China needs an audit regulator | China Accounting Blog | Paul Gillis

China needs an audit regulator

Xiao Gang, Chairman of the Chinese Securities Regulatory Commission (CSRC), said last week that during 2015 the CSRC would phase out the current approval based system for Chinese IPOs and implement a registration-based system. A registration-based system will be more like the process used by the U.S. Sec-urities and Exchange Commission. Regulators will let the market judge offerings, focusing instead on compliance. 

Most high profile IPOs from China are not listed on China’s stock exchanges but rather on US or Hong Kong exchanges, and the changes will not apply to those companies. 

This is a good step forward for China’s stock markets, in large part because it has the potential to create a more efficient market less subject to corruption and political favoritism.  

As regulators step back, it is critical that other institutional players, particularly auditors, lawyers, and investment bankers step up. They will become the prin-cipal gatekeepers to the market. Without increased professionalism by these players, the Chinese stock markets could become increasingly dangerous for investors. 

Too many auditors have been willing to sign off on numbers that magically meet CSRC IPO requirements. The Big Four are not major players in the domestic IPO market, which is dominated by local firms. Although some large local firms have emerged, they do not dominate the local stock markets like the Big Four dom-inate most markets around the world. Hopefully, investors will start paying more attention to the audit firms selected by Chinese concerns, and that will lead to larger, higher quality accounting firms dominating the market. 

The CSRC has promised to tighten post-IPO supervision and to punish those who violate the rules. That is laudable, but the devil will be in the details. For the auditors, I suggest that China put in place an independent audit regulator that would be eligible to join the International Forum of Independent Audit Regulators (IFIAR), a group that now includes regulators in 51 jurisdictions. Hong Kong is currently deciding on necessary reforms that would allow it to join IFIAR. An independent audit regulator with the funding to do its job and the willingness to take on recalcitrant accounting firms is now the global standard for securities markets. 

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