Green Compliance in China – How to Prepare for Environmental Regulations

Despite increasingly robust laws, proper implementation and compliance with China’s environmental regulations have often stood in the way of progress. That is expected to change as ambitious targets demand stricter regulatory standards, monitoring, and better policy implementation. These in turn mean that businesses can no longer stick with the status quo, and, depending on their industry and scope, must prepare to make necessary changes to avoid risks from a sudden transition.

Green compliance, or environmental compliance, refers to conforming to environmental laws, regulations, standards, and other requirements by businesses to legally operate in a specific jurisdiction.

Given the state’s determination to transform China into a green, low-carbon, and circular economy, green compliance will grow more important for companies doing business in the country.

While many green compliance requirements are currently limited in scope and implementation, recent regulatory trends demonstrate that the standards and implementation will soon become more detailed and stricter. Those who are better prepared will enjoy a comparative advantage.

In this article, we introduce China’s major green compliance obligations and provide tips for businesses to make necessary changes.

Green compliance obligations in China

Carbon trading

On July 16, 2021, China launched the world’s largest carbon trading market after several delays. At launch, the carbon market covered over 2,225 companies in the power generation sector, most of which are state-owned enterprises (SOEs). Together, these companies are responsible for about half of China’s energy-related emissions, and 10-14 percent of the world’s total.

Under the carbon trading scheme, each company is allowed by the government to emit a certain amount of CO2 emissions each year. If the company ends the year beneath its allotted limit, it can sell the difference on the market as a credit. Conversely, if the company exceeds its limit, it is required to buy additional credits to compensate.

Failure to pay quotas on time and in full is regarded as incompliance and will lead to penalties, such as fines and “name and shame”. As of May 2022, the Ministry of Ecology and Environment (MEE) has punished over 100 firms in the national carbon market for incompliance.

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While the fine for non-compliant firms is currently limited to RMB 20,000-30,000 (US$2,960-4,450) each and the “name and shame” penalty will likely not hurt enough, it still provides a reason for businesses in China to integrate carbon pricing into their business and risk strategies. That is because the system can be expanded in the future to become more comprehensive, and the penalties made higher to speed up China’s decarbonization process. Eventually, China’s carbon market may cover a much broader set of companies, while the emergence of a global trading system also remains a possibility. Further, the price of carbon will likely be closer to RMB 180-200 (US$27.77-30.86) per ton by the end of the decade.

One way that companies can prepare for carbon trading requirements is to put an internal price on carbon. This can either be an internal tax to encourage emissions reductions within the company to fund green initiatives or a shadow price that allows the company to track its emissions.

ESG reporting

ESG stands for environmental, social, and governance – which represents the three main criteria for investors to quantify and evaluate a company’s level of sustainability. While there is currently no legislation covering the ESG responsibilities of all companies in China, it has been trying to enhance ESG requirements by mandating major polluters and companies that finance them to submit annual reports detailing a range of environmental information.

For example, on February 8, 2022, the Measures for the Administration of Legal Disclosure of Enterprise Environmental Information (the Measures) released by the MEE came into effect, according to which:

• Companies identified as being required to disclose environmental information must compile a yearly “Legal Disclosure Report of Environmental Information” and upload the report onto the “Enterprise Environmental Information Legal Disclosure System”, which was set up by the MEE and its local counterparts on the official government websites.
• Companies may sometimes be required to file ad hoc reports throughout the year to disclose information, such as changes to company details, administrative licenses, updates on administrative penalties, changes to legal representatives, and other ad hoc information that arises throughout the year.
• The annual report detailing the information of any given year (from January 1 to December 31) must be submitted by March 15 of the following year.

Companies required to disclose environmental information include:

• Major dischargers of pollutants.
• Companies that are required to undergo mandatory clean production audits under the Clean Production Audit Measures.
• Publicly listed companies and bond-issuing companies (and their subsidiaries) – if they have been penalized for ecological or environmental violations in the previous year.

Failing to comply with the ESG reporting requirements listed in the Measures could make companies liable for penalties of RMB 10,000 (US$1,580) to RMB 100,000 (US$15,805). This will also be included in the company’s credit record.

While the fines proposed in the Measures are relatively small for large corporations, the potential negative impact on their corporate credit record could be much more damaging and could cause reputational damage, mandated suspension of production, or missing out on bids for government contracts.

In addition to the mandatory ESG reporting requirements, it is noticed that voluntary ESG reporting has increased significantly in China over the past decade. According to JPMorgan, 86 percent of companies listed on the CSI 300 Index – the top 300 stocks traded on the Shanghai and Shenzhen stock exchanges, produced ESG reports in 2020, up from just 49 percent in 2010, despite not being required to do so. A proactive stance on sustainability reporting can help future-proof businesses, not only against further regulation but also against changing attitudes of investors and stakeholders and facilitate funding easier in a climate-conscious world.

Greater emphasis on ESG reporting will require significant changes by companies, including hiring key staff and investing in systems to collect and manage the required information. On their part, smaller companies would likely need support from third-party professional services.

Clean production audit

A clean production audit is conducted on the production processes and services according to certain procedures, to find out the cause of high energy consumption, high material consumption, and heavy pollution. This intelligence is then used to recommend and implement feasible technical and economic schemes to achieve cleaner production.

According to the Clean Production Audit Measures, the following companies have to undergo mandatory clean production audits:

• Companies that discharge pollutants in excess of national or local standards.
• Companies that exceed the prescribed energy consumption limit for unit production and hence constitute “high energy consumption”.
• Companies that use toxic and harmful raw materials for production or discharge toxic and harmful substances during production.

The county-level environmental authority in charge will publish the list of companies that are subject to mandatory clean production audits upon the approval of provincial-level environmental departments. Within one month after the list is published, the identified companies must release relevant information on local media or on their respective company website. Further, such companies must launch a clean production audit within two months after the list is published and complete the audit within one year after the list is published.

The competent environmental authority in charge at or above the county level shall, within the scope of their respective functions and duties, organize clean production experts or entrust relevant agencies to evaluate and accept the results of these clean production audits.

Companies that fail to implement a mandatory clean production audit, falsify their clean production checks, or fail to properly report the result of the audit – shall be ordered by the competent environmental authority in charge at or above the county level to make the rectification within a prescribed time period. If the violating company refuses to make such rectification, it shall be fined between RMB 50,000 (US$7,400) to RMB 500,000 (US$74,000).

Pollutant discharge permit

A pollutant discharge permit is an integrated permit that enables relevant entities to discharge pollutants into the environment. China has been gradually promoting the implementation of the pollutant discharge permit system for industries since the mid-2010s. Previously, entities had to obtain separate environmental permits for each aspect of the operation of a polluting entity or activity.

The Regulation on the Administration of Pollutant Discharge Permits (the Regulation) came into effect on March 1, 2021 and marked the establishment of a national pollutant discharge permit system in China. The regulation was designed to standardize the permit application procedures, improve discharge management, tighten supervision, and clarify the responsibilities of relevant discharging entities.

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Now discharging entities are required to obtain a pollutant discharging permit prior to the launch of their production facilities or the actual discharge of pollutants, save for discharging entities that generate/discharge only a limited amount of pollutants and have only a minor environmental impact. The latter type of discharging entity is only required to complete a pollutant discharge registration, a much simpler process.

Whether an enterprise is subject to permit management or registration management is stipulated in the Inventory of Classified Management of Discharge Permits for Stationary Pollution Sources. For discharging entities subject to the permitting system, a tiered management system – key management and simplified management – is adopted based on factors including quantity of pollutant emissions and environmental impacts.

The main obligations for discharging entities include:

• Carrying out self-monitoring and keeping the original monitoring records for at least five years.
• Establishing a ledger record system for environmental governance.
• Periodically reporting on pollutant discharge permit implementation.
• Disclosing pollutant discharge information on the national pollutant discharge permit management platform as required.

For discharging units that are subject to key management, automatic pollutant discharge monitoring equipment is required to be installed, maintained, and connected to the monitoring equipment of the local ecological and environmental authority in charge.

Violations of the pollutant discharge permit system, such as discharges without a pollutant discharge permit, discharges that exceed applicable standards, or discharges made without a required permit re-application, will lead to fines that are up to RMB 1 million (US$148,000) and administrative sanctions, such as production or business restrictions or suspension, or even business shutdown. The main responsible person may also be held accountable for severe, continuous, and intentional violations.

Environmental damage repairment and compensation

China has been piloting programs to improve its ecological and environmental damage compensation system since 2015. Some top-level guidance was released in 2017 and 2020.

On April 26, 2022, 14 authorities, including the MEE and the Supreme People’s Court, jointly released the Rules on Compensation for Ecological and Environmental Damage, which clarified the responsibilities of the polluter for repairable and unrepairable damages. Damages that can be repaired should be so done by the polluter or an entrusted third party. Polluters that cause irreparable damage should compensate for the related losses according to law and bear the related expenses within the scope of compensation for ecological and environmental damage or conduct alternative repair to realize the equal restoration of the ecology and its service functions.

Tips to prepare for China’s tightening green compliance environment

In addition to knowing and understanding the major green compliance requirements in China as mentioned above, the below tips could be useful:

• Audit your facility and supply chain: To be compliant and retain a competitive advantage on green consumption practices, knowing where your business stands is the first step. Companies can begin by conducting regular green audits on their facilities and supply chains to gauge their distance towards achieving green compliance and thus make targeted improvements.
• Invest in management tools, technology, and services: To fulfill green compliance responsibilities, polluters should first be able to monitor and measure the pollutants they discharge accurately and efficiently. Investing in management tools and technologies or hiring third-party professional services will be necessary to secure this goal. While larger companies may implement multi-dimensional solutions that combine two or more methods, the best choice for smaller companies might be seeking external professional assistance due to its cost-efficiency.
• Pay close attention to future developments: With China serious about greening its economy, several regulatory updates and environment protection rules are expected to be issued within this decade. Companies are suggested to create a detailed plan for investments, changes to operational workflows, and exposure to incompliant links in the supply chain to effectively adapt to strengthening green compliance requirements. The sooner the process and planning are initiated, the better the organization will be prepared.
• Fit sustainability into your risk management strategy: Along with factors like operational and labor costs, sustainability is becoming a mainstream consideration for risk management and business planning. In some industries and jurisdictions, investors and other stakeholders already expect sustainability practices from companies.

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