US-China audit agreement not yet a done deal

China and the United States have signed an agreement to solve the accounting disputes of US-listed Chinese firms but both sides have different understandings of the approach of cooperation.

The United States’ Public Company Accounting Oversight Board (PCAOB), the China Securities Regulatory Commission (CSRC) and China’s Ministry of Finance last Friday signed a statement of protocol, which will allow PCAOB to inspect and investigate registered public accounting firms headquartered in mainland China and Hong Kong completely and consistent with US law.

However, CSRC said the materials such as audit work papers that the US regulator needs access to will be obtained by and transferred through the Chinese side.

Some commentators said the wordings of the statements released by PCAOB and CSRC were different and such inconsistency might create obstacles for the implementation of the agreement.

Some analysts said the agreement was good news for the Hong Kong and Chinese stock markets and would provide support to US-listed Chinese firms, or so-called China “concept stocks”, in the short run.

Alibaba Group’s Hong Kong-listed shares closed at HK$95.15 (US$12.12) on Monday, up 10.6% from last Wednesday when investors started speculating that the US and China would soon reach an agreement on accounting standards. Meituan’s shares have increased 13.8% to HK$186.7 while Weibo’s shares have surged 14.5% to HK$160.8 over the same period.

Currently, more than 200 Chinese companies are listed on US capital markets. They are using the audit services provided by more than 30 Chinese audit firms registered with the PCAOB.

Alibaba has announced it plans for a primary listing in Hong Kong. Image: Agencies

On March 10, the US Securities and Exchange Commission (SEC) announced that five Chinese companies – biopharmaceutical firms BeiGene, Zai Lab and Hutchmed, fast-food chain Yum China and wafer cleaning equipment maker ACM Research – could be delisted if they could not meet US accounting standards.

It later added 17 Chinese companies to its list of entities facing possible expulsion from American exchanges on April 21 and 80 more, including and Bilibili, on May 4.

The CSRC said it stood firmly against politicizing securities regulations and that the Ministry of Finance had recently made positive progress on the issue after engaging with PCAOB.

On July 24, the Financial Times reported China was preparing a system to separate US-listed Chinese companies into three groups based on their level of data sensitivity so that they could more readily comply with US’ information disclosure requirements and China’s data security rules at the same time. But the CSRC said it had not yet researched a plan for such a system.

Alibaba said in a filing to the Hong Kong stock exchange on July 26 that it would apply for changing its current secondary listing status to a primary one. Upon completion of the change, Alibaba would become a dual-primary listed company on the NYSE in the form of American Depositary Shares (“ADSs”) and on the Hong Kong stock exchange in the form of ordinary shares.

On July 29, the SEC put Alibaba on its watchlist and warned that the Chinese internet giant would be forced to delist from the US if US auditors could not inspect its financial statements.

The US and Chinese regulators finally reached an initial agreement on the matter on August 26.

PCAOB Chair Erica Williams said in a statement: “The US Congress sent a strong message with the passage of the Holding Foreign Companies Accountable Act that access to the US capital markets is a privilege, not a right. The PCAOB has been working to execute our mandate under the law.

“The agreement grants the PCAOB complete access to the audit work papers, audit personnel, and other information we need to inspect and investigate any firm we choose, with no loopholes and no exceptions. But the real test will be whether the words agreed to on paper translate into complete access in practice.”

According to the Statement of Protocol unveiled by the US side, the PCAOB has sole discretion to select the firms, audit engagements and potential violations it inspects and investigates – without consultation with, nor input from, Chinese authorities.

Moreover, procedures are in place for PCAOB inspectors and investigators to view complete audit work papers with all information included and for the PCAOB to retain information as needed. The PCAOB has direct access to interview and take testimony from all personnel associated with the audits the PCAOB inspects or investigates.

PCAOB will send teams to mainland China and Hong Kong to see whether the Chinese side’s promises hold up. The teams will report their work to the PCAOB at the end of this year.

A CSRC spokesperson said: “Retaining the listing of China concept stocks in the US is beneficial to investors, the listed companies, and also to both China and the US. It is a win-win arrangement. This is an important basis for the two sides to sit down and negotiate and reach an agreement.”

However, the spokesperson stressed that the Chinese side would take part in and assist in the interviews and testimonies of relevant personnel of audit firms requested by the US side. He said audit work papers that the US regulator needs access to would be obtained by and transferred through the Chinese side.

A mobile screen with apps from the four Chinese technological giants – Baidu, Alibaba, QQ from Tencent and MI from Xiaomi. Photo: AFP / Riccardo Milani / Hans Lucas

The CSRC said it looked forward to cooperating with US regulators. It also said if both sides could compromise on new accounting practices, US-listed Chinese firms would be able to avoid being forced to delist.

Dickie Wong, executive director of research at Kingston Securities Ltd, said the agreement was good news for China concept stocks but it did not mean that these companies should now stop preparing for their possible delistings from US markets.

Wong said Chinese regulators had apparently compromised to the US requests by granting PCAOB access to obtain Chinese firms’ audit work papers. But he said even if PCAOB could obtain all these documents, it might not be fully satisfied in the end.

Conita Hung, investment strategy director at Tiger Faith Asset Management, said the agreement would help support the share prices of Chinese stocks in the short run as it provided investors with hope that the accounting dispute would be resolved later this year.

Hung said the fact that the Chinese government had over the past two months eased its curbs against internet firms would also have a positive impact on Chinese stocks.

Author: JEFF PAO, Asia Times

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