Due Diligence in State Owned Enterprise | Detect the Risk in Public Ownership

Many countries have attempted to privatize businesses in recent years, but several Organization for Economic Co-operation and Development(OECD) and partner countries still own and operate commercial companies. 

Do you know that 34 countries (31 of them are OECD members) show that they together own 2,111 state-owned enterprises (SOEs). 

When a government backs a business, it may seem trustworthy by default. But behind the emblem and funding, who actually controls it? Who benefits from its contracts? What level of risk exposure does it present? And does it comply with the national and international regulations?

SOEs, also known as state owned enterprises, carry national weight, but that doesn’t make them immune to financial or operational risk. These businesses are not limited to local infrastructure; they are global investors, suppliers, and partners across high-risk sectors.

Without verifying their legal existence, ownership, and compliance history, any partnership becomes a regulatory gamble. Read the blog to explore the importance of due diligence on state-owned companies before acquiring, merging, or partnering with them.

What is a State Owned Enterprise?

State-owned enterprises (SOEs) are companies owned or controlled by a government, whether at the national or administrative level. In practical terms, SOE meaning refers to a government that holds a significant stake (often over 50% ownership or even a golden share that grants veto or special rights). 

Moreover, it has the legal means to direct the company’s operations. SOEs go by various names in distinct jurisdictions, involving:

1. Government-owned corporations 
2. Public sector undertakings(PSUs) 
3. Crown corporations

However, they all share the feature of public sector ownership.

Common Challenges of State Owned Companies  

State-owned companies often face legal and compliance challenges arising from their public ownership and strategic significance. Listed below are some common pain points of state-owned businesses.

Monetary and Bribery Risks

Due to their close ties to government functions and large procurement budgets, SOEs are frequently exposed to corruption and money laundering risks. Between 1999 and 2014, 78% of foreign bribery cases involving SOE officials were related to public purchases. Therefore, the risk of money-related fraud is slightly higher in these organizations.

Opaque Ownership and Company Control Structures 

Paradoxically, knowing who really controls an SOE can be complicated despite the state’s involvement. Many SOEs have complex subsidiary structures or mixed ownership (with minority private investors or cross-holdings), which can obscure the lines of control. This ambiguity complicates due diligence: it may be unclear which government department or official is pulling the strings behind an SOE’s decisions.

Compliance and Sanction Entity Risk  

Many state-owned businesses historically have not been held to the same corporate governance and compliance standards as publicly listed private companies. Moreover, SOEs operating internationally can be exposed to sanctions imposed by other states on international bodies.

Political Influence and Governance Challenges 

Officials controlling the state-owned entities are politically exposed persons (PEPs). Hence, they are prone to crimes like bribery and corruption. Therefore, in some cases, increased political influence can lead to the disruption of long-term strategies, weakening internal controls, and an increased risk of corruption, bribery, and unethical practices. 

This ultimately impacts operational performance, legal compliance, and the trust of the client or partner.

Due to these risks, Financial Action Task Force(FATF) Recommendations 12 and 22 mandated the additional AML/CTF measures for business relationships with PEP and Relative and Close Associates (RCA). 

The FATF provides guidance on effectively applying these measures across foreign, domestic, and international PEPs.

In conclusion, state-owned businesses are commonly exposed to money laundering risks, ownership structure verification, and non-compliance with international and administrative AML regulatory requirements. This makes doing business with an SOE challenging.

Why do State Owned Businesses Need Due Diligence?

With the discussed risk profile of state-owned businesses, it is essential for organizations, investors, suppliers, and business clients to perform enhanced due diligence (EDD) before partnering with SOEs. 

The same is the case with SOEs; they can also conduct EDD of businesses or entities they aim to work with. Due diligence will eventually help the company to scrutinize the SOE’s reputation and associated UBOs, enabling the business to avoid risky dealings.

From a global perspective, due diligence will help your business avoid partnerships with the SOEs, which are subject to international sanctions or trade restrictions. 

For example, in recent years numerous SOEs in countries under sanctions (such as some Russian, Iranian, or North Korean state firms) have been blacklisted by bodies like the U.S. Office of Foreign Assets Control (OFAC) and the EU council.

Due diligence is necessary to verify whether the SOE or any of its subsidiaries, ultimate beneficial owners (UBOs), or directors appear on sanctions lists or watchlists.

Additionally, international financiers and development businesses impose due diligence as a condition for working with state entities.

What are the Key Aspects of Business Verification for State Owned Businesses?

When conducting due diligence on a state owned company, businesses will get information on the following aspects in business verification. Covering the following areas ensures that you truly “know” the state-owned partners or the targeted company.

Legal Registration and Existence 

Due diligence confirms the legal existence and status of the SOE company.  It includes verifying the certificate of incorporation, business registration number (BRN), date of formation, and the law under which it operates. Moreover, The KYB’s due diligence offers comprehensive business registration lookup services that fetch data from official business registries in real time.

The KYB report provides authoritative data on the company’s name, registered address, registration ID, and incorporation date, directly sourced from the official business registry. 

Ownership and Control 

Although the most complicated aspect of SOE due diligence is uncovering the ownership and control structure. Because not every state provides UBO data, knowing who owns and runs the company is crucial for assessing risks like political exposure, conflicts of interest, and governance strength.

However, ownership doesn’t tell the whole story. A state might control an enterprise with less than 50% ownership through legal arrangements that grant veto power.

Beyond mapping the government’s role, business verification identifies key entities in control of the SOE. In conclusion, business verification answers: Who owns the business? Uncovers the hidden liabilities and flags risk profiles of suspicious entities.

Compliance and Reporting 

AML compliance is a fundamental requirement for businesses across all industries. If the state-owned business has foreign relationships with banks or any other financial institutions, they are required to comply with international regulations as well. 

Therefore, the compliance report supports regulatory compliance and protects the company’s reputation.

Prevent Uncertainties in Mergers or Partnerships

In situations where private or public firms might acquire an interest in SOE or vice versa. The risk of hidden liabilities can often lie beneath the surface. Proper business verification prevents buyers from acquiring businesses that are associated with money laundering crimes. It evaluates political and policy risk along with intricate company control hierarchies.

How The KYB Can Assist a Business in Conducting State Owned Companies Due Diligence

We often hear ‘Modern problems require modern solutions, ’ and platforms like The KYB are your business’s go-to solution. It streamlines the due diligence process by gathering and analyzing business data fetched from the official registries.

Performing comprehensive due diligence on state-owned enterprises can be a daunting task, especially in a global or cross-border context. The KYB specializes in empowering businesses by conducting corporate due diligence and verifying companies across 250  countries and jurisdictions.

One of the primary advantages of The KYB is that it has access to authoritative data sources worldwide. State-owned entities often require verification through local government registries, which may be challenging to navigate due to language barriers or bureaucratic hurdles. 

The KYB also provides information on who owns the business and then checks those names against warnings and regulatory enforcement, and checks if they are politically exposed persons (PEPs) or related to relatives and close associates (RCAs).

Therefore, The KYB offers your business the ease of assessing other business entities’ compliance and financial profiles. Contact us or visit The KYB’s website for a free demo!

Frequently Asked Questions

What was the Purpose of SOE?

State-owned enterprises are established to serve strategic national interests, provide essential public services, and promote economic development in sectors where market failures exist.

Are State-Owned Companies Better?

Not necessarily; while SOEs can ensure public accountability and long-term stability, they often face challenges in efficiency, transparency, and political interference compared to private firms.