Drown HK audit regulation in a bathtub | China Accounting Blog | Paul Gillis

Drown HK audit regulation in a bathtub

Hong Kong has finally released proposed legislation (over 250 pages) to reform audit regulation in Hong Kong. This process began in 2014 after the European Union withdrew regulatory equivalency from Hong Kong citing its ineffective system of audit self-regulation. Although most members of the profession publicly supported the proposed legislation, privately they have been resisting it, which is why the process has taken so long. 

If the legislation is enacted, the Financial Reporting Council (FRC) will become the regulator of auditors of public interest entities in Hong Kong, much as the US’s PCAOB and Canada's Public Accountability Board (CPAB) took over regulation of auditors of public companies in the US and Canada.

Section 20F provides that the HKICPA Council may impose any condition on registration of auditors that it considers appropriate. The PCAOB has refused to register any more Chinese or HK CPA firms on the basis that they are unable to agree to turn over working papers for inspection. The PCAOB has not chosen to revoke existing registrations of firms that are unable to turn over working papers, although it has picked on a couple of small firms. I don’t see that firms will be required to consent to turning over working papers as a condition of registration in Hong Kong. 

Under proposed Section 21F, Hong Kong auditors can face up to 7 years in prison for failing to produce audit working papers. This may be sufficient to get auditors attention. Hong Kong is likely to win many of the IPOs from China in 2018 (thanks in large part to gutting corporate governance rules that previously sent them to New York). A resolution needs to be reached on regulating Chinese companies listed overseas. The US has failed, and while Hong Kong has a chance to fix this, I expect they will not. 

A budget of HK$90 million (US$11.5 million) has been proposed for the FRC. Because this is a three-fold increase for the FRC (which had a notional role prior to this legislation) the HKICPAs has objected to the budget. The CPAB has a budget of C$16.6 million (HK$104 million) and regulates a market half the size of Hong Kong. To size the budget of FRC comparable to Canada would require HK$225 million). The proposed budget is far too small for the FRC to be an effective regulator and the CICPA pushback on the undersized budget is self-serving and shocking. Paraphrasing Grover Norquist, it appears the HKICPAs wants to make independent audit regulation in Hong Kong small enough "that they can drag it in the bathroom and drown it in the bathtub".

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