Yan Min and Liu Guangzhong, representatives of the Ministry of Finance responded to recent foreign press reports concerning the localization of the Big Four. Most press reports have correctly analyzed the new rules as following international practice that requires a local CPA license before a person can own an interest in a local CPA firm.
Yan said two points needed to be clarified.
First, Yan indicates that the intent of the rule is not to force out foreign partners. Yan indicates that about 50% of Big Four partners currently are not locally qualified, most of who are Hong Kong CPAs. Since the new rules limit non-licensed ownership to 40%, all of the unlicensed partners will not be able to continue as partners, and I expect Yan is signaling that it is acceptable for them to be retained as principals. The title of principal is commonly used in the firms for individuals with partner status but without the necessary license to practice.
Second, Liu said that audit quality would be retained through the changes. He indicated that the core management structure changes will be gradual and will not affect the firm’s management pattern. That is a curious statement, given that the rules require a significant and immediate change in the management committee of the firms and the replacement of the senior partner with a Chinese national within three years. Perhaps Liu is signaling that the current arrangements under which the firms operate Hong Kong and China as a single firm will be allowed to continue. That would make the new rules merely symbolic in effect.
Perhaps MOF is taking the long view. The mainland practices of the Big Four are now larger than their Hong Kong practices, and the size differential is bound to increase. Even if the current generation of foreign and Hong Kong partners is allowed to continue to dominate management ranks, that is not likely to continue past the next generation of partners. The new rules may have just been for public consumption, while the real localization will continue at its own pace.
If the changes are done in a responsible and measured manner, I do not believe that there will be an adverse impact on audit quality. If anything, I expect audit quality in China to improve over time. Because the Big Four firms have been able to be extremely selective in recruiting from large pools of candidates in China, the quality of new local audit partners is likely to be higher. The new local audit partners should also have a much deeper understanding of mainland culture and business practices, making them more effective than foreigners trying to audit in China.
They are concerns that local partners may not be as independent as foreign partners with respect to large state owned enterprises. Will these partners be more susceptible to political pressures than foreign partners? I am not sure the situation will be any worse than it is today. The present model under which the company pays auditors creates a fiscal impairment to independence. No solution to that model has been found. As long as management pays the auditor there is an incentive to keeping the client happy. While local partners might be more easily influenced by patriotic appeals, it would be a very difficult decision for foreign partners to decide to go up against the interests of the state.