This article has been written by Angana Sarmah, pursuing a Diploma in International Business Law from LawSikho.

Introduction 

State-owned firms have long dominated the industrial and commercial sectors of most economies around the world. They’ve had a chequered history and now face extreme challenges and threats as a result of rapid changes in the commercial landscape. Despite the fact that the new consumer-oriented economy needs a level of flexibility and responsiveness that state-owned organizations normally lack, SOEs have traditionally assisted the government in reforms and their role has become even more critical. 

This article aims to give our readers an outline of this crucial part of any economy called “State-owned enterprises” commonly known as SOE and will provide an overview of the facts that lead to SOE restructuring. A special highlight is given on SOE restructuring in China with a brief discussion on China’s SOE reform process, current policies, and what they mean for the foreign investors who wish to invest in state-owned enterprises. Before getting into the restructuring part of SOEs, let us first understand what are State-owned Enterprises in the first place.

State-owned enterprise

A state-owned enterprise (SOE) is a business enterprise that is created by a country’s government to perform commercial activities on its behalf. The main target of the state-owned enterprises is to serve the people of their country and help in creating an environment full of growth and stability. It is significantly controlled by the government or state through full, majority, or significant minority ownership and is typically reserved to participate in specific commercial activities. 

SOEs are also known as state-owned companies, state-owned entities, public sector undertakings, government business enterprises, crown corporations, commercial government agencies, state-owned corporations, etc. In India, SOEs are commonly referred to as Public sector undertakings (PSUs) and the government holds a majority in those entities.

State-owned entities mainly operate in the sectors such as railways, postal services, natural resources, weapons, banking, broadcasting, natural resources, and telecommunications.

Let’s take a look at some of the benefits of state-owned businesses:

• Governments are inclined to financially support SOEs regularly.
• SOEs receive benefits from the state-owned banks in the form of low-interest rates on loans.
• SOEs being one of the dominant parts of the economy have access to a large customer base.

Creation of SOEs

The process of creation of SOEs differs from country to country. The majority of countries need government resolution or legislation through approval from parliament in order to create an SOE. In India, for example, Public sector undertakings (PSUs) are set up through an act of the Parliament. In the case of Finland, if the creation of an SOE has any effect on public finances, then it has to come into existence through legislation. In many countries across the world, a Cabinet decision or decree is mandatory for the creation of SOEs.

Understanding restructuring

Restructuring is a type of corporate action plan considered by the company to reform the financial and operational aspects of the company, typically while under financial duress. The ultimate goal of restructuring is to improve the business and help its government to achieve financial and economic stability. There are other factors that can call for restructuring, such as, if the company is aiming for a merger, is out for sale, or change of ownership. The main aim of restructuring a company is to make the business more efficient, integrated, and profitable. In cases, where a company is going through an internal restructure, then the process, departments, and operations are subjected to major changes in order to make its employees and operations more efficient and unified. The restructuring process often leads to heavy negotiations on restructuring plans which requires professional advice from legal and financial advisors. 

However, it has been witnessed that all corporate restructuring does not necessarily end on a positive note and there have been instances, where the company admitted downfall and started liquidating its assets to pay off its creditors before permanently closing. We might witness more restructuring in the future as this global pandemic has resulted in major financial losses for many SOEs across the world.

Factors leading to the restructuring of SOE’s

In many countries, state-owned enterprises are in a very poor state. There are various reasons why SOEs function inefficiently and are rather seen as a drag on the development of the economy. Mismanagement, incompetence, political interference, deteriorating financial fundamentals, excessive debts, lack of vision, a lack of skills, lack of investment and corruption, all these factors have led to huge financial losses of SOEs. The governments are providing constant life support to these state enterprises in the form of huge financial assistants. Governments are fuelling millions funding poorly managed SOEs and striving to keep them alive. SOEs are going for diverse types of restructuring such as manpower, operations, strategic, financial, and organizational restructuring including setting up of joint ventures in many countries across the world.

SOEs in China

As per reports, Chinese SOEs contribute to approximately 30 percent of the country’s GDP. This percentage exceeds that of many other developing countries in the world. 

The State-owned Assets Supervision and Administration Commission of the State Council (SASAC) was established in the year 2003 by the People’s Republic of China, it is a special institution directly subordinate to State Council. The objective of SASAC is to manage and supervise the activities of state-owned enterprises. In China, SOEs can be divided based on their supervising body into four categories:

• SASAC is regulated and supervises the Central industrial SOEs;
• SASAC also regulates and supervises the Local State-owned and State-holding enterprises in 36 provinces;
• The Central Huijin Investment Co. Ltd. regulates the financial institutions; and
• The Ministry of Finance (MOF) supervises all Entities.

China’s economy has relied heavily on SOEs, an economic organization considered to have lower production efficiency, yet has achieved outstanding economic growth.

The heavy policy burdens and the soft budget constraint also led to lower performance among SOEs. Because of their special role in the economy, such as the need to maintain social stability, Chinese SOEs bear heavy policy burdens, including (a) high capital intensity (especially in strategically important industries), suggesting high financing costs, and (b) the costs related to retirement pensions, social welfare, and the hiring of redundant workers.

Chinese SOEs are social enterprises in the sense that they are designed to efficiently balance the demands of numerous stakeholders. China provides a better enabling ecology for SOEs to promote the development of social value, allowing them to forego profitability and efficiency when it is necessary to fulfill social duties. As a result of this feature, the Chinese government is able to concentrate on developing social welfare with supporting economic infrastructure.

SOE reforms in China

In the last few decades, SOEs in China has undergone several stages of critical reforms aiming to improve their governance. It has been noted that China is privatizing by gradually reforming its state-owned enterprises into modern corporations enabling them to compete with other strong economies of the world. The central feature of China’s economic development planning is through increasing the competitiveness of its SOEs and transforming them into excellent enterprises. 

Since the late 1990s, there has been a wave of large SOEs mergers and privatization and they have remained a dominant entity in the process of developing the economy of the country. The government of China is aware that SOEs are poorly managed and are less efficient, therefore constantly striving to make the country’s SOEs bigger, improved, efficient, and stronger, and consequently turning them into modern competitive corporations. It has been observed that Mixed-ownership reform, SOE Mergers & Acquisitions, and Foreign Investments have remained the key feature of the restructuring process of SOEs in various industries and regions across China.

As per data from SASAC, two-third of all corporations under central SOEs have attained mixed-ownership. The corporations under mixed ownership are from the field of railways, natural resources, construction, and electricity.

China plans to complete more than 70 percent of the reform tasks by implementing a “2020-2022 3-Year Action Plan” by the end of this year. China unveiled this new three-year action plan in 2020, hoping to address unbalanced development in China using the power of SOEs and to take reform in state-owned assets and firms to a new level. As per reports, in order to facilitate the mixed-ownership reforms of the country’s SOEs, a financial boost of around 200 billion Yuan was established last year. 

The restructuring of SOEs in China is expected to enhance corporate governance and achieve efficient financial and operational management by bringing in private investors as stakeholders of the SOEs. That includes more projects in the mixed-ownership reform and state-owned asset restructuring. Corporate decisions, operations, and talent management will be more market-oriented. The goal is to introduce more private capital into the state-owned economy and improve state-owned entities’ profitability.

The SASAC said that it will go all-out to reduce the debt on SOEs and to stabilize the debt: asset ratio and to make SOEs stable, it also vowed to increase its efforts to forestall major debt risks.

Foreign Investment Laws in China

The new Foreign Investment Law (FIL) clarifies that foreign investment will undergo scrutiny under the ‘negative list’ system.  As long as the Foreign Investment enterprise does not fall under the ‘negative list’, such enterprise will be exempted from the requirement of pre-approval and recordal filings. 

A foreign investor who decides to invest funds in the reform of SOE through merger and acquisitions or by any other means, which involves national security (such as military-related industry, agriculture, energy and resources, infrastructure, transport, technology, and assembly manufacturing), then such investment will be shall be subject to review on national security as per relevant state regulations.

Foreign investors must meet the following requirements for participating in the Restructuring of SOEs:

• Before restructuring, the holder of state-owned property must organize all debt and liabilities, settled all debts of the SOE;
• The restructuring SOE shall jointly with the investor execute a structure for payment settlement of its employees, staff, and workers if the investor holds the controlling right of the SOE/ owns the SOE in the entirety/ or an essential part of the SOE’s assets is transferred to foreign investors;
• For asset-based restructuring, the pre-restructuring enterprise’s debt liabilities and credit rights will continue to be a liability. Other restructuring procedures require the post-restructuring firm to assume responsibility for past credit rights and debt responsibilities.
• The restructuring party should make information about the restructuring public and ask international investors to engage in the restructuring in a big way. It should also look into things like qualifications of the foreign investors, credit ratings, financial position and stability of the investor, management ability, payment security, and so on.
• Public bidding shall be considered in the restructuring procedure in cases where transferring state-owned properties or selling state-owned assets are involved. This will aid to ascertain and identify potential and competent foreign investors and will also help to achieve adequate selling or transferring amounts.

Taxation of resident enterprises

Enterprises with foreign investments, such as Sino foreign equity joint ventures, Sino foreign cooperative joint ventures, and fully foreign-owned enterprises are liable to pay Enterprise Income Tax (EIT) at the rate of 25% on their worldwide income, irrespective of the fact that whether such income is generated from outside or inside China. All Resident enterprises and Non-resident enterprises having income in China are liable to pay tax under Enterprise Income Tax (EIT) at the rate of 25%. Resident enterprises and Non-resident enterprises are also liable to pay VAT on import of goods, sale of goods, sale of property, lease of property, etc., in addition to EIT.

Conclusion

SOEs reform is urgently needed to aid the planned transition to a market economy and China’s SOE reform has been central to China’s economic reform over the last 40 years. However, Institutional flaws, on the other hand, necessitate a more cautious approach. SOEs have also aided the government in achieving policy goals such as social stability, as well as advancing national interests. But governments are finding it more difficult to give subsidies to loss-making SOEs as the contribution towards national output is falling. SOEs face a number of challenges and concerns, including the need to reform in order to increase efficiency, boost investment, and, as a result, develop and employ people.

References

1. https://www.investopedia.com/terms/s/soe.asp.
2. https://www.china-briefing.com/news/chinas-soe-reform-process/.
3. https://news.cgtn.com/news/2021-02-08/SOE-reform-to-tackle-China-s-uneven-development-XIF3L8R1Ju/index.html.

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