Big Four localization | China Accounting Blog | Paul Gillis

Big Four localization

The Big Four are busy preparing for the restructure of their practices in accordance with the new MOF guidelines that limit the number of expatriate partners. The deadline is based on the date the current joint venture runs out its 20-year life. KPMG, first to obtain a JV license in 1992, faces the first deadline of August 17. E&Y follows in September. PwC has until March 2018 because it formed a new joint venture in 1998 when PW and C&L merged, but I have heard that PwC plans to reorganize next year. 

The new rules require that at least 60% (increasing over five years to 80%) of the partners of the firm are locally qualified. In order to be locally qualified the partners need at least five years public accounting experience with three years in China. Those without Chinese qualifications can make up 40% (reducing to 20% over five years) of the partners. Those without Chinese qualifications must be at least 40 years old but less than 65 years old, and must hold recognized foreign qualifications and have ten years of experience. The senior partner must be a Chinese citizen (not including Hong Kong, Macau or Taiwan), although that requirement appears to violate China’s WTO commitment of national treatment for accountancy. I don’t see the firms letting any foreign partners go because of these rules. They will first figure out how many locally qualified partners they have, then select the maximum number of expatriates to be partners, and classify the rest as principals – non-partners with partner status. 

The Big Four firms have all indicated their support for the program, as they should, since the alternative was to simply apply China’s WTO commitments and localize 100%. The final deal is excellent for the Big Four firms, and leaves China as an outlier with the most liberal rules in the world allowing unlicensed partners to practice accounting. The firms have so far been silent about how they will implement the new rules. Here is my speculation.

The Big Four firms in China operate through a number of legal entities. The new rules apply to the auditing practice, which has been conducted through a joint venture. For example, according to its website, KPMG operates its audit practice through KPMG Huazhen, a Sino-foreign joint venture. Consulting services, including tax, are offered through a wholly foreign owned enterprise (WFOE); in KPMG’s case, KPMG Advisory (China) Limited. The new rules apply only to the joint venture, which will now be restructured into a limited partnership. The consulting practices can continue to be foreign controlled.  

None of the Big Four manage their practices following the legal structure. Instead the management committees are typically made up of partners representing individual lines of business like audit and tax, geographies like Beijing and Hong Kong, and functional responsibilities like human resources and finance. Most of the partners on each firm’s management committees are from Hong Kong. There are two main reasons for that; Hong Kong has more experienced partners, and since the senior partners are all from Hong Kong, they tend to select people who share a common language and culture.  

I believe the firms will attempt to leave the present management committees in place. In order to comply with the new rules, a separate management committee will be formed for the audit practice on the mainland only. The senior partner of the mainland audit practice will likely have a seat on the firm wide management committee, but that may be the extent of PRC representation. All of the power will be with the firm wide senior partner and the firm wide management committee, and the China audit senior partner and China audit management committee will have limited responsibilities.  

I do not think that those arrangements are what Chinese regulators had in mind. They are expecting locals to be in control of the firms. Professional services firm managers tend to have less power than managers of other businesses. The management of knowledge professionals has been compared to to herding cats. Accounting firm partners resist command and control management styles, and getting partners to work in the same direction requires patience and persuasion. The one tool that accounting firm management can use is compensation. Management power in accounting firms comes mostly from the ability to set the compensation of partners. 

The firms are likely to wish to continue the present practice of having the firm wide management committee set the compensation of all partners and to determine that the profit pool from which such profits are distributed is based on the combined profits of all practice units. If those arrangements continue, the local audit management committee will have little power. If the China audit practice that will soon be locally controlled decides not to participate in those arrangements, it will have the ability to allocate the profits of the highly profitable China audit practice as it decides.  

The firms will argue that it is not in the best interest of the local partners to seize control of the China audit practice and its profits. The China audit practice is likely the most profitable business segment for the firms. The argument that management will advance is that the firms will be more successful by integrating geographies and service lines. From a financial perspective, the local partners would probably do much better if they can control the distribution of their own profits. Local partners (with the guidance of regulators) have an important decision to make this summer. Because these local partners tend to be fairly junior, I expect management will succeed in retaining the present arrangements. 

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