management has been a second focal area for SOE reform, as many SOEs are seen as inefficient or poorly run compared with their competitors. The Opinions emphasize that reforms should promote public listings of SOEs as a way of increasing public governance. By some estimates, newly listed SOEs could bring some RMB 30 trillion ($4.7 trillion) into the China stock market.

Additionally, the plan calls for more independence of SOE day-to-day management from government oversight. To that end, the Opinions infer that government intervention should only occur when there is a legal basis for such intervention, and affirm that SOEs will have more autonomy to appoint senior executives and compensate senior executives according to performance. In a related note, the plan also states that SOEs will be taxed at 30 percent of their profits, bringing them closer in line with other enterprises. Such steps are a positive signal for the ability of SOEs to operate on market terms.

The Opinions also call for leaders of the Chinese Communist Party (CCP) and SASAC to refine the management selection process for SOE leadership. The updated criteria should broaden the channels by which SOE leaders are selected, and create a more transparent system to recruit, transition, and remove leaders from their posts. The CCP, however, will still retain key areas of control over SOE operations: the document states that the CCP’s oversight in SOEs should be strengthened, and requires that the chair of the SOE board of directors also serve as the company’s party secretary.

Regarding oversight, the plan proposes shifting SASAC’s role from direct SOE management to managing the capital provided to SOEs, suggesting greater operational autonomy in the future. The plan also references the creation of “state-owned asset investment companies” that will report to SASAC. However, it is unclear how either of these pieces would work in practice, and the function of these state-owned asset investment companies and their impact on both business and public service SOEs is not specified.

The Opinions also outline a strong focus on anti-corruption mechanisms—reiterating a message conveyed strongly in July by the central government reform leadership. The Opinions propose enforcing new and mandatory internal audits, liability mechanisms for discipline infractions, and third-party investor oversight to help reduce corruption within SOEs. Anti-corruption investigations are to be led by party officials within the SOE, and overseen by China’s Central Commission for Discipline Inspection.

The impact on business

The State Council is planning to have all SOE reforms completed by 2020, a goal that aligns with Third Plenum reforms. However, lack of implementation details leaves few quantifiable means to meet this goal, and it remains unclear what the next steps might be—or whether the SOE reforms will address concerns raised by USCBC member companies about the competitive landscape in China. The plan does little to assuage the significant majority of USCBC member companies that believe that their Chinese competitors, including SOEs, get benefits that US companies are unable to access.

At this time, it is unclear how SOE reforms will impact companies that are currently in business partnerships with SOEs. The Opinions suggest that a SOE may need to evaluate its internal auditing practices, and may choose to devote more time and resources to the classification process, as well as changes to its governance. Both of these factors could increase the degree to which SOEs may need to focus internally, leaving an uncertain impact for partnerships with foreign companies.

Chinese officials have suggested that SOE reforms could provide opportunities for US companies seeking strategic partnerships with SOEs targeting third-country markets, such as through China’s One Belt, One Road plan. While this could help some US companies in particular sectors, companies operating outside of these sectors seeking opportunities in state-dominated sectors or partnerships with SOEs may not see much positive impact from these reforms, given their limited scope.