Graft Fight In New Phase With UK Rolls-Royce Probe

The accelerating anti-graft campaign in China could be entering a new phase, with word that Britain's anti-corruption watchdog has formally launched an investigation into jet engine maker Rolls-Royce (OTCPK:RYCEY). The move marks the latest investigation of a major foreign firm related to its China operations, as Beijing itself engages in an increasingly aggressive campaign to root out corruption at state-owned enterprises. While this latest investigation is certainly a welcome development in the drive to clean up China's business environment, the acceleration of the broader campaign could also create major disruptions in the country's business world over the short-term.

News of the latest anti-bribery investigation comes from Rolls-Royce itself, which says that Britain's Serious Fraud Office (SFO) is formally probing the company for violations of domestic laws aimed at preventing companies from engaging in bribery and other forms of corruption in their overseas operations (English article). Reports on the probe say that Rolls-Royce is being investigated for possible bribery in both China and also in Indonesia. The reports note that Rolls-Royce itself conducted an internal probe earlier this year into possible corruption at some of its overseas operations, and that results of that investigation have been passed to the SFO. They cite one example of possible bribes given to the son of a high-ranking official in Indonesia, though no specific cases are cited for China.

I suspect the company also uncovered evidence of rampant bribe giving in its Chinese operations, since such practice is quite common in China. In this case, the bribes were most likely given to officials in China's aviation industry, since Rolls-Royce is one of the world's top 2 makers of commercial aircraft engines used on planes built by leading manufacturers Boeing (NYSE: BA) and Airbus (Paris: EADS). China has been one of the world's top buyers of aircraft from both companies over the last decade, as it rapidly builds up its fleet of aircraft to meet growing demand.

This new probe follows 2 similar ones launched in the US earlier this year against banking giants Morgan Stanley (NYSE: MS) and JPMorgan (NYSE: JPM). (previous post) In those cases, each company was probed for its hiring practices in China. Specifically, U.S. regulators were trying to determine whether the companies hired friends and relatives of powerful Chinese business and government leaders in an effort to win investment banking business from big state-owned companies.

The offshore probes mark the extension of a much larger campaign within China itself, which initially targeted foreign firms but has more recently taken aim at top officials in big state-owned enterprises. The drive started over the summer with price-fixing allegations against foreign milk powder producers. Since then most attention has moved to the big state-run firms, with executives from names like PetroChina (HKEx: 857; Shanghai: 601857; NYSE: PTR), Chalco (HKEx: 2600) and China Cosco (HKEx: 1919; Shanghai: 601919) all coming under scrutiny.

So, should this latest move by Britain's anti-corruption watchdog be cause for concern? The answer to that question is probably "yes" for British firms doing business in China and multinationals in general. I suspect we could see another investigation or 2 come from similar watchdogs in the U.S. and Western Europe, meaning all major western multinationals could be vulnerable for the next few months.

From my perspective, these investigations are certainly welcome and will send an important signal to foreign firms doing business in China that they can no longer engage in the kind of bribery and other corrupt practices that are far too common in the country. At the same time, however, this growing number of probes could also have a disruptive effect as many of the previous "channels" for doing business are suddenly shut down due to growing caution from everyone involved. As this major transformation takes place, look for disruptions to occur, creating confusion and even big temporary slowdowns in some industries.

Bottom line: The latest anti-corruption probe at Rolls-Royce marks the acceleration of clean up that will benefit China's business climate in the long-term but could lead to short-term disruptions.

Disclosure: No positions

Source: Graft Fight In New Phase With UK Rolls-Royce Probe

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