Copyright © 2007www.khlaw.com

Its causes, effects, and a practical solution to providing customer assurance and restoring

markets

www.khlaw.comWashington, D.C. ● Brussels ● San Francisco ● Shanghai

Crises of Confidencein Chinese Food Ingredients and

Exports

Presentation by John S. Eldred, Chief Representative

Food Technology and Innovation Asia 2008

November 20, 2008InterContinental Hotel, Beijing

Keller and Heckman LLPShanghai, PRCThe Bund Center, 222 Yan’an Dong LuShanghai 200002, China+86 21 6335 1000; eldred@khlaw.com

Crises of Confidence in Chinese Food Exports

Two Crises: 2007 and 2008

2007 harmed exports, and the markets have not fully recovered

2008 broader because of the huge impact domestically in China, but also has affected exports

We will examine the causes of each crisis, their effects, and what can be done to restore markets and consumer confidence

2007: Last Summer’s Newspaper Headlines

“Chinese Gluten Linked to Pet Deaths”

“How U.S. Should Approach China’s Tainted Imports”

“An Export Boom Facing a Quality Crisis”

“Customers Worldwide Pressing Beijing to Act After Tainted Foods Cases”

“Farmed in China’s Foul Waters, Imported Fish Treated with Drugs”

The 2007 Crisis

Began in April, 2007 with the discovery of wheat gluten intentionally adulterated with melamine and cyanuric acid

Led to major recall and enormous press publicity

A large story became huge when the deliberate adulteration became apparent

The 2007 Crisis

This caused the press to focus and heavily publicize other incidents involving Chinese products that might have otherwise gone unnoticed.

In short order followed stories about

Diethylene glycol in toothpasteSalmonella in spice ingredientsUnapproved drugs in seafood

The 2007 Crisis

The press stories then spread to non-food items. Stories about defective automobile tires and toys with lead-based paint heightened U.S. consumer concern about all Chinese products.

Consumer concern in the U.S. drives business behavior and purchasing decisions.

The Causes: 2007

Two things come together at the same time:

1. Small Chinese operators cutting corners to reduce costs, without fear of real adverse financial consequences;

2. Coupled with, the U.S. press sensationalizing routine food-quality incidents, often without analysis of the issue. Such incidents occur regularly in the food supply chain throughout the world unaccompanied by a crisis atmosphere.

The Effects

Substantial damage to reputation of Chinese food products, ingredients, and additives

2007 Poll ：80% of U.S. consumers say “made in China” means “may be contaminated.”

Reduced Chinese exports to U.S. & EU

Potential new U.S. legislation/political consequences playing into hands of those in the U.S. who oppose free trade

Melamine Redux: The headlines:

50,000 children sickened, 12,000 hospitalized, 4 deaths due to melamine in infant formulaLocal government aware of problem in August but did not reportMore recently, melamine found in eggs, egg products and bakery agents in Japan and KoreaAsian bans of Chinese dairy products, recalls throughout Asia of a wide variety of processed foods

2008 Crisis

In short, blame to go around everywhere

2008 Crisis

2008 Crisis

The cause: again, unscrupulous operators adding melamine to milk

Motivated purely by greed

2008 Crisis

But a major assist in the crisis has to be awarded to:

GOVERNMENT, at all levels, for a failure to 1. inspect and prevent, 2. to act in a way that would deter the greedy perpetrators, 3. to have a judicial system that would make all who facilitated the disaster financially responsible; and to:

The Dairy Industry, for a failure to realize the potential for contamination and to institute a rigorous testing program to prevent it.

2008 Crisis

2008 Crisis

To elaborate on the causes:

Government should have recognized the potential, especially after the 2007 melamine incident, and should have required registration and regular inspection of milk collection centersAnd should be prepared to take quick action against any violators

2008 Crisis

Industry should have recognized the potential for any ingredient that has value due to protein content is potentially suspect, and should have a rigorous supplier qualification program backed up by lot by lot testing

2008 Crisis

May not yet be over: if milk and milk powder laced with melamine, why not eggs, soy, vegetable proteins: anything that can be diluted with water but where protein content is required

Some Remedial Responses

2007: After first silence, and then denials, the government acknowledged that there were problems. Some small businesses were closed, and a new “certification” program for exports was established.

A new recall system is to be implemented.

2008: A new Food Safety Law is to be passed, later this year

All dairy products required to register with government and more inspections implemented.

Shortcomings

These steps alone will not be reassuring to export consumers and customers.

A government certificate will not have significant meaning or be of much help.

China in many ways already has a good regulatory system.

Continuous inspection by independent third parties or the government is not feasible or necessary in China or elsewhere.

The Solution

Government and industry both have major roles to play. Government must establish a framework to hold violators accountable in a meaningful way, while still acting on the basis of sound science.

Industry must take steps to protect themselves and cannot rely on government alone.

The Solution to the Crises: Government

First, require registration and inspection of all “risk”areas

Recognize, however, that continuous inspection is not feasible

Vigorous and prompt prosecution of perpetrators of intentional violations to act as a deterrent to others

Establish judicial system that holds all stakeholders in the food chain accountable for significant financial damages. This will provide a deterrent effect not only to branded goods manufactures but to raw material suppliers as well.

The Solution: Industry Role

First, to recognize that quality has a price, and that procurement at the lowest price is not always best

Second, to “think ahead” of the perpetrators as to other situations that might arise, and to plan for them.

Finally, a “customer assurance program” to instill confidence in export customers and domestic consumers that their brands can be trusted.

Customer Assurance Program

Has three elements:

EducationTestingAudit

Customer Assurance: Education

Chinese processors must learn the laws and regulations of the export markets, so they will be prepared for import country testing.

Advice must be knowledgeable, experienced, and credible.

Advice will vary from product to product. For example, all additives and processing aids used in the production of agricultural products and ingredients must first be evaluated to see if they are permitted in the country of import.

Customer Assurance: Education

Determine if any pesticide residues present are in accord with the regulations of the import countries.

A determination that the product meets relevant national and international standards for processed foods and for food additives.

Where relevant, whether the product is free of pathogenic microorganisms.

Customer Assurance: Testing

Next, product needs to be tested by an independent laboratory that has credibility in the country of import. The type of testing will depend on the product to be tested.

To maintain credibility, the testing should be performed by an independent agent on a sample randomly selected from recent inventory or from an in-process sample.

This is due to a concern, real or imagined, that some firms keep “clean” samples to give to testing labs that are not representative of production.

Customer Assurance: Testing

Added assurance can be obtained by the agent selecting the sample also conducting an inspection of the processing facility, allowing him/her to observe hygiene and sanitary procedures, and to observe the presence of substances such as melamine which have no business being in a processing plant.

Customer Assurance: Audit

After a thorough evaluation and adequate testing of representative samples, the producer will receive an audit report from a competent authority attesting to the compliance of a given product with the import country’s laws.

Such an audit report should provide the assurance the customer needs.

Summary

These crises will pass, and others will be prevented, if

Government establishes a framework of deterrence and accountabilityIndustry does its job in putting quality first and in establishing a Customer Assurance ProgramAll sides base decisions on sound science and not politics

Summary

In summary, the Customer Assurance Program is a three point program:

EDUCATION of the producer to know what and what not to do

TESTING of a truly representative sample of the product, which if satisfactory will lead to an

AUDIT REPORT by a competent, credible third party organization with the requisite knowledge and high reputation22

Conclusion

Keller and Heckman LLP, with offices in Shanghai, Brussels, San Francisco, and Washington, can custom design an education, testing, and audit program for Chinese producers that will provide assurance to export customers and restore markets and confidence in China’s products.

Contact US

You are welcome to contact us at our Shanghai office

TEL: 8621 6335 1000FAX: 8621 6335 1618