Regulatory reforms stalled | China Accounting Blog | Paul Gillis

Regulatory reforms stalled

A number of regulatory reforms related to auditing in China appear to have stalled, creating risk for investors. 

The most significant change was proposed in Hong Kong, where the regulation of listed company auditors would be taken away from the Hong Kong Institute of CPAs (HKICPAs) and given to the Financial Regulatory Commission. Hong Kong had faced the embarrassment of having its regulatory equivalency with the European Union revoked because of the lack of an independent audit regulator. The HKICPA has proven to be an ineffective regulator. Public consultations were held in Autumn 2014 and then everyone went silent. In March, HK Secretary for Financial Services and the Treasury, Professor KC Chan, reported that the government had completed the public consultation and found majority support for the direction of the reforms. The consultation conclusions are to be published in the middle of this year. 

China’s Ministry of Finance issued draft regulations on cross-border audit services on April 21, 2014. The proposed regulations would ban foreign auditors from working in China, requiring them to work with affiliates on the mainland.  While the proposed regulations had no meaningful effect on the Big Four, since they all have huge practices on the mainland. I believe the regulation was targeted at the many small US CPA firms that had been traveling to the mainland to audit reverse mergers. Chinese regulators felt that shoddy work by some of these foreign firms had unfairly tarnished the reputation of Chinese accountants. Perhaps unexpectedly, the proposed regulation caused uproar among smaller Hong Kong CPA firms that had significant practices serving mainland companies with listings in Hong Kong. As far as I can tell, nothing has been done since April.

The Public Company Accounting Board (PCAOB) has been attempting for over a decade to negotiate access to China in order to inspect accounting firms that audit companies listed in the US. Last November PCAOB chairman James Doty said the negotiations were in a "difficult and frustrating place” and the lack of progress indicates things have not gotten any better. The sellout by the SEC to settle the case against the Big Four on audit working paper access will make it difficutl for the PCAOB to achieve meaningful access. 

In a related matter, VIE reforms are now working their way through China’s legislative process. The proposed new foreign investment law makes it clear that foreign controlled VIEs are banned, but opens the door to VIEs (and perhaps alternative structures) so long as the foreign company remains under Chinese control. Many of China’s larger internet companies have structures in place to keep control in Chinese hands.  Others may need to restructure to continue to operate, or else seek special permission. Multinational corporations that use the VIE structure may have greater difficulties. The US Chamber of Commerce, the American Chamber of Commerce in China and the American Chamber of Commerce in Shanghai jointly asked China to provide grandfathering for existing VIEs or a 25-year grace period, likely a fool’s errand. 

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