Rio Tinto Arrests Underscore Challenges Of China Trade

After more than five weeks in detention on suspicion of stealing state secrets, Chinese authorities on Aug. 11 formally arrested four employees of Anglo-Australian miner Rio Tinto (RTP-N, RIO-L) on charges of bribery and stealing commercial secrets.

The employees, including an Australian national, had been part of a sales team hammering out multibillion-dollar iron ore contracts with China. Chinese authorities say the employees were bribing officials at state-owned steel mills to get market information about the steel industry that they could use against China in their negotiations on iron ore contract prices.

The arrests have strained Sino- Australian relations and likely elevated blood-pressure levels among some foreign operators in China — many of whom are scurrying to consult lawyers about what kinds of market information gathering is legal in the world’s fastest growing economy.

The question of what constitutes a “state secret” and what sorts of market intelligence and data is illegal to possess and what isn’t — particularly when so many agencies and businesses in China are still fully or partially state-owned — is a quandary for most foreign companies who are used to collecting market data in the normal course of doing business.

“It is a different way of doing business there and recent developments highlight the political risk,” concludes a Toronto-based mining analyst who did not want to be identified.

“I think it is more of an issue for the major mining companies — the smaller operators will sneak under the radar.”

Nico Howson, a long-time China watcher and now assistant professor of law at the University of Michigan Law School, argues that the law of state secrets in China is “overbroad and abused in connection with application to PRC (People’s Republic of China) citizens, in particular dissidents and their legal counsel.” The main problem is that the law does not require that certain information be identified as a “state secret” for its possession by a non-authorized person to make that person subject to prosecution,” he says.

“Foreign companies are well-advised to avoid procuring information which is obviously privileged and to set up internal controls ensuring that their employees don’t act overenthusiastically in seeking out such information,” he cautions.

Howson also points out that the Australian citizen who was arrested, Hu Shitai, was born in China and graduated from Beijing University, while the other three Rio Tinto representatives are Chinese citizens. “An interesting part of the story is the selective prosecution against Rio Tinto’s PRC-origin employees,” he says. “If the People’s Procurate is pursuing a bribery prosecution, why — in addition to Chinese steel mill ore buyers and PRC-origin personnel at foreign ore sellers — are Rio Tinto, and its foreign citizen executives who did the real negotiating, not implicated?”

Many analysts, mining executives and lawyers looking at the case also strongly believe the arrests had nothing to do with Rio Tinto’s decision in June to cancel a US$19.5-billion deal that would have given Aluminum Corp. of China (ACH-N), or Chinalco, part ownership in the company. (Rio Tinto then formed a deal with BHP Billiton (BHP-N, BLT-L) instead.)

“I am not into conspiracy theories,” says Assif Shameen, a veteran Singapore-based journalist and commentator on Asian business. “The Chinese aren’t the country bumpkins they were a decade ago — they know how Wall Street works and after all they have two trillion bucks invested in U. S. T-bills, bonds, equities and so on. They know that the Chinalco deal was a non-starter once the credit crunch began to ease in mid-March and commodity prices began to recover.”

Chinalco could have come back with a new restructured offer and worked things out with the Rio board, Shameen adds, but the way the deal was structured earlier really didn’t leave room for that.

Shameen and others interviewed for this article argue that the arrests of the Rio Tinto staff have to do with the strategic importance of iron ore to China and endemic corruption in the steel industry more than any tit-for-tat behaviour against Rio Tinto. (Chinalco remains a shareholder in the Australian mining giant.)

“There’s been a very strong problem here for a very long time in terms of how the steel sector has been run and to use an analogy, I’d say that ‘the referee has always been there but they’ve never been to the field,'” notes a Vancouver-based mining executive who has spent several years working in China.

“I don’t know a huge amount about the iron ore negotiations but as I understand you’ve got some larger groups in China who get the right to negotiate long-term contracts with the big guys — the Rio Tintos, the BHPs and the Vales — and then they sell off those rights to the smaller guys and that’s where you start to get the potential corruption and bribes to get access to ore.”

In the view of the executive, who wished to remain anonymous, it is the multiple layers and inefficiencies in China’s competitive steel sector that increases the potential for conflict and corruption.

“The fact is you’ve got these multi-tiered, different-sized steel mills all trying to compete and get a share of raw materials so I suspect this causes strains and bribery,” he asserts.

The executive also pointed out that the government is now trying to root out some of the corruption in the industry. “This time someone has decided to enforce the rules and how you interpret that in China is viewed differently,” he explains. “Is it espionage or spying? I think there is huge miscommunication about what people are doing and what information they are gathering.”

Daniel Harris, a specialist on international law at Harris & Moure, a Seattle-headquartered law firm, argues that China made the arrests for domestic consumption. In a blog, he recently stated that Beijing is “trying to show they are in control and they have done this to assert their control over iron ore pricing and to show the populace that when it comes to corruption, nobody is above the law, not even foreigners. . . This matter has always been a lot more about what the Chinese government is trying to say to its own populace than what it is trying to say to foreigners.”

Howson of the Michigan Law School agrees that the steel industry in China is well known to be corrupt. “The Chinese government has begun to arrest Chinese steel industry executives, including Shougang’s Tang Yixi, and thus, this may be a bribery prosecution which reaches into the whole industry.”

In Howson’s view, the case highlights what has been both a problem and an opportunity in China. In Rio Tinto’s case, it was the opportunity to continue to sell masses of Australian-origin iron ore to hungry Chinese steel producers, he says.

“The challenge or problem is for foreign companies like Rio Tinto not to succumb to easy promises of privileged access, privileged information, or some kind of special step up promising completion of a huge and profitable deal,” he argues. “For almost two decades, China’s trade and investment environment has been littered with such promises and a good deal of corrupt exchange that has deprived foreign and Chinese investors and traders of anything like a level playing field. The problem is now especially difficult in regard to PRC-origin but foreign-educated returned executives (haigui) who can gain posts as representatives of large foreign concerns based upon the promise of special access, connections, and information.”

For observers like Shameen, however, the case really highlights the importance of iron ore to China as a strategic metal on which the growth of its economy depends. China is the world’s dominant consumer of iron ore, without which there would be no steel plants, no improvements in China’s infrastructure, little growth and social chaos.

“Iron ore is to China what oil is to the U. S.,” he ex
plains. “Remember what the Kuwait War was all about? It wasn’t about democracy or the sovereignty of some sheikdom but ensuring oil supplies to the U. S. So you need to look at this Rio/iron ore case the way you look at the Kuwait War. It’s all about ensuring supplies of a key resource without which your economy and your entire economic growth plan will crumble.”

While the arrests have undoubtedly raised the level of uncertainty about the invisible lines and grey areas of doing business in China — many agree that the case has been overblown in the media, particularly in Australia — and that the outcome won’t have a long-term impact on foreign companies doing business in China.

“It won’t cast a chill over mining investment in China although companies looking to enter the region will no doubt tread more cautiously,” noted the Toronto analyst.

Others see it this way: China has emerged as a huge consumer of goods, services, and resources. Last year, car sales in China surpassed those in the U. S. for the first time in history. China is now the world’s second-largest importing nation. Consumption levels are currently only 37% of the country’s gross domestic product in contrast to 70% in the U. S., but that figure is expected to swell in the years ahead. By some estimates China consumes 42.6% of the world’s coal, 60% percent of its iron, 38% of its steel, 54% of its cement, 28.5% of its copper and 35% of its aluminum.

“Everyone is bending over backwards to please China,” veteran journalist Shameen argues. “Ten years ago, there were hundreds of multinationals setting up shop in China but few actually made any money. Fast-forward to 2009 and most multinationals are losing money in the U. S. and in Europe, or barely breaking even, and the only place they are really making a lot of money is China. Will they do something to jeopardize that? No.”

Anecdotally, Shameen points to McDonald’s and Starbucks to make his point, arguing that the multinationals make more money per person, per burger, per cup of coffee in China than they do in the U. S. Will they walk away because four people got arrested in China or will they expand, he asks rhetorically. “You bet they will open more stores in China.

“Mining companies more than anyone know that China is where the real demand is,” he says. “They will be the last ones to retreat.”