Things are moving at a head spinning pace in China accounting. There are three somewhat related issues that are developing very quickly.
The SEC asked the judge in the Deloitte case to stay the case for six months because of negotiations. I think this means that a deal is imminent, which is probably a result of Mary Schapiro’s visit to Beijing a couple of weeks ago.
MOF has approved KPMG’s localization plan. KPMG’s joint venture is the first to expire on August 13. Now the issue goes to the PCAOB, which must decide whether to allow KPMG to keep their old registration.
The SEC launched an investigation of New Oriental’s VIE in what is likely the greatest challenge the VIE structure has faced.
Taken together, I think these events indicate that U.S. and Chinese officials may have decided to step back from the abyss and look to find a way to solve the problems related to U.S. listed Chinese companies.
There have been increasing indications that China wanted to stop the use of U.S. capital markets by its private companies. Perhaps the best evidence of this is the fact that there has only been one IPO in the past year and it essentially failed. The China Development Bank has been active in taking U.S. listed companies private. Officials were obviously frustrated with entrepreneurs evading Chinese laws through use of offshore companies and VIE structure. It is in the interest of both the SEC and Chinese regulators to shut down the use of the VIE structure and I would not be surprised to learn they are working together on this.
But China’s own capital markets are not ready to take the place of the U.S. markets. These markets and the RMB private equity funds that support them have grown spectacularly in recent years, but probably need another five to ten years to mature sufficiently to meet China’s private sector’s needs. Shutting down access to U.S. markets prematurely threatens indigenous innovation in China’s private sector, with potential long-term adverse consequences to China’s economy.
It is time to resolve the uncertainties that have weighed down this market.
First, U.S. and Chinese regulators need to work through their impasse, and the SEC’s action in the Deloitte case is promising. China needs the U.S. markets, at least for a few more years, and it needs to accept that using U.S. markets comes with compliance with U.S. laws. A deal with the PCAOB and the SEC is in China’s best interest.
China also needs to get control of the U.S. listed Chinese companies. Most of these companies incorporated in the Cayman Islands to get out from under Chinese regulation. China should encourage these companies to come home by merging the offshore company into the Chinese operating company. To do this China should allow the Chinese operating company to directly list abroad – just as it allowed the SOEs that listed in the U.S. to do. Once China allows direct listing of private companies abroad, the need for the VIE disappears, and VIEs can also be folded into the operating company. Investors win in that scenario. The companies may also be allowed to seek a secondary listing on China’s stock exchanges, and over time the Chinese listing may become the primary listing.
China has attempted to restrict foreign investment in certain sectors such as the Internet and education, but the restrictions have been easily circumvented through use of the VIE structure. China’s real concern is that foreigners do not control sensitive industries. A better way to achieve their goal may be to have the companies use two classes of shares – Class A sold only to Chinese that have certain voting rights on critical issues, and Class B sold to foreigners that are identical except for those voting rights. Facebook has a similar share structure.