Phoney claims?

American presidents past, present and (perhaps) even future have all been drawn into the divisive China debate in the last month.

This week saw Barack Obama battling it out with contender Mitt Romney to talk toughest on trade politics and China. Romney in particular has been making headlines with his repeated promises (four in the most recent presidential debate alone) to label China “a currency manipulator” on his first day in office, should he be elected.

But last week it was more the spirit of long-gone Abraham Lincoln that Chinese executives were hoping to invoke, particularly his observation that “character is like a tree and reputation like its shadow”.

Huawei, now the largest global information and communications technology provider by revenues, first employed Lincoln’s aphorism last year in an open letter to the US government requesting an investigation into any concerns that Washington might have about its operations. The hope was that a formal review would clear the air. But the report’s findings – announced this month – only look like stoking up further acrimony.

What were the recommendations?

They came from the House of Representatives’ Intelligence Committee, after an 11-month probe into Huawei and its Chinese peer, ZTE.

The conclusions were pretty damning stuff: that the two firms “cannot be trusted to be free of foreign state influence and thus pose a security threat to the United States and to our systems” and that US network providers and system developers are “strongly encouraged to seek other vendors for their projects”.

This reflects longstanding American concerns that information travelling through Chinese-made networks could be snooped on, or even that crucial infrastructure could be disrupted or turned off through pre-installed “kill switches”. We have covered such suspicions before (see WiC96), as well as their role in derailing Huawei’s efforts to win new contracts or acquire businesses in the United States. But the belief was that a formal review would lay the ground for a more productive relationship with US regulators. If so, it was a forlorn hope.

So the Chinese firms are disappointed?

Very. They claim to have made strenuous efforts to reassure the American authorities that their suspicions are misconceived, with ZTE insisting that it set an “unprecedented standard” for cooperation between a Chinese company and a Congressional inquiry. Huawei has also said that it cooperated in an open and transparent manner.

But the investigators weren’t impressed by their efforts. “Neither company was willing to provide sufficient evidence to ameliorate the Committee’s concerns,” the report concluded. “Neither company was forthcoming with detailed information about its formal relationships or regulatory interaction with Chinese authorities. Neither company provided specific details about the precise role of each company’s Chinese Communist Party Committee.”

Huawei has come in for criticism in the past about its opaque ownership structure, which some allege is designed to obscure its residual ties to the Chinese military. In June we alluded to the rumours once again, after a story on the company seemed to lead to a local magazine’s entire print run being pulled from news stands in China (WiC155). But Stan Abrams, an IP lawyer and author of the China Hearsay blog, tends to agree that the two firms – at least from a Chinese perspective – probably did provide an unprecedented amount of information to the Committee. Yet this effort was doomed to failure, he says, by the gulf in worldview between the Chinese firms and the members of the Committee. “There was simply no way the two sides were ever going to come together,” Abrams suggests.

And both sides see the purpose of the investigation differently too?

For the Committee, the final decision was based firmly on security fears. As it explained during the hearing, the investigation was “not political jousting or trade protectionism masquerading as national security”.

American regulators also argue that their anxiety is more than justified, following a rising incidence of cyber espionage apparently from Chinese sources.

But the Chinese are deeply unconvinced. An immediate gripe is that no hard evidence of security breaches was made available in the public sections of the report, although its authors alluded to material in an annex to its findings, which was classified.

This lack of transparency chimes with complaints made by other Chinese interests, including Sany Group, about the blocking of a purchase of an Oregon wind farm near a US naval facility at the beginning of October. But the Chinese claim that no evidence was given on why the purchase constituted a security threat. In an unexpected twist, they are now suing Obama and his Treasury Secretary Tim Geithner for violating the US constitution.

One of Sany’s founders Xiang Wenbo complained to media of the US action: “They are petty scoundrels who can’t be reasoned with. The US treats China like a hostile country. Whatever we do is deemed as endangering American national security.”

CNET News, a tech industry journal based in the United States, also noted that the final report on ZTE and Huawei didn’t specify instances of data theft, although lawmakers had raised red flags about ZTE equipment enabled with “backdoors” for sneaking into networks undetected. Committee chairman Mike Rogers also told reporters about “numerous examples” of “beaconing” in which routers turn on independently and start to transmit data. Huawei has acknowledged a similar case in the past from a laptop belonging to one of its employees, which connected to a customer network and transmitted data outside of the country. But it insists that the laptop was infected via a shared WiFi network, and that the beaconing wasn’t prompted by Huawei software.

And the Chinese also say they are being singled out?

Yes, their second objection is that there is little logic in only targeting Huawei and ZTE when the rest of the industry also relies on Made in China components too.

“Virtually all of the telecom infrastructure equipment now sold in the US and throughout the world contains components made, in whole or in part, in China. That includes the equipment manufactured and sold by every Western vendor in the United States, much of which is made by Chinese joint venture partners and suppliers,” ZTE countered last week.

Hence the view that – if Huawei and ZTE are to be genuinely regarded as national security threats because of their Chinese origins – other vendors should also be subject to the same level of scrutiny.

So why do the Chinese firms think they are being blocked in the US?

They see it as a clear case of commercial skulduggery. “We have to suspect that the only purpose of such a report is to impede competition and obstruct Chinese ICT companies from entering the US market,” Huawei said in a statement to the press.

Huawei overtook Ericsson as the leading global supplier of telecoms equipment for the first half of this year, with $16 billion in revenues. It is also regarded by many as a new breed of Chinese challenger that develops its own technologies, rather than manufacturing or assembling them for overseas firms.

In August CNET News talked about Huawei as a “patent machine” which deserved credit for breakthroughs in networking standards that let mobile carriers support multiple communications on a single network. The Economist magazine took a similar line, noting that Huawei had won contracts in half of the rollouts of Europe’s 4G networks, as well as having pioneered the ‘dongle’ technology that allows laptops to connect wirelessly to the web.

This adds to the Chinese sense that US firms are running scared of the competition. Chinese newspapers including the National Business Daily have even alleged – citing unattributed sources – that Cisco Systems has been a guiding force behind the Committee’s findings. The allegation sounds unlikely, although there is a history of bad blood between the two companies, after Cisco sued Huawei for using stolen source code in its routers and switches. Huawei admitted to using some of the code (although it claimed it came via a third-party) and Cisco dropped the lawsuit after it was removed. But senior executives at the American firm have continued to chide Huawei in the press, includng comments from company boss John Chambers that the Chinese don’t always “play by the rules” on IP protection and computer security.

Cisco’s relations with ZTE aren’t too rosy at the moment either, after the termination of a sales partnership this month following revelations that ZTE was selling Cisco-branded networking equipment in Iran.

So it’s only in America that Huawei is running into problems?

This was the implication in much of the Chinese media’s coverage. Both companies also maintain that there is little hesitancy from hundreds of buyers in almost all of the 150 other markets in which they sell equipment.

In fact, that’s not quite true. The Indian government has expressed reservations, while Huawei has struggled to penetrate markets like Japan and South Korea. In March this year the Australian government also barred Huawei from bidding for contracts on its national broadband network, on advice from its own security agency that there was “credible evidence” that the Chinese provider was connected to the People’s Liberation Army, according to The Australian newspaper. The current risk is that the reputational blowback from the US Committee’s findings will prompt other security agencies to look again at Huawei’s products.

Just a day after the report came out this month, Canada also spoke out on Huawei’s bid to serve as a supplier to the country’s new ‘super pipe’ project for email, phone calls and data. “The government is going to be choosing carefully in the construction of this network and it has invoked the national security exception for the building of this network,” a prime ministerial spokesman told reporters. “I’ll leave it to you if you think that Huawei should be a part of [the] Canadian government security system.”

There were signs that something similar could be on the agenda in the UK too, after an announcement that Huawei’s relationship with BT could also be reviewed, including its role as supplier to BT’s new fibre broadband network. This would be particularly damaging. Huawei has trumpeted its working arrangements in Britain, where the security services have signed off on a vetting procedure said to ensure that only secure products are used in the national telecom infrastructure. If this falls through, it would be a public relations disaster.

So how might the Chinese firms respond?

One option is to refocus on other growth markets, not least the demand for new 4G networks at home in China. CBN was reporting last week that both Huawei and ZTE saw their overseas revenues peak as a percentage of total sales four years ago, although that trend might be reversed with the emerging opportunities to support new 4G networks in other markets. Here, the Securities Daily also expects Huawei to have an edge, especially as it is supporting the launch of China Mobile’s new TD-LTE network standard in a hundred Chinese cities next year.

Another approach – especially where suspicion about Chinese networking gear is greatest – is to focus on other products. Huawei has been doing this already in the United States by selling mobile phones, which did not fall within the remit of the security review.

“We’re not talking about handsets,” Congressman Rogers told the press conference in the aftermath of the Committee’s report, “only those devices that involve the processing of data on a large scale.”

Currently Huawei and ZTE have about 7% of the US mobile phone handset market between them, up from 4% a year ago, according to Strategy Analytics. Much of that is for lower-tier phones, although Huawei wants to win more of the smartphone segment and launched the Ascend P1 this year to generally favourable reviews.

But the challenge is how to build a loyal following among consumers, especially now that – if Americans have even heard of Huawei – the association could be a negative one.

Analysts say too that US carriers might now have second thoughts about supporting Chinese handsets, due to the Committee’s recommendations. Other business areas also could become harder to pursue. For instance, Huawei’s push into products for data centres and videoconferencing would seem more problematic given the backdrop of snooping allegations.

Chinese regulators might also choose to fight fire with fire, making it much harder for American networking firms to win new contracts in China.

This was the harder line proposed in an editorial in the Global Times last week, with a suggestion that other countries needed to understand that “if Chinese companies encounter harassment there, they should expect companies from these countries to meet the same treatment in China”.

Other newspapers made similar points, saying that there had to be more reciprocity in how network providers are treated and that it would never have been possible for foreign firms to win so many new contracts in China if its own regulators had shown similar prejudices.

Tea Leaf Nation, a blog that tracks China’s social media, reported on a similar annoyance online.

“Is America only secure when Chinese companies make hats and socks, and not high-tech products?” asked one netizen, as plenty of others called for a tit-for-tat shunning of American brands.

But similar to some of the unease at plans for an anti-Japanese boycott in August (see WiC161), others queried whether this would turn out to be disruptive.

Unlike Huawei’s limited presence in the United States, American products made by the likes of Apple are already deeply integrated into everyday Chinese lives, one netizen warned. And others simply questioned whether the fighting talk was an overreaction. “We were just boycotting Japanese goods, now we’re boycotting American ones?” was the weary riposte from another online contributor.

---

© ChinTell Ltd. All rights reserved.

Sponsored by HSBC.

The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.