The South China Morning Post (SCMP) has two articles today that say that Chinese regulators are cracking down on Hong Kong firms coming into China to do audits. According to the SCMP, the proposal will require firms to use their mainland affiliates to staff engagements.
Prior to this proposal, it was possible for an overseas firm to obtain a temporary audit practice certificate to come to the mainland to audit a specific company. The process was cumbersome and often ignored.
Now the mainland affiliate will have to supply the staff for the audit. I believe that was already the case in most Big Four audits. But the rule, if implemented, will highlight the principal auditor issue that I raised on Alibaba last week. Based on Alibaba’s risk disclosures, it appears that the PwC was using mainland staff for a significant part of the audit. This proposed rule will simply make sure they do that, and will likely mean that PwC Zhong Tian instead of PwC Hong Kong signs the audit report.
As the SCMP articles explain, the practice of Hong Kong firms signing mainland audit reports is institutionalized in Hong Kong, and the loss of this franchise will hurt the Hong Kong profession. I observe that all large SOE audits are signed by the Hong Kong member firm of the Big Four, even though I believe that all of them are actually audited by mainland staff.
Mainland CPA firms have been allowed to sign H-shares in Hong Kong for several years, but all Red Chips are required to have Hong Kong auditors. The proposed rules may force a change for Red Chips as well as private companies like Tencent.
The SCMP article observes that the proposed rules will destroy career opportunities for young Hong Kong accountants. That is true only if they do not get themselves to the mainland and pass the Chinese CPA examination. But this will have no meaningful effect on the Big Four firms - the work simply shifts to the mainland, as it mostly already has.
The other firms that will be threatened by the proposed rules are the smaller U.S. based firms that developed a robust business auditing reverse mergers listed in the U.S. I think these firms are about the wiped out, and many of their clients may have a tough time finding new auditors. Neither the Big Four mainland affiliates nor other Chinese CPA firms will touch them.