On Thursday night I was honored to be recognized by the International Financial Law Review as the Market Reformer of the Year at their annual awards ceremony in Hong Kong.
I told the group that the award was undeserved. While I have been a voice for market reform, I cannot point to a single reform that I have helped to make happen. Nonetheless, there are three issues that I am focused on for the next year.
Transparency in Asia
First, I am concerned about recent changes by governments in Asia to reduce transparency. In China, it has become impossible to access basic corporate data from the SAIC. It is just not possible to do effective due diligence if you cannot confirm basic data concerning the identity of market participants. This information has also been used by short sellers to target companies, and by reporters to out corruption. The government has allowed the interests of the powerful to trump the legitimate needs of the public, and that never ends well for investors.
In Hong Kong, David Webb recently was forced by Hong Kong regulators to take down his useful website that provided identification information on corporate directors of Hong Kong companies. Hong Kong regulators may be well meaning in trying to protect the privacy of personal data. However, when someone wants to operate in the public space as a director of a public company, data privacy laws should not protect their identities. We need to know who these people are. If you want to stay out of the public spotlight, stay out of the public.
Transnational audit regulation
The second major issue I am focused on is accounting regulation. All of the accounting frauds in China have highlighted the risk of weak accounting regulation. While China does a pretty good job of regulating accountants working on locally listed companies, they do nothing on foreign listings. That would be OK if foreign regulators picked up the slack, but they cannot do so. China claims national sovereignty concerns mean that foreign regulators cannot regulate overseas listed Chinese companies. This has led to a big battle between the U.S. and China over securities regulation, and in particular the regulation of accounting firms.
The SEC is after the practice rights of Chinese firms auditing U.S. listed companies. The PCAOB is trying to negotiate access to do joint inspections with China, and failing to reach agreement may lead to a mass delisting of Chinese companies listed in the U.S. Similar problems have arisen in Hong Kong, where Hong Kong regulators have been unable to get accounting firms to turn over working papers of Chinese companies. It will be up to China to decide. If China wants its companies to access foreign capital markets, it is going to have to allow foreign regulation of these companies. Otherwise, China needs to pull its companies off of foreign exchanges.
There is increasing concern that the problems that have plagued U.S. listed Chinese companies are spreading to Hong Kong. We have not seen as many frauds in Hong Kong, but that may be changing. I believe that accounting regulation in Hong Kong needs substantial reform. Before Enron the accounting profession was usually self-regulated, but in the aftermath of that round of corporate crises many countries around the world set up independent audit regulators. Many Asian nations followed this global practice, including Singapore, Malaysia and Thailand. But Hong Kong was a hold out – keeping its system of self-regulation by the Hong Kong Institute of CPAs. Not surprisingly, HKICPAs has a pathetic track record of regulating the large accounting firms. While SFC has some regulatory oversight over accountants, Hong Kong needs a robust independent audit regulator charged with ensuring that Hong Kong accountants are performing their audits at a high standard. The Financial Reporting Council has oversight responsibilities but it is an underfunded and toothless regulator.
Variable Interest Entities
My third concern is China related. China was slow to develop the institutions to support its private sector. While private enterprise became legal early in the opening up process, it did not become legitimate until Jiang Zemin welcomed businessmen into the Communist Party. Chinese entrepreneurs were forced to look overseas for capital, and in order to get around Chinese laws they formed complex offshore structures. Chinese operations were often held through variable interest entities or VIEs, where the business is controlled through contracts rather than through ownership. These structures have become a disaster for investors, who find the promised legal protections are elusive and the structures are impossible to operate. Accountants and attorneys share responsibility for creating these monstrosities, and we should share the burden of cleaning up this mess. We need to help China find a way to regularize these structures, providing greater protection for investors and better regulatory compliance for Chinese regulators.