Regulatory capture in Hong Kong | China Accounting Blog | Paul Gillis

Regulatory capture in Hong Kong

Again in 2013, Hong Kong placed first in the Heritage Foundation’s Index of Economic Freedom, which measures its view of the economic freeness of various countries. The index focuses on the presence of the rule of law and the absence of government regulation. On the latter point Hong Kong does particularly well, scoring 98.9 in Business Freedom compared to 90.5 for the United States and 48.0 for China. 

Of course, business rarely wants no regulation – after all that might lead to excessive competition. The professions have long sought closure – blocking outsiders from the work of the profession in exchange for regulatory oversight. Milton Friedman in Capitalism and Freedom observed this behavior: “the pressure on the legislature to license an occupation rarely comes from the members of the public . . . On the contrary, the pressure invariably comes from the occupation itself.” 

The accounting profession secured a particularly sweet deal in Hong Kong. They blocked access to their lucrative market to accounting firms from outside Hong Kong while convincing regulators to allow them to regulate themselves through the Hong Kong Institute of CPAs (HKICPAs).  

That deal is coming to an end. The world called B.S. on the accounting profession’s self-regulation after Enron, and most of the world has separated accounting regulation from the profession. But not in Hong Kong. Hong Kong made a symbolic move towards regulating accountants with the Financial Reporting Council (FRC), but made sure that the FRC was underfunded and toothless. The financial world has called Hong Kong out on this, the most serious blow being the removal of regulatory equivalency by the European Union. So reforms are once again in the winds. 

The proposed reforms, however, seek to perpetuate regulatory capture. A proposal advanced by the SFC and HKICPAs would transfer the important function of audit inspections from the HKICPAs to the FRC, funded by levies on investors. But the HKICPAs wants FRC to outsource those inspections back to the HKICPAs, leading once again to the profession reviewing its own work, but being paid for it this time. 

Outsourcing audit inspections to the inspected firms is a horrible idea, and I have written a piece for Forensic Asia on it.  Effective audit regulation is important for investors, and investors should be speaking up loudly to make sure the profession does not keep the FRC in captivity. 

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