Countries are scrambling to secure protective equipment and medical supplies to aid against the pandemic, and have turned to China to meet their needs. But the rush of demand exposes buyers to compliance and quality risks. Rosie Hawes offers advice on how to avoid procurement pitfalls

While mainland China has long been one of the world’s leading manufacturers of healthcare products, demand for medical equipment amid the global pandemic has skyrocketed. This increased competition and commercial pressure has transformed the market, and even experienced organizations may struggle with supply lines due to significant changes to the business and regulatory environment.

Obtaining COVID-19-related medical equipment is requiring an intensive effort during a time of crisis when resource supply faces unprecedented stress, and the ability to navigate a constantly shifting and unfamiliar landscape is often determining whether an organization is successful.

Recent reports of unsuccessful efforts to obtain medical supplies have included incidents of faulty, low-quality or counterfeit goods, as well as delayed, partial or ultimately failed deliveries of contracted supplies. Gaining an effective understanding of the integrity and backgrounds of potential supply partners is challenging and complex, and can often reveal undisclosed beneficiaries, dishonest behaviour, and even fraud or a failure to pay.

A review of more than 140 suppliers since April in mainland China – in relation to COVID-19-related medical procurement efforts for business as well as compliance teams – shows that 42% lacked the required qualifications or licences, 37% showed no evidence they could meet expected production capacity, or had limited or no related experience, and 27% had regulatory or legal issues.

To add to the challenges, the surge in demand and competition for crucial medical supplies combines two combustible elements. The first is inexperienced buyers, as many organizations from around the world are now trying for the first time to source COVID-19-related medical equipment directly from mainland China. The second is opportunistic sellers, taking advantage of the situation by overpricing goods, speculating, and making dubious claims about their stock and capabilities.

INCREASED SCRUTINY OF EXPORTS

In this environment, Chinese regulators are moving quickly to prevent and limit the possible reputational damage of unqualified medical equipment being shipped to overseas markets. For buyers, this presents a range of new and rapidly changing compliance challenges, and potential pitfalls. It is difficult to stay on top of changing regulations and ensure compliance.

Exports of the type of COVID-19-related equipment currently in demand – including masks (protective masks, surgical masks and disposable medical masks) and medical protective clothing, ventilators, COVID-19 testing reagents and infrared thermometers – are subject to inspection by customs authorities in mainland China before being released for shipment.

These new requirements came into effect on 31 March 2020, when three government bodies – the Ministry of Commerce, the General Administration of Customs and the National Medical Products Administration – placed extra restrictions on the export of key items related to COVID-19, resulting in more stringent quality and accreditation checks. Since 10 April, customs authorities in mainland China have been inspecting all shipments, with no exceptions, of 11 different types of medical equipment – face masks, protective clothing, infrared thermometers, ventilators, surgical caps, goggles, gloves, shoe covers, disinfectants, disinfecting wipes and patient monitors.

However, these regulations were changed on 26 April 2020, allowing exports to be qualified either in mainland China or overseas. Companies that either comply with domestic requirements, or that have overseas licences and registrations in accordance with the EU’s CE mark (which indicates the goods meet European Economic Area standards) or US Food and Drug Administration standards, can now export COVID-19-related equipment. Therefore, it is not strictly necessary for companies to have relevant qualifications in mainland China to be able to export, as was previously required.

Mainland China regulates medical devices and equipment under three separate levels of classification, determined by the level of technology and risk associated with the medical equipment in question. Class I products include, for example, protective eyeglasses and protective face shields. Medical face masks, protective clothing and infrared thermometers are typically Class II devices, while ventilators can be either Class II or Class III, depending on functionality. Testing reagents for COVID-19 are categorized as Class III, which is subject to additional special regulations. Medical manufacturers must register and be licensed separately to produce and sell each kind of medical device under the proper classification.

Given the challenges and the complexities around regulations, the China Chamber of Commerce for Import and Export of Medicines and Health Products has been maintaining a database of medical equipment manufacturers that have received overseas certification, and customs reportedly relies on this database to conduct checks on companies.

The companies must apply to be included in this database, which is under development and continually expanding. If a company does not appear in the database, it does not necessarily mean it lacks the required overseas certification, but it may be more difficult and time consuming to import items from companies that are not part of the database. Although this is seen as a positive move, efforts are still in the implementation stage, and outbound COVID-19-related medical supplies are still subject to strict customs reviews.

Before formalizing a contract or releasing any payment, buyers of these types of equipment can protect themselves by understanding whether the product they are seeking is subject to newly tightened export restrictions, and whether their supplier or broker has the proper qualifications to export goods and clear a customs review.

RAPID THIRD-PARTY SUPPLIER SCREENING: A CASE STUDY

A UAE-based client had been contacted by three apparently US-based brokerage firms claiming to be able to source medical devices from a total of 25 companies in mainland China.

Teams from the global risk consultancy, Control Risks, in mainland China and the US conducted public-record research to verify the licences and export qualifications of these 25 Chinese companies, as well as the three “US-based” brokerage firms, additionally seeking to confirm their track record of supplying medical devices, capacity to fulfil large orders, and any potential red-flag issues. Eight of the Chinese companies appeared credible, with transparent trading histories and holding appropriate licences.

In the cases of the other parties:

  • One of the brokers had been incorporated only a few weeks earlier, in Puerto Rico, and had no track record whatsoever, raising questions about its capabilities and who it may represent. Another had undisclosed links to a politician of a Caribbean country. This tie to a politically exposed person, who is in a position to exploit his position of influence, presented an enhanced risk from a corruption perspective.
  • Eight of the Chinese suppliers had no track record at all in the medical equipment sector. Several had been recently founded, and did not appear to be operational. Those that had established operations were from unrelated industries such as construction materials, luggage and adult toys. While China has seen a dramatic rise in companies switching industries to produce personal protective equipment (PPE), the credible ones typically have a track record in producing similar products.
  • Nine companies had some track record in the medical sector, but had only switched to producing PPE from unrelated products in response to COVID-19. Some were able to provide copies of relevant certificates and licences, while others were still applying for them. Liaising with these kinds of companies is less risky in terms of product safety, but ultimately without the licences and certificates they will be unable to export the goods overseas.

The client was able to disregard those companies without a credible history and focus on further discussions with those already licensed to export, while building a relationship with some of the nine companies that had recently expanded their medical goods production to include PPE, to build up a pipeline for future deliveries.

RISK OF COUNTERFEIT CERTIFICATES

A new type of agency has recently appeared on the market, promoting their ability to assist manufacturers with export procedures. Not all these agencies are legitimate and they may seek to take advantage of the inexperience of mainland China-based manufacturers that had previously been supplying only to the domestic market, but are now seeing unprecedented demand from international buyers.

These new agents claim to be able to assist manufacturers with the EU’s CE certification and advertise their services with fees ranging from RMB8,000 (US$1,100) to RMB28,000. CE accreditation for medical devices can take weeks or years to complete under normal circumstances, and the process varies according to the product. Between the complexities of, and unfamiliarity with, these new procedures, and amid a high-pressure business environment, manufacturers may mistakenly obtain counterfeit quality certifications and present these in good faith to buyers.

The global risk consultancy, Control Risks, has spoken with legitimate distributors who report being offered illegitimate materials for sale to present to prospective personal protective equipment (PPE) or other COVID-19-related medical equipment buyers. This has included counterfeit certificates, fake purchasing orders, and, in one case, even videos of equipment stocked in a warehouse to be provided to buyers as false proof of the existence of adequate inventory to fulfil orders.

To address this developing risk of counterfeit quality certification and unqualified agents, on 5 April 2020, China’s Administration for Market Regulation issued guidance and named qualified agencies for relevant export procedures. Included in this guidance were eight agencies that authorities recognize as having the authority to award CE certifications, and 44 agencies that have the authority to support ISO13485 certification (the standard for a quality management system for the design and manufacture of medical devices) in mainland China.

EFFECTIVE DUE DILIGENCE

Gaining a good understanding of mainland China-based partners in the medical industry is challenging under normal circumstances, but in the current climate a focused public record review can provide a significant level of comfort.

In-person site visits to verify the existence, condition and nature of operations of a manufacturer can provide even greater assurance and validation of your supply partner’s ability to meet your organization’s needs. Not only Chinese-language capabilities, but an understanding of the challenging and quickly changing market conditions and regulations, are key.

Turnaround on screening and contracting processes is urgent and highly compressed amid the pandemic, putting added pressure on compliance and procurement teams. Despite overwhelming pressure to acquire COVID-19-related medical equipment quickly, just a day or two is enough to be able to establish whether supply partners are who they say they are, and whether they are likely to be able to follow through on a contract in line with your expectations.

When it comes to the identification and screening of supply partners, while COVID-19-related supplier screening does not need to be onerous, there are some crucial issues to address to ensure a successful supply partnership:

  • Is the supplier a legitimately registered company? Is it appropriately registered to manufacture relevant medical equipment? Does it have a relevant, positive track record in delivering these products?
  • Who is the ultimate manufacturer of the goods? Is your partner the supplier, or are they subcontracting out to another company?
  • Will your supply partner be able to get the goods out of China? Do they have the necessary licensing and credentials to meet export requirements?
  • Will the company be able to meet order numbers as contracted? Are there any indications they may delay or default in fulfilling the contract, including overwhelming client demand or financial issues?
  • What is the ownership structure of the company? Is the company associated with any government entities? Is it politically exposed?

Being able to address these critical questions is key to ensuring the success of obtaining vital COVID-19 medical supplies.

Rosie Hawes is a partner at Control Risks’ compliance, forensics and intelligence practice in Greater China and North Asia.