The PCAOB has announced that it will be coming to China next week to meet with Chinese officials to forge a “cooperative resolution to cross-border auditing oversight.” The delegation of PCAOB and SEC officials will meet with representatives of the Ministry of Finance and the China Securities Regulatory Commission. The Ministry of Finance regulates auditors in China.
The meeting is a result of high-level discussions between the U.S. and China at the Third Meeting of the U.S. China Strategic & Economic Dialogue held in Washington in May, which reached the following conclusion:
The United States and China welcome continued dialogue between the bilateral competent authorities on the oversight of accounting firms providing audit services for public companies in the two countries, so as to enhance mutual trust and strive to reach agreement on cross-border oversight cooperation. Both countries agree to make joint efforts to accelerate the process.
The MOF now has the political cover it needs to make a deal with the PCAOB, and I expect that one will emerge from the meetings this week. The deal could take several forms – one might be inspections by the MOF that are made available to the PCAOB. This would be a poor result, since the MOF does not have the requisite skills in U.S. GAAP and auditing standards to effectively do these inspections. A better result would be some form of joint inspections, where PCAOB examiners are teamed with MOF examiners. That solution could provide benefits to both the PCOAB and the MOF, as the PCAOB would gain local language and business skills, and the MOF would get a chance to observe PCAOB regulators in action. I think it is unlikely that the PCAOB will be granted unfettered access to Chinese accounting firms.
The objective of this exercise is to close the regulatory holes that presently exist with respect to the auditing of U.S. listed Chinese companies. It will mostly impact the Big Four in China, who collect 85% of the audit fees on U.S. listed Chinese companies. Although there are 110 accounting firms on the mainland and in Hong Kong that have registered with the PCAOB, few actually do the audits on U.S. listed Chinese companies and apparently register because they do a substantial amount of work to support the audits of foreign companies in China that are listed in the U.S. The PCAOB is interested in these firms as well.
Most of the recent audit scandals in China have been related to Chinese companies that have come to market through reverse mergers. Small U.S. based accounting firms that are already subject to PCAOB inspections audit most of these companies. These negotiations are unlikely to change much with respect to these firms, and accordingly may have only a modest impact at cleaning up this sector.