Financial regulators in Beijing have asked some US-listed Chinese companies and their audit firms to prepare for inspections by American accountants in Hong Kong, sources revealed on Friday.
The move by the China Securities Regulatory Commission (CSRC) is part of efforts to end a decade-long dispute over auditing.
The CSRC recently gave verbal notices to some audit firms, advising them to start preparing paperwork to move staff and documents to Hong Kong, one of the sources said.
This is because it expects the countries to reach an agreement soon to resolve the dispute over the auditing compliance of US-listed Chinese firms, the source added.
The CSRC recently informed US-listed Chinese firms that they should be prepared to transfer audit working papers and other relevant material from the mainland to Hong Kong for future US on-site inspections, two other sources said.
Hong Kong to be Inspection Hub
Hong Kong will become the on-site inspection hub for US regulators and Chinese companies listed in America will have to transfer their working papers to the city, as per the latest proposal drafted by the CSRC, the second source said.
The news appears to confirm a report by Wall Street Journal on Thursday that Washington and Beijing are close to an agreement that will allow US accounting regulators to inspect audit records of Chinese companies listed on US exchanges.
It said securities regulators in Beijing were making arrangements for Chinese companies listed in New York and their accounting firms to transfer audit working papers and other data from China to Hong Kong, as the audits would be conducted.
By Friday, 163 companies, including Alibaba Group, JD.Com, and NIO had been identified by the US regulator as facing trading prohibition risks for not complying with audit requirements.
However, Asian shares rose on Friday, buoyed by hope China and the United States will hammer out an audit deal to solve the delisting risks facing these Chinese firms.
‘Pilot Inspections Will be Key Test’
The reaction of US regulators to the measures suggested by the CSRC is not yet known.
However, if the Wall Street Journal report is correct, the process appears likely to begin with a round of pilot inspections in Hong Kong conducted by regulators from the US Public Company Accounting Oversight Board (PCAOB).
“If the report is confirmed, and US regulators travel soon to conduct pilot inspections in Hong Kong, the probability of a broad deal on audits by the end of this year or soon after will rise to 85%, from Eurasia Group’s current call of 65%,” Michael Hirson and Eurasia Group analysts said in a note on Friday.
They said pilot inspections were the “key test” of whether the two sides can resolve issues that have long stymied an audit deal.
“If the pilot inspections go ahead, it means that the US and Chinese regulators have resolved key issues in principle. The Public Company Accounting Oversight Board (PCAOB), the lead US regulator, will not go the trouble of traveling to Hong Kong if it lacks confidence in China’s commitment to a deal,” Hirson said.
There would still be a risk – which Eurasia Group rated a “15% probability” – of an agreement falling through during or after the pilot inspections.
“Chinese security agencies could baulk at specific PCAOB demands to provide certain types of information and not respond to US regulators’ satisfaction, they said, noting that the auditors and their oversight agency, the Securities and Exchange Commission, “are under heavy pressure from Congress to ensure that any deal with China on audits is rigorous and have no reason to compromise”.
But if the pilot inspections were deemed acceptable, the auditors would then perform on-site inspections of listed companies.
“If successful, it would pave the way for a broader deal that avoids the mass delisting of Chinese firms from US exchanges under the terms of the Holding Foreign Companies Accountable Act,” they said.
The PCAOB has yet to respond to requests for comment.
Chinese and US officials have been in talks to resolve the long-running audit dispute, which could result in Chinese companies being banned from US exchanges if China does not comply with Washington’s demand for complete access to the books of US-listed Chinese companies.
Beijing has to date barred foreign inspection of audit documents from local accounting firms, citing national security concerns.
Chinese State Companies to Delist
Two weeks ago, five US-listed Chinese state-owned companies, whose operations would have been under scrutiny by US regulators, said they would voluntarily delist from the New York Stock Exchange.
And even if a deal is reached, Eurasia Group’s analysts believed “Beijing will order some firms to preemptively delist rather than be subject to annual inspections”.
So the next focus is likely to be whether China’s major tech firms such as Alibaba, which recently moved its primary listing to Hong Kong, plus JD.com, Netease and Pinduoduo are told to delist, because they have large collections of personal data that may be deemed too sensitive for US auditors.
The two sides had hoped to reach a deal by the end of the year, but Eurasia Group said that deadline had become less pressing as Congress has not moved to speed up the timeline for delisting from early 2024 to early 2023.
Meanwhile, China’s financial chiefs – anxious to support the economy, which has been hobbled by a resurgence of Covid cases and the debt crisis in the property sector, have vowed will also take more steps, such as increasing funding support for infrastructure projects and ramping up support for private firms and technology companies, state media quoted the cabinet as saying on Wednesday.
- Reuters with reporting and editing by Jim Pollard
NOTE: This report was updated with new details and the headline changed on August 26, 2022.