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Breaking China – does the PRC market crash leave your supply chain exposed?

28 July 2015

While European media has been in a frenzy for the last few weeks over the deal or no deal implications of a bailout of the $238bn Greek economy, rather less attention has been paid until very recently to the $10.36tn Chinese economy which has been suffering its own economic turmoil.

An estimated $3tn was  wiped off the value of the Chinese stock market between June and mid-July, leading to unprecedented intervention from the Government which has imposed banning orders on some companies from selling stocks for six months and taken various other measures which, at the time of writing, seem to be having limited effect. If that sounds a lot to lose – it is – the loss in value is roughly the equivalent of the entire UK GDP being deleted in six weeks.

Media coverage has been mixed – some panicky; some facetious – red is normally a lucky colour in China; some less concerned, pointing out that the percentage of the total population in China with direct exposure to the stock market is small (while, perhaps, losing sight of the likelihood that many of those who are exposed will have median or above average income and will therefore be important for the growth of the domestic consumer economy and for the continued growth of the burgeoning market for European imported items of €164.7bn last year).

Clearly, if you have operations in China or sell directly to it, then you should already be thinking carefully about the direct and indirect implications of the stock market crash.

However, on any level, when €302.5bn of EU products and services come from China each year and a little over half of that goes back, anything which makes China sneeze should make any senior business leader – including lawyers – pause for thought.  

So, what can you as a GC or in-house lawyer be doing right now to try to mitigate any possible fallout for your company?

Most importantly, if you don't know it inside out already, get familiar with the supply chain to you, and with your customers' supply and sales chain of which you are a part. Can you see any bits of the chain which have "material" links into and out of China?

Bear in mind that "material" may mean a small volume of supply of something critical to your business as well as a large volume supply. An obvious example is "rare earths" supply – look on Google for a few minutes if you're not familiar with them – it is quite thought provoking.

Then back to the lawyering! Do you have all of your live contracts accessible? What kinds of break clause do you have in place with your suppliers and with your customers? How will the wording of any force majeure clauses affect your business? Do they account for this kind of economic eventuality? Contractually, do you have freedom to seek out alternative suppliers and, if so, who in the supply chain to you should be doing this, when and at whose expense? If the Chinese component is at the top of your supply chain then what is the possible impact on that supply chain – what happens if a link in the chain goes bust?

So, assuming you or your team has a role to play as a contract lifecycle manager on the buy and/or sell side, it's to best to analyse – and analyse now – those contracts in detail to surface any likely exposures from prime contractors and subcontractors and towards customers who you might not be able to supply or from whom payment might not be forthcoming. If this role is performed by another team then it might be wise to prompt them to do this analysis now so that you know where you are in the event that things in China get worse.

So it's still up for debate as to how serious this recent crash really is; some argue it's trivial and the actual impact on business will be relatively minor. But either way it's as well to prepare as it is quite possible that this collapse will create issues which last for years. A lot will depend on how exposed your suppliers or customers are, directly or indirectly, to funding from what is – and is likely to remain – a very unstable stock market. There will undoubtedly be an impact on trade finance and working capital in your supply chain and in the purchasing chain for any of your customers who sell (in)directly to China, so you need to look at how easy it is to make changes to your contracts – or, even, to get out of them – if you consider that the current uncertainty is exposing you to an uncomfortable level of risk.

Either way, it's far better to form a view now and decide not to react than to leave it too late and realise you've, well, left it too late.