There is a turf battle between the Securities and Futures Commission (SFC) in Hong Kong and Hong Kong Exchanges and Clearing (HKEx) over who should regulate new listings in Hong Kong.
Hong Kong is somewhat unusual since regulation of listings and auditors has been delegated to the regulated, a form of regulatory capture. The HKEx regulates listed companies, with the Hong Kong Institute of CPAs (HKICPAs) regulating auditors, leaving government regulators in a supporting role. Unsurprising, self-regulation rarely works, since market participants rarely take actions against themselves.
Self-regulation is usually the preference of the regulated professions because professionals get the benefits of regulation but control any disadvantages of regulation. Professionals always seek closure – to limit market access to newcomers. In Hong Kong, CPAs must be licensed by the HKICPAs, meaning that only members can provide audit services. Yet while limiting market access and competition, the HKICPAs has done a pathetic job regulating its members. Fines, when they happen, are insignificant and even serious violations by the Big Four get only a slap on the wrist.
The failure to effectively regulate listings and auditors may have contributed to recent failures of IPOs. Tianhe Chemicals Group Limited listed on the Hong Kong exchange in May, 2014 only to be brought to its knees by allegations by short selling research firm Anonymous Analytics that the company was a fraud. The stock remains suspended, which appears to be at least partly related to the inability of the company’s new auditors to issue an opinion.
Weak regulation in Hong Kong led the European Union to withdraw regulatory equivalency for Hong Kong with respect to auditor inspections. Under regulatory equivalency, EU regulators would be able to rely on the work of Hong Kong regulators as if it were its own. The removal of regulatory equivalency was a major embarrassment for Hong Kong, which moved to restructure audit regulation by transferring most functions to the Financial Reporting Council. Unfortunately, these reforms appear to have stalled since nothing has happened since a public consultation was concluded in 2015.
The transfer of regulatory responsibility for listings away from the exchange to the SFC is a good move that will increase the transparency and quality of the Hong Kong capital market. Hong Kong needs to move forward on implementing audit regulatory reform as quickly as possible.