Numbers game: Beijing closer to a deal on audits of Chinese companies listed on US exchanges
South China Morning Post
9 min read
As Washington and Beijing clash on fronts ranging from defence and human rights to trade and diplomacy, they might be making headway in one area: accounting.
Over the past several weeks, Beijing has signalled a willingness to compromise in an audit dispute that has threatened Chinese companies with delisting from American stock exchanges unless they comply with US accounting regulations.
Chinese Vice-Premier Liu He last month said that progress was being made concern a deal on audit information for Chinese companies listed on US exchanges. Photo: Reuters alt=Chinese Vice-Premier Liu He last month said that progress was being made concern a deal on audit information for Chinese companies listed on US exchanges. Photo: Reuters>
This month, Beijing proposed scrapping a rule requiring Chinese companies listed on foreign exchanges to be "primarily" inspected by Chinese regulators. That offer built on the optimism sparked by Vice-Premier Liu He's announcement in March of progress in talks with American regulators.
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"My probability of an agreement being reached went up significantly with [that] statement," said Martin Chorzempa, a fellow at the Peterson Institute for International Economics and expert on Beijing's financial liberalisation.
It indicated flexibility by Beijing, Chorzempa said, and that "they really do care about Chinese firms being able to list abroad".
Cooperation on any front in US-China relations seemed unlikely after years of recriminations on just about every issue - including Beijing's determination to support domestic hi-tech companies, like Huawei Technologies, capable of out-competing US businesses.
Beijing's efforts to produce national champions prompted then-president Donald Trump to launch a trade war in 2018 against China that his successor US President Joe Biden has kept in place.
As bilateral tensions escalated, Beijing also began cracking down on non-state Chinese companies at home last year, which has chilled new foreign listings - Didi Chuxing, a Chinese equivalent of Uber, listed on the New York Stock Exchange only to run afoul of Beijing regulators, who said the company had not received clearance for the move. Didi said in December it would leave the exchange.
Numerous Chinese companies are expected to be delisted from the New York Stock Exchange should they fail to comply with audit regulations. Photo: Reuters alt=Numerous Chinese companies are expected to be delisted from the New York Stock Exchange should they fail to comply with audit regulations. Photo: Reuters>
The US Public Company Accounting Oversight Board (PCAOB), the agency that is negotiating with its Chinese counterpart, has agreements with regulators worldwide giving it access to auditing information on firms listed in the US.
But since the board's inception in 2002, when there were just a handful of Chinese firms listed on American exchanges, China has largely refused to cooperate, citing concerns over state secrets. US regulators looked the other way.
That changed in 2020, when Congress passed the Holding Foreign Companies Accountable Act (HFCAA). Seen as primarily aimed at China, the law requires foreign companies listed on US exchanges to adhere to the PCAOB's auditing rules. Companies that fail to comply for three consecutive years face delisting.
The Securities and Exchange Commission (SEC) began identifying companies in breach of the act last month. So far, 40 Chinese companies have been named, including Baidu and Weibo.
The stakes are significant. Following two decades of steady listings by Chinese companies on US exchanges, there are now 261 with a combined market capitalisation of US$1.4 trillion, according to the US-China Economic and Security Review Commission. That compares with 248 companies with market capitalisation of US$2.1 trillion a year ago.
After years of accepting China's opacity, US regulators have hardened their position as US-China relations have worsened. The PCAOB is demanding the audit documents of US-listed Chinese firms, saying that access is not just necessary, it's "non-negotiable".
The board's stricter stance goes beyond its need to implement the new law. It also felt its Chinese counterparts failed to act in good faith during an earlier joint inspection attempt.
"I understand it did not go well" with the China Securities Regulatory Commission (CSRC), said Paul Gillis, an accounting professor at Peking University's Guanghua School of Management.
The Chinese side refused to let the US board to ask questions, Gillis, a former partner at PwC, added: "The PCAOB decided it could not do a proper inspection under those conditions and walked away."
There are also fraud concerns. In 2020, Luckin Coffee admitted inflating its revenues by more than US$311 million and paid US$180 million in fines without admitting wrongdoing - after its stock lost 90 per cent of its value and was delisted from Nasdaq. Luckin securities are still traded in the US via over-the-counter (OTC) markets, which don't require a central exchange or broker.
The Luckin scandal helped fuel Congressional passage of the HFCAA, which Trump signed into law in late 2020, just before his term ended. The SEC added Luckin to the list of HFCAA non-compliant companies last week.
Chorzempa does not believe the US law will prevent fraud cases like the Luckin scandal which, according to the SEC, the company self-reported during an external audit rather than having regulators discover it.
"These issues involving Chinese companies and potential accounting irregularities will probably still exist, even if the PCAOB is able to get full access to the documents," Chorzempa said. "It's important for the policymakers on both sides to really focus on what is the policy imperative here and can we achieve that?"
Deteriorating US-China relations in recent years have shrunk the space for cooperation.
Since the Trump administration, the US has targeted Chinese companies like telecoms giants Huawei and ZTE over national security concerns. In that same vein, China Telecom, China Unicom, and China Mobile were eventually forced to delist from the New York Stock Exchange by a Trump executive order that Biden let stand.
Traders on the floor of the New York Stock Exchange. In the last year, new listings of Chinese companies have slowed to a trickle. Photo: Reuters alt=Traders on the floor of the New York Stock Exchange. In the last year, new listings of Chinese companies have slowed to a trickle. Photo: Reuters>
Derek Scissors, a fellow at the American Enterprise Institute who follows China's economy and investments, said that in addition to other frictions, "the political will to compromise on Chinese listings in the US was reduced on both sides with China's crackdown on some non-state enterprises starting in late 2020" .
"This soon reduced the capitalisation of large firms listed in the US and it brought an increase in China's desire to have such firms listed at home," Scissors added. "A compromise became less valuable to both sides."
Since then, others say, China has decided it still needs access to US capital markets and regards US inspections as the only way that will continue.
"China will eventually want its companies to use domestic equity markets exclusively, but they are not ready for it at this point," Gillis said.
For one thing, he said, "the lack of institutional investors in China is a problem. Institutional investors like pension plans and endowments provide a discipline to the market that is not present in China."
Not agreeing on accounting regulations carries risks of its own. Gillis said that a failure by Washington and Beijing to strike a deal in such a narrow technical field would portend a complete financial decoupling of the world's two largest economies, and neither side wants that.
But the dispute has already begun to reshape US-China financial ties.
Chinese firms are thinking twice about listing on US stock exchanges. According to the US-China commission, there were 18 new listings and nine delistings of Chinese companies on US stock exchanges since May 2021. New listings have slowed to a trickle, with just two in the past nine months.
"This dispute has revealed that there are benefits to both companies and investors to have listings in both Hong Kong and the US," said David Adelman, managing director at KraneShares, an asset management firm focused on China.
Adelman added that a resolution could further globalise Chinese companies by increasing choices for investors.
KraneShares and other institutional investors have converted their US holdings of Chinese companies to Hong Kong holdings to mitigate the delisting risk - nor is the firm planning on reversing course even if Beijing and Washington reach a deal.
"From the company's perspective, having both listings is the best of both worlds. For an investor, I think they'll gravitate where liquidity lies," Brendan Ahern, KraneShares' chief investment officer, said.
"For large global institutional investors, there's potential advantages to a US listing today. But clearly, that can evolve."
A January report by the China Renaissance brokerage firm found that some 80 Chinese companies now listed on US markets - accounting for the vast majority of Chinese market capitalisation - are eligible to list in Hong Kong.
Analysts and investors said that a deal is in both Beijing and Washington's interests and expressed cautious optimism that one could be reached, possibly within months. Still, they expect some delisting to continue.
"I think China will decide that some companies or parts of companies are too sensitive to allow foreign regulators to see audit working papers," Gillis said. Those companies, he noted, could be taken private and relisted in Hong Kong or on mainland exchanges.
"First, the SEC will give each company 'strike one' for using an uninspectable auditor for 2021," Gillis suggested.
"Inspections will begin late in 2022 and if the PCAOB decides that China is not allowing adequate access, I think the SEC will issue 'strike two' for 2022. Under the HFCAA, it is three strikes and the company is delisted."
"I think China will decide that some companies or parts of companies are too sensitive to allow foreign regulators to see audit working papers," said Paul Gillis of Peking University's Guanghua School of Management. alt="I think China will decide that some companies or parts of companies are too sensitive to allow foreign regulators to see audit working papers," said Paul Gillis of Peking University's Guanghua School of Management.>
Scissors sketched a further outcome: "A compromise is possible if China designates some firms as being able to disclose fully, because these firms are small or operate in non-sensitive sectors and it doesn't anticipate any issue with state secrets."
He noted that any deal that lets Beijing redact audit documents would be "savaged politically" by Washington. And while he expected large-scale delisting to proceed, Scissors did not think it mattered that much since there are other ways to invest in the People's Republic of China.
"The US law involved came into force after four years of fast-rising American investment in Chinese securities in the PRC - that money can still flow easily," he said.
