The central government’s crackdown on polluters, including factory shutdowns and relocations, is necessary, but thoughtless attempts by some local governments may affect the manufacturing industry, write Paul Davies, Bridget Reineking and Andrew Westgate

China has made rapid strides in developing a robust, modern environmental regulatory system in the past decade. This progress includes a policy framework overhaul triggered by the Environmental Protection Law (EPL) in 2014, an ongoing reform of emissions and discharges permitting a new draft Soil Pollution Law to impose liability for remediation of contaminated land, and the launch of the world’s largest emissions trading system in 2017.

Policy evolution has been accompanied by both growing public awareness and a focus on environmental issues − air pollution and food safety in particular − and the central government’s increasingly vigorous enforcement of environmental laws. China’s Premier, Li Keqiang, declared war on pollution in 2014, and finally, in October 2017, environmental protection was enshrined in official Communist Party ideology as part of “Xi Jinping Thought” − which was added to the party constitution at the 19th National Congress of the Communist Party of China (CPC).

One of the most significant aspects of this stepped-up emphasis on enforcement has been factory closures, which have been employed with increasing frequency by regulators tasked with fighting Premier Li’s “war on pollution.” This article analyzes the drivers behind factory shutdowns in China and the steps companies can take to prepare for, and protect themselves against, enforcement action.

A heavy hand

The past few years have featured some of the largest environmental crackdowns in Chinese history. Planning for these crackdowns began in July 2015, when the Central Leading Group for Comprehensively Deepening Reforms issued a trial Environmental Protection Supervision and Inspection Plan. This inspection plan called for inspections across all of China’s 31 provinces, targeting both polluting factories and local officials failing to enforce environmental law.

That same year, Chen Jining, then the newly appointed Minister of Environmental Protection, vowed that environmental law would not be a “paper tiger”, but a “sharp weapon with teeth of steel”. The government then launched the first of four nationwide environmental inspections at the end of 2015, with the last phase − in which tens of thousands of factories were temporarily shut down − ending shortly before the 19th National Congress.

Some estimates suggest that about 40% of the country’s factories were forced to shut down at some point in 2017, and as many as 70,000 factories were reportedly shut down in the provinces of Hebei, Henan and Shandong alone.

These facility closures have become a major challenge for local and multinational manufacturers in China. Many small and medium-sized enterprises have been slow to adapt to the new wave of environmental regulations, and because smaller manufacturers often emit greater quantities of pollutants per unit of production, they have become a focus for regulators.

But even companies with state-of-the-art emissions control systems and robust compliance programmes have encountered difficulties due to shutdowns of their suppliers and customers, particularly those located in or around certain sensitive regions such as Beijing, and especially during the winter season, when ambient air pollution levels are typically higher.

Furthermore, because Chinese emissions limits are often enforced at the level of industrial parks, if the park as a whole does not meet emission targets, the government may order all park facilities to lower emissions or temporarily cease operations. Examples of these types of shutdowns in the past few years include:

  • April 2016, the local government ordered all 28 companies located in Hai An Chemical Industrial Park in Haian, Jiangsu province to cease operations and address waste gas emissions that had led to odour problems and complaints from local residents. The majority of factories in the park were required to suspend operation immediately, and facilities were given three days to comply.
  • July 2016, the local government ordered all 200 companies located in the Shangqiu City Liangyuan Industry Concentration Park (including well-known public companies such as Sinopharmacy, Kangshifu and Jiumuwang) to suspend production immediately to meet local air pollution targets. Although regulators indicated to companies that the suspension was temporary, the government’s notification did not specify a time period for the shutdown. The order proved quite controversial, and was revoked later the same day. Although the scope of the actual shutdown is not clear, the extreme shutdown order and its sudden revocation showed the uncertainty in some local governments’ enforcement efforts.
  • December 2016, after a joint local and central government investigation, all manufacturing plants in Jishan Chemical Industrial Park were required to suspend operations and rectify waste water, waste gas, and solid waste pollution issues. Further, a government report indicated that enterprises unable to ensure compliance with applicable emission standards would not be allowed to resume operations and would be suspended indefinitely.
  • January 2017, the Guangdong Environmental Protection Bureau announced a shutdown of several industrial parks housing printing plants along Xin Ye Road in Shixi Industrial Area, until the plants rectified environmental violations the regulators had identified.
  • December 2017, regulators found the Binhai Economic Development Area Coastal Industrial Park, and another 36 industrial parks in Jiangsu province, to be in violation of distance requirements from sensitive receptors. Regulators ordered the parks to resolve the violation by the end of December 2018, through relocation or removal of the sensitive receptors, park reconfiguration, or relocation or repurposing of park facilities. If the violations are not rectified, regulators have indicated they will rescind the authorizations of the industrial parks.

Policy and factory shutdowns

Chinese environmental policy has been driven in large part by ambitious goals set by top leadership at the State Council and the Ministry of Environmental Protection (MEP), but is primarily implemented by provincial and local Environmental Protection Bureaus (EPBs). For example, China’s highest policy making body, the State Council, issued the Action Plan for Air Pollution Control and the Action Plan for Water Pollution Control in 2013 and 2015, respectively.

Each plan established requirements for 10 types of pollution control methods related to air and water pollution. Because the MEP lacks the staff to effectively monitor the entire country, enforcement falls primarily to local officials, who have come under increasing pressure to enforce environmental laws and achieve environmentally based performance goals.

The EPL, for example, provides that government officials who fail to properly supervise regulated companies may face demotion, financial penalties or even criminal sanctions. The central government investigated more than 18,000 Chinese officials during the latest environmental crackdown in 2017.

The MEP conducted these latest investigations in conjunction with the Communist Party’s primary anti-corruption task force, the Central Commission for Discipline Inspection. This co-operation highlights the overlap between increased environment enforcement and President Xi’s larger anti-corruption campaign.

The performance of government officials is now also assessed on the basis of air quality and other environmental metrics in addition to, and sometimes more prominently than, GDP growth. The Action Plan for Water Pollution also ties funding for pollution control equipment to implementation of the plan to incentivize active enforcement.

In order to meet their ambitious targets, local EPBs and officials have sought broad regulatory powers to ensure compliance. For example, draft revisions to environmental protection regulations issued in April 2016 for Shanghai included a provision allowing project approvals to be suspended in counties, townships and industrial parks that exceed emissions targets.

Jiangsu province also issued a plan to “shut down a series of chemical industrial factories, relocate a series of chemical industrial factories, upgrade a series of chemical industrial factories, and restructure a series of chemical industrial factories” (the Four Series Plan).

EPBs and officials have also targeted particular industries for more stringent emission limits and potential shutdowns. The Action Plan for Water Pollution, for example, targets facilities engaged in paper-making, coking, nitrogenous fertilizer, nonferrous metals, printing and dyeing, agricultural and byproducts processing, the manufacture of active pharmaceutical ingredients, tanning, pesticide, and electroplating for regulatory scrutiny and potential closure.

Enforcement actions in China have also historically been tied to major events of national significance. Prior to the Beijing Olympics in 2008, cars were restricted by licence plate number in Beijing, and factories in surrounding provinces were shuttered for several months leading up to the games to maximize the chances of clear skies. Similar efforts before the Asia-Pacific Economic Co-operation (APEC) meeting in Beijing in 2014 led locals to coin the term “APEC blue” for the colour of the sky during the period that surrounding factories were shut down.

More recently, authorities have begun to issue policies relating to lower production limits or shutdowns in the winter, when older, district-wide heating systems are activated, leading to visible increases in ambient air pollution. In September 2017, the MEP, the National Development and Reformation Commission (NDRC), and the Ministries of Public Security, Finance, Housing and Urban-Rural Development, Industry and Information Technology, and Transportation, as well as six provincial-level governments, issued the Action Plan for Comprehensive Control of Air Pollution in Autumn and Winter for 2017-2018 in Beijing, Tianjin, and Hebei provinces and Surrounding Areas.

The plan established industry-wide production limits during the heating season (typically from 15 November to 15 March) for industries including steel making, coking, foundry, construction materials, non-ferrous metals, and chemicals, in addition to strengthening emissions control requirements. Based on this action plan, local governments in the region are issuing more detailed lists of industries and companies that will be required to curtail or temporarily cease production.

Relocation orders

The central government has recently issued policies calling for the relocation of entire classes of companies away from the outskirts or industrial sections of major cities like Beijing and Shanghai to specialized industrial parks far from urban centres, due to safety hazard and environmental concerns.

These policies suggest that the government recognizes that temporary shutdowns are a stop-gap solution. In 2011, for example, the State Administration of Work Safety issued a plan requiring companies manufacturing hazardous chemicals to relocate to chemical industrial parks by 2015. More recently, the State Council issued a Guiding Opinion on Pushing Forward the Relocating and Transforming of Hazardous Chemical Manufacturing Companies Located in Densely Populated Urban Areas.

The plan calls for enterprises located in densely populated areas, such as residential and commercial areas, to relocate their facilities unless they can meet strict emission limits. In principle, the plan requires all medium and small enterprises, and large enterprises in high-risk industries, to relocate by the end of 2020. By 2025, all companies manufacturing hazardous chemicals must relocate to industrial parks equipped for this purpose.

The guiding opinion calls for local governments to support relocation efforts by offering financial support for relocation, and offering tax breaks to offset the costs, and for banks and financial institutions to offer support through lending and encouraging bond issuances.

China also has a national Regulation on the Expropriation of Buildings on State-owned Land and Compensation, which entitles the owners of a building to compensation for not only the value of the building, but also for production losses and relocation costs. In some cases, this compensation scheme appears to have worked well; Shanghai Hutchison Pharmaceuticals reached a land compensation agreement with the Shanghai government in December 2015, under which it would receive US$113.1 million in subsidies to give up its remaining 35 years of land use rights at a site within the city and relocate to a new US$95 million factory in the suburbs.

Implementation, however, remains uneven. Many cash-strapped local governments may have trouble offering meaningful compensation to factories forced to relocate. For example, in an implementing regulation issued in December 2017, the government of Yunan province issued a plan to implement the guidance, which proposed to offer compensation of just RMB200-300 (US$32-48) per square metre of the facility’s footprint.

As a result of funding shortfalls, implementation has proceeded very slowly, with many facilities identified for relocation in provincial implementation plans not even having started the process of moving for lack of capital, despite a deadline less than three years away. Unless funding for relocation of such facilities can be secured, either through government assistance or through lending institutions, some facilities may simply shut down and not reopen.

In comparison with national relocation policies, which are generally financed by the central government and enforced systematically across an industry, provincial EPBs have usually required certain non-compliant factories to relocate at their own cost.

For example, Nantong Xingao Dyeing, of Nantong City, Jiangsu province, was put on a Key Pollution Rectification Project List by the local EPB and subsequently ordered to relocate in 2017, with no apparent financial support or compensation from the local government. As a result, the company was forced to wind down production at its facility and relocate at its own expense.

Adapting to regulatory environment

Firms operating in China cannot eliminate the risk and unpredictability of regulatory shutdowns, but they can reduce and mitigate the effects by taking proactive measures. First, companies need to be attuned to the regulatory environment and local regulators’ policy directives. Compliance with current regulations is not enough − firms need to “see where the ball is going” in order to anticipate regulators’ next area of focus.

Second, companies need to understand not only their own regulatory compliance obligations, but also any emission limits or requirements that apply to the industrial park or district in which they are located. Although firms cannot control whether their neighbouring facilities stay within the applicable limits, they can increase their ability to anticipate the periods or reasons for which regulators will seek to curtail production.

Third, companies need to identify and engage competent local counsel who are familiar with the regional personnel and the practices of the local regulator. Because local priorities and the discretion of local regulators drive so much of the uncertainty in enforcement activity in China, these relationships and a local familiarity can prove critical in preparing for, and responding to, enforcement actions.

Fourth, firms should prepare and train employees on response plans to handle surprise regulatory inspections and the aftermath of such inspections.

Fortunately, despite the widespread use of factory shutdowns, there are indications that the MEP is aware of the issues created by unpredictable closures and the potential impact on China’s position as the world’s preeminent manufacturer.

The director general of the MEP’s department of law and policy, Bie Tao, has stated that the MEP “opposes reckless law enforcement by simply shutting down polluting companies”, and has called such shutdowns “irresponsible and capricious”.

Although the MEP remains understaffed in comparison to agencies such as the US Environmental Protection Agency, the agency has increased its oversight and authority over local EPBs, and factory shutdowns may become a focus of this effort in the future. Multinationals should engage with the MEP to support its efforts to increase transparency and consistency in Chinese environmental law enforcement.

Paul Davies is a partner at Latham & Watkins in London. Bridget Reineking and Andrew Westgate are associates at Latham & Watkins in Washington DC and New York, respectively.

This article was prepared in conjunction with Scott Fulton, John Pendergrass, and Zhuoshi Liu, of the Environmental Law Institute in Washington DC, and George Zhu and Lin Na of JunHe, a Chinese law firm.