How is China approaching SOE reform

The government sees SOE reform as a strategic tool for increasing the competitiveness of the state sector.

The ongoing reformation of China’s state-owned enterprises (SOEs) is a critical part of the country’s future. Increasing SOEs’ competitiveness and transforming them into world-class enterprises is a central feature of China’s economic planning. Evidence of the progress made to date is the fact that SOEs occupied 82 of China’s 129 spots on Fortune’s Global 500 list of the world’s largest corporations by revenue in 2019¹.

How we got here

China’s SOEs have undergone a series of progressive reforms since the 1970s. Having started as state-controlled and managed factories, SOEs began converting to the model of modern corporations in the 1990s. In 2003, the State-owned Assets Supervision and Administration Commission (SASAC) was established to fund and regulate non-financial SOEs, which were eventually grouped into three categories: key industries², pillar industries³ and normal industries^{4 5}. Relative to their role in China’s national security and economic development agendas, each category came with differing levels of control from the government, with “key industry” SOEs subject to the most control.

In 2013, the government stepped up its merging of large SOEs and its permission of mixed-ownership programs, which has continued until today. The 2013 reforms, which were reinforced in 2015, also transitioned the government’s role in SOEs from “managing assets” to “managing capital”⁶. This had the effect of limiting the government’s role to the strategic allocation of state capital and reducing its direct intervention in SOEs’ daily operations, with the aim of increasing the overall efficiency of these enterprises.

The government’s “managing capital” model was made concrete in 2017 with the introduction of a grouping scheme with three classifications – industrial enterprise groups, investment groups, and operating groups⁷. In this set-up, the government would no longer directly manage the commercial activities of individual SOEs, but only the investment and operating groups, determining SOEs’ overarching strategic direction and dispensing capital as per their needs. 

The current state of play

Fast-forward to today, and SOEs are being positioned as the primary driver of China’s economic and technological future. The current reform agenda is unambiguous in its intention to make SOEs “stronger, better, and bigger”. The approach is to follow what the SASAC has dubbed zhuada fangxiao (grasp the big, release the small), which has significantly reduced the number of small SOEs through privatization and asset sales, while at the same time increasing the size of the SOEs that are seen as strategically important for the state economy⁸.

The vision for SOEs can be summed up in a statement by the SASAC published at the end of 2019: “The focus will be on ramping up technological innovation by [SOEs], and making the most of SOEs to encourage innovation and develop the advanced manufacturing sector.”⁹

The reforms needed to achieve these goals are multifaceted. According to Chinese president Xi Jinping, the government will “promote strengthening, improvement, and expansion of state capital, effectively prevent [the] loss of state assets, deepen the reform of [SOEs], develop a mixed-ownership economy, and cultivate globally competitive world-class firms.”¹⁰

It is important to note that in this process, not all SOEs will be treated equally. To optimize the allocation of resources, a threefold criterion for identifying the SOEs to be reformed is in place. Only those SOEs that are most representative of their industries, have the most potential to benefit, and have the greatest capacity to integrate the reforms successfully will be chosen.

The how-to of mixed-ownership reforms

The success of China’s reforms – again, in view of SOEs becoming world-class enterprises – hinges on their approach to further introducing mixed-ownership and equity diversification into their business models. There are six important strategic points to be aware of.

Preparing for reform

To ensure the reforms are effective in their target organizations, certain preparations are necessary. These include SOEs examining the market environment such as the competitive landscape; identifying industry trends and tailoring their strategic planning accordingly; taking an inventory of existing resources relative to their business objectives; and mapping out clear, long-term development goals. These prescriptions for SOEs are to ensure they gain the most benefit from the implementation of the reforms.

Balancing interests

Mixed-ownership describes the ability of an investor to take a financial stake in an SOE. The implications require SOEs to balance the interests of three core stakeholders. One is the company itself and its long-term development needs, which is to say a given SOE should not build an asset portfolio that is misaligned with its own interests. The second is the company’s prospective investors, whose interests revolve around their ability to see returns from their positions. The third is the government, which wants to the see the reforms implemented in the optimal and most cost-efficient way. Aligning the interests of these three stakeholders is critical for the present reforms to return the desired benefits.

Good corporate governance

Corporate governance is another strategic element of the current reforms. As China’s SOEs have “corporatized” – that is, adopted the characteristics and structure of modern corporations – they have also maintained their identity as part of the state economy. The intention behind what has been called the “three groups and management” corporate governance framework is to advance SOEs’ marketization, competitiveness, and accountability. The “three groups” refer to shareholders, boards of directors, and supervisory committees; while the “management” dimension refers to SOEs’ senior management. The roles and interests of each are important to note.

Shareholders are equity investors in a given SOE. The board of directors guides senior management in developing corporate strategies and managing their implementation. Supervisory committees oversee the board of directors, governing their decisions to protect the interests of shareholders. Senior management are the day-to-day operators of an SOE and are accountable to the board of directors and the supervisory committee.

Also part of this mix (to varying degrees over the years) are market mechanisms that help all controlling parties with optimizing the allocation of resources and competing for talent.

Implementing reforms

Mixed-ownership reform can be implemented all at once or step by step, depending on what is most appropriate. The criteria for determining the approach to implementation revolve around the mix of assets in a given SOE’s portfolio and whether any assets need to be sold off before welcoming investment; the tax implications of introducing mixed-ownership reforms for a particular SOE; and whether clearly defined investment requirements have been promulgated for investors. Together, these measures will help the government, in conjunction with the SOEs, determine how best to approach implementation.

Allowing withdrawals

A major consideration for private investors is their ability to withdraw profits once they are made. If a given SOE does not have a viable process for investors to withdraw funds, they may not be ready for reform. That, or they may need more time to prepare. Ensuring a sound withdrawal process is key to successful mixed-ownership reforms. 

Dedicated teams

Building a dedicated team for planning and implementing mixed-ownership reforms in an SOE is seen as necessary for ensuring the process runs smoothly. Such teams are to assist with asset mapping, strategic planning, and investor research. They will also act as coordinators, keeping all involved parties informed and moving forward together.

SOE reform has been advancing since it began some 40 years ago. Today, China sees its state sector as a primary driver of growth across key industries. The SOEs that comprise these industries are positioned to receive increasing support as they attempt to transform their business models and increase their competitiveness, both at home and abroad.