The proposal by the Ministry of Finance to reform regulation of auditors of overseas listed companies created a firestorm in Hong Kong. Meetings with mainland regulators and interested parties took place in Hong Kong this week. A senior partner of one of the second-tier firms told an academic conference on Tuesday that if the proposal went into effect he would have to fire half of his staff.
The proposal to bring the audits of overseas listed Chinese companies under MOF regulation is an excellent one, and long overdue. This has been a regula-tory hole – ignored by Chinese regulators who blocked foreign regulators from filling the gap.
The proposal, however, threatens the livelihood of many Hong Kong CPAs. One of the provisions requires overseas firms, including Hong Kong firms, to use a Chinese affiliate selected from the top 100 Chinese firms to do the audit work on the mainland. That is the rule that concerns Hong Kong CPAs.
The Hong Kong Stock Exchange long ago gave a franchise to Hong Kong CPAs by requiring their signature on any listing in Hong Kong. That franchise eroded a little over the years, first as some of the big Hongs like Jardines and Swire left Hong Kong before handover and their audits moved to London. Then China forced open the market to audit H-Shares and now Chinese firms, mostly Big Four affiliates, audit some of the H-Shares. But exchange rules require that all Red Chips and private Chinese companies use a Hong Kong auditor.
The Big Four grew significantly on the mainland in the last decade, with prac-tices that now have about 10,000 accountants each. In the early years of China’s opening up, teams of accountants flew in from Hong Kong to audit the first listings of Chinese companies in Hong Kong. As the Big Four matured on the mainland, most of these audits were taken over by the mainland firm. Large numbers of partners and managers from the Hong Kong firms relocated to the Mainland and joined the Mainland firms. The firms encouraged this behavior by managing the firms as a single business unit and pooling the profits.
For the Big Four, the proposed rules have little effect.They are already doing the audits on the mainland for the most part. They do need some flexibility to be able to move staff around and MOF should be reasonable on that point. The Big Four need to sign the audit reports for mainland audits on the mainland, as auditing standards require.
For second-tier and local Hong Kong firms, the proposed rules are devastating. Although many already have affiliates on the mainland, they do not want to turn China audits over to those firms because they do not pool profits with them. If they are blocked from going to the mainland, they will suffer a huge loss of business.
The solution to the problem is obvious. Open up the China market to Hong Kong accounting firms. Hong Kong and the mainland signed the Closer Economic Partnership Arrangement (CEPA) that set a key objective to remove barriers to cross border services. A barrier to Hong Kong CPAs traveling to China to do audits is an unreasonable trade restriction. It is completely reasonable for China to require those CPAs who wish to do China audits to also acquire mainland credentials if they wish to work on the mainland, and the Chinese CPA exam-ination is open to all.
The problem, of course, is that CEPA is not a one sided agreement. Hong Kong must also open its market to Chinese accountants.The restriction that only Hong Kong accountants can sign off on accounts for listed companies is unreasonable. So is the requirement that only Hong Kong accountants can sign off on statutory accounts. Hong Kong would be completely reasonable to require Chinese ac-countants who wish to sign off on Hong Kong accounts to have Hong Kong credentials, and many already do.
Of course, that solution is not the one that any of the firms in Hong Kong want. The local firms would lose their profitable franchise auditing Chinese companies to their mainland affiliates. All firms, including the Big Four, would face new competition for statutory audit work in Hong Kong, as mainland firms would compete effectively on price in this profitable sector. Business in Hong Kong, would benefit from greater competition in the accounting sector.