A worker packs up new smartphone devices at the end of the production line at Huawei's production campus on April 11, 2019 in Dongguan, China. Kevin Frayer | Getty Images

BEIJING — China is making changes to the local business environment, in a move that's expected to vastly increase the amount of data companies must share with the central government. Chinese authorities want to collate information from businesses operating in China — domestic and foreign firms alike — and integrate them into a centralized digital database, according to a report released Aug. 28 by the European Union Chamber of Commerce in China, in cooperation with China-focused consultancy Sinolytics. While Beijing insists the system is meant to create a "fair, transparent and predictable" business environment, there are concerns about how the government might use the data, especially in light of escalating trade tensions with the U.S. The new system could also bring China significantly closer to its goal of tracking the actions of people and businesses so that it can reward behaviors it likes and punish behaviors it doesn't — the so-called "social credit" system.

The new database enables the government to track and monitor the activities of all businesses in China. It also seeks to improve how companies comply with the law, and raises the penalty for those working with partners involved with fraudulent activity. A test version of the massive database — called the National "Internet+Monitoring" System — is likely to be released in September, and a final version by the end of the year, according to the EU Chamber and Sinolytics report. Joerg Wuttke, president of the European Union Chamber of Commerce in China, said at a press event on Aug. 28 that the new system can help level the playing field between domestic and foreign businesses in China. It can also enforce Chinese law better since there's less room for "fiddling by government officials," he added. "We think it has a clearing effect on China," he said.

China's 'social credit' system

The corporate monitoring system appears to be key to making the country's much-debated social credit system a reality. The goal of the database is to integrate a multitude of information collection channels that already exist in China, thereby overcoming a major hurdle for creating a nationwide social credit system by 2020. To be clear, the credit system pre-dates the latest trade tensions and plans were formally launched by the powerful Chinese State Council in 2014. When completed, the full social credit system will target individual citizens, businesses and the Chinese government, according to Beijing-based research firm Trivium China. It will consist of three parts: a master database, a blacklisting system and a structure for punishments and rewards. Most media reports so far have focused on how the social credits will track individual actions in China, but the government appears to be stepping up its emphasis on the corporate aspect. In fact, the State Council agreed in June to establish a credit record system for "market players" and "institutions" that would reward and punish "acts of good or bad faith" and tie them to a company's registration number. Theoretically, once the corporate social credit system (SCS) is up and running, the government can see whether a company has complied with regulations, or engaged in the potentially vague definition of "good behavior," according to the EU Chamber and Sinolytics report. "Higher scores can mean lower tax rates, better credit conditions, easier market access and more public procurement opportunities for companies. Lower scores lead to the opposite, and can even result in blacklisting," the report said.

It opens the opportunity to use the system in a fairly targeted way in the midst of a trade conflict. Bjorn Conrad Sinolytics CEO

The analysis also notes that companies will bear the burden of tracking whether their business partners, such as suppliers, are adhering to government rules. The ratings of individual employees can also affect a company's score. But the authors warn: "It is no exaggeration to say that the Corporate SCS will be the most comprehensive system created by any government to impose a self-regulating marketplace, nor is it inconceivable that the Corporate SCS could mean life or death for individual companies."

A potential weapon in the trade war

A system that can limit market access significantly raises concerns for foreign companies, and that's especially pertinent in light of an escalating U.S.-China trade dispute. Sinolytics CEO Bjorn Conrad estimated the data that companies will need to provide could be ten times more than the current requirement. He pointed out that most of the information isn't sensitive, but he was surprised by how quickly the government departments were working together to get the system up and running. "It opens the opportunity to use the system in a fairly targeted way in the midst of a trade conflict," Conrad said at last week's press event. China is also taking steps to improve the ability of overseas businesses to operate in its historically closed market. A foreign investment law, set to take effect Jan. 1, 2020, addresses some complaints about forced technology transfer and lack of intellectual property protection — key sticking points in trade negotiations between Washington and Beijing. But the EU Chamber and Sinolytics report points out that the implementation of a social credit system indicates how China is stepping up other kinds of controls as well. "The lifting of hard market barriers can therefore be explained, at least in part, by the government's growing confidence in its ability to influence companies, both foreign and Chinese, in a more nuanced way," the authors wrote.

Implications for businesses

There are also worries that authorities are developing parallel blacklists, raising concerns about their potential connection with the corporate social credit system. The State Administration for Market Regulation, whose oversight includes anti-monopoly practices and market entity registration, is working on a list for "heavily distrusted" market entities. The market regulator did not immediately respond to CNBC's request for comment on whether the list was related to the National "Internet+Monitoring" System. The Ministry of Commerce also has plans for an "unreliable entities list," which was announced in late May following the U.S. decision to put Chinese telecom giant Huawei on a blacklist that effectively prevents it from doing business with its American suppliers. During a press conference last Thursday, Commerce Ministry Spokesman Gao Feng said that as far as he understands, the "unreliable entities list" is separate from a credit system. "What I would like to emphasize is, the Chinese government's strengthening of the development of the corporate social credit system, is in order to create a more standardized, fair, transparent and predictable legal business environment," Gao said in Mandarin, according to a CNBC translation.

One of the major differences between the Chinese business environment and that of major countries in North America and Europe is the role of law. In Western countries, government and private entities must abide by the law. In China, respect for the law tends to depend more on authorities' willingness and interpretation of how to implement it, often contributing to variations in practice at a provincial or municipal level. That can create certain business opportunities, but also greater uncertainty. "There's a lot of companies here that are content to drift around in grey areas ... Now this system, the emergence of the (social credit system), means they can't do that anymore," said Kendra Schaefer, head of digital research at Beijing-based research and analysis firm Trivium China. She is also a project lead for Trivium's research on social credit. However, she said the biggest concern for companies is that a simple violation could have significant consequences. She also pointed out that the corporate social credit system can force foreign companies to operate in alignment with Chinese authorities and against the interests of foreign countries.

How it will be done