In 2013, after years of negotiations, Beijing yielded to pressure and agreed to let US regulators inspect the audit work of Chinese companies whose securities traded in New York.
But the historic breakthrough was shattered when US officials travelled to China to check the audits of a large tech group and were stonewalled by regulators.
Almost 10 years later, US officials, as well as hundreds of Chinese companies and global investors that own about $1.4tn of their shares, are hoping that a new agreement will produce a very different outcome.
Last week, Washington and Beijing announced they had reached another deal for US accounting regulators to inspect China-based audits, which could prevent about 200 Chinese companies being kicked off US exchanges.
Details are scant, but the agreement was a rare concession from Chinese authorities at a time when geopolitical tensions with the west are high.
People close to the matter said the new agreement was based on the same deal signed between the two superpowers in 2013. Due to China’s strict coronavirus pandemic protocols, auditors — the bulk of which are the Chinese arms of Big Four accountants PwC, Deloitte, KPMG and EY — will transfer companies’ financial working papers to Hong Kong and US officials will inspect them there.
Officials from the Public Company Accounting and Oversight Board (PCAOB), the US accounting watchdog, will travel to Hong Kong in mid-September to see if China keeps its word.
“This is different from 2013,” said Jason Elder, a corporate finance partner at law firm Mayer Brown in Hong Kong. “The pressure and consequences of failure to deliver this time around are more acute.”
Since the agreement was announced on Friday morning in New York, stakeholders in the debate around US access to Chinese audits have been cautious.
Despite shares of US-listed Chinese companies climbing last week on reports that a deal was close, by Friday afternoon investors were again shedding their holdings. Markets have shown little sign that the prolonged volatility around a countdown to Chinese delistings, which would take effect in 2024, has ended.
Goldman Sachs, which has been one of the biggest beneficiaries of Chinese companies listing in New York during the past two decades, thinks it is still a coin toss. On Monday, the bank’s analysts estimated there was a 50 per cent chance that Chinese shares would be forced off Wall Street, down from around 95 per cent two months ago.
“My advice is don’t count the chickens before they hatch,” said Clement Chan, head of assurance at accounting firm BDO in Hong Kong. “This is a positive development. However, the devil is in the details.”
The compliance of — and potential liability for — the auditors to Chinese companies will also be a crucial detail to define over the coming months as they face an unprecedented level of international scrutiny of their work.
US listings by Chinese companies are considered to be a barometer for the state of financial relations between the world’s two largest superpowers. Relations were at a 30-year low when the US introduced the Holding Foreign Companies Accountable Act in 2020, amid a trade war with China and shortly after a scandal at Luckin Coffee, China’s largest coffee chain, which defrauded its Nasdaq investors in a $300mn accounting scandal.
The legislation required foreign companies traded on US markets to make their audit work available for inspection every three years, or face a trading ban.
Relations have since deteriorated further, weakening investor sentiment to the extent that the Golden Dragon index that tracks Chinese tech groups on the Nasdaq has lost almost a third of its value in the past 12 months, triple the loss of the S&P 500. China has also been contending with significant domestic issues: its economy contracted sharply in the second quarter of this year and annual growth has slowed after widespread Covid-19 lockdowns.
“No one is confident but everyone understands that there is political willingness to make it work,” said a portfolio manager at a major global asset manager that owns large US-listed Chinese tech companies. “It is not a coincidence that this has come out at the same time as China is rolling out measures to support its economy.”
That willingness is so stark that China even appeared to have resolved a key sticking point that has held up years of negotiations. Its top securities regulator, the China Securities Regulatory Commission, said on Friday the two sides had found a “feasible path” for the US to carry out audit inspections while maintaining China’s national security over sensitive data.
But Chinese bureaucracy is vast and allows for a huge number of authorities to intervene on what they consider to be national security information. “Only when a China auditor is handing over a lot of information to the PCAOB do we know that China has resolved this issue of what is and what is not sensitive data,” said a person close to the US side of the talks.
The simultaneous announcements threw up new sticking points. There was a clear clash between the two sides’ statements last week regarding the level of involvement that Chinese authorities will have in the US audit inspections.
The CSRC said that audit work papers “will be obtained by and transferred through the Chinese side” and that China will also “take part in and assist” PCAOB interviews of relevant personnel of audit firms. Yet the PCAOB said it had sole discretion to select firms “without consultation with, nor input from Chinese authorities”.
“There have been so many head fakes on this subject that people are cautious regardless of the language disparity,” said the portfolio manager.
The PCAOB has been unwavering in its demand for complete access to the work papers and personnel it needs to inspect a company’s financial audit. Its chair Erica Williams said on Friday it would accept “no loopholes and no exceptions”.
It is not yet known what company audits the US will choose to inspect, or whether its list will include the audits of the five state-owned energy, industrial and finance giants that delisted from New York this month. The move was widely seen as an attempt to exempt those groups from US inspections.
For the US, the credibility of its own capital markets relies on it forcing China to comply with its audit rules. Chinese companies listing in New York via American depositary receipts under a “variable interest entity” structure, whereby investors already have fewer rights to the underlying assets and less information compared with other US equities, can pose a risk to its reputation.
Despite the economic importance of collaboration between American and Chinese regulators, several political and technical factors could still derail the next months of work in Hong Kong.
“The CSRC may want to be more than just a back-seat driver, and try to drive the bus itself,” said Wang Qi, chief executive of fund manager MegaTrust Investment in Hong Kong. “This will be the first major collaboration between the financial regulators of the two countries . . . It will certainly take some time for the two parties to hammer out the execution details.”
As inspections begin to be carried out next month, China will have to decide how it wants to strike the balance of maintaining US listings and safeguarding political and national security. “The US is a big market that China cannot ignore,” said a corporate lawyer in Shanghai who has worked on China-related deals. “There is no real alternative solution for Chinese companies . . . and financing offshore is needed.”