When evaluating Chinese companies, overseas investors and partners often scrutinize financial statements and operational metrics. Yet one of the most pervasive risks remains hidden in plain sight: related-party transactions (RPTs). These deals between a company and its executives, major shareholders, or affiliated entities account for nearly 70% of corporate fraud cases in China, according to China Securities Regulatory Commission (CSRC) data.
What Exactly Are Related-Party Transactions?
RPTs occur when a company conducts business with entities or individuals connected to its:
- Controlling shareholders or their relatives
- Directors, supervisors, or senior management
- Subsidiaries or parent companies
- Other entities under common control
Common Examples in China:
- Asset Transfers: Selling property/equipment to a shareholder’s private company at below-market prices.
- Loan Guarantees: Providing collateral for loans benefiting executives’ external ventures.
- Service Agreements: Overpaying a relative-owned supplier for “consulting services.”
Why RPTs Pose Extreme Risks in China
1. Fund Diversion & Tunneling
The 2024 China Company Law (Articles 182-185) mandates board/shareholder approval for RPTs and prohibits undisclosed deals. Yet enforcement gaps persist. In 2023, a Shenzhen-listed manufacturer collapsed after $120M was funneled to chairman-linked distributors via inflated contracts.
2. Earnings Manipulation
RPTs can artificially boost revenue. Example:
- Company A “sells” products to Chairman’s private Firm B at 30% markup.
- Firm B holds inventory indefinitely, inflating Company A’s profits.
3. Regulatory & Reputational Fallout
Undisclosed RPTs violate:
- CSRC Disclosure Rules: Material RPTs require immediate public filing.
- Tax Laws: The State Taxation Administration targets RPTs used for profit shifting.
In 2022, a pharmaceutical firm faced delisting after hiding $80M in shareholder loans.
How to Detect Red Flags: A Due Diligence Checklist
🔍 In Official Enterprise Credit Reports
China’s National Enterprise Credit Information Publicity System (NECIPS) reveals critical clues:
- “Major Client/Supplier” Disclosures: Check for entities sharing addresses/phone numbers with the target company’s executives.
- Equity Links: Use shareholder/director listings to trace affiliate networks.
- Penalties: Look for fines labeled “关联交易违规” (RPT violations).
Example: The sample report for Xintou Huaying Petrochemical lists subsidiaries like Xinjiang Xintou Huaying Energy Technology – a potential RPT channel.
📉 Financial Statement Analysis
- Abnormal Margins: Compare gross margins with industry averages. Sudden spikes may signal artificial pricing.
- Receivable Imbalances: High dues from “mystery” clients warrant scrutiny.
- Cash Flow Mismatches: Profits without corresponding cash inflows suggest circular transactions.
Protecting Your Business: 3 Action Steps
- Demand Full Disclosure
Under China’s 2024 Company Law (Art. 140), shareholders can sue for access to RPT documents. - Conduct Network Mapping
Trace executives’ external roles using tools like China’s Executive Risk Reports. - Leverage Professional Verification
Basic credit reports lack depth. Opt for Professional Enterprise Credit Reports that cross-reference:
- Judicial records
- Tax filings
- Industry-specific databases
The Bottom Line
While not all RPTs are harmful, opacity equals risk in China’s business landscape. As the new Company Law tightens governance (effective July 2024), proactive due diligence is non-negotiable.
“Trust, but verify – especially when money moves between cousins.”
— Common saying among China due diligence specialists
Protect your investments by treating every undisclosed related party as a potential landmine.