What to watch next in the US-China ADR audit dispute
The United States and China have taken an important first step to prevent U.S.-listed Chinese stocks like Alibaba from being kicked out of U.S. stock exchanges.
Holger Gogoline | iStock | Getty Images
BEIJING — The United States and China recently took an important first step to prevent U.S.-listed Chinese stocks like Alibaba from being forced off U.S. stock exchanges.
What needs to happen next is a ground inspection in China by the United States with adequate support from Chinese officials, analysts said.
“Many implementation details can probably only be understood by audit firms and [Ministry of Finance] – together with [the China Securities Regulatory Commission] — through audit trials on real cases under this unprecedented agreement,” said Winston Ma, assistant professor of law at New York University.
The U.S. Public Company Accounting Oversight Board said its inspectors were due to arrive in Hong Kong in mid-September, shortly after “all audit working papers requested by the PCAOB should be made available to them. “.
Audit working papers differ from actual business information collected by accounting firms.
Working papers record the audit procedure, testing, information gathered and review findings, according to the PCAOB website. It is unclear what level of highly sensitive information, if any, would be included in working papers.
The ability of the United States to inspect these working papers for Chinese companies listed in the United States is a dispute that has been going on for years. Political and legal developments in the United States over the past two years have accelerated the threat that Chinese companies may need to pull out of US stock exchanges.
A turning point came in late August when the PCAOB and the China Securities Regulatory Commission signed a cooperation agreement that laid the regulatory groundwork for allowing US inspections of audit firms within China’s borders.
This is according to statements from the two government entities, which also said China’s finance ministry signed the deal.
“I see this as great ‘progress,’ which meant that both parties were ready to take action to get things done,” said Stephanie Tang, head of private equity for Greater China and partner at Hogan Lovells. .
“The subject or audience of this PCAOB investigation would be audit firms,” she said, noting that she is not an accountant.
Need more clarity in implementation
Accounting firms registered in China are overseen by the Ministry of Finance, making them the leader on the Chinese side of the next steps, said Ming Liao, founding partner of Beijing-based Prospect Avenue Capital.
However, there is uncertainty over the implementation of the deal as it only established a framework, analysts said.
“Our accounting firms still don’t know how to do this,” said Peter Tsui, president of the Hong Kong-based China Internal Auditors Association. That’s according to a CNBC translation of his Mandarin remarks on Thursday.
He said questions remained about what information companies should share in order to remain compliant with Chinese regulations.
“Give [us] some guidelines,” Tsui said.
Tsui said the inspections should go smoothly if it’s just a matter of accountants on both sides, and there’s no political interference from the US side. He said the Big Four accounting firms – KPMG, PwC, Deloitte and EY – are members of the association.
China’s Ministry of Finance has yet to issue a public statement on the audit cooperation agreement. The department did not immediately respond to a CNBC request for comment.
One development Prospect Avenue Capital’s Liao is watching is whether U.S. President Joe Biden and Chinese President Xi Jinping will meet in person this fall for the first time under the Biden administration. That could speed up a final agreement on the audit dispute, he said.
“Ultimately, resolving the audit working papers issue hinges on political interaction between China and the United States,” Liao said in Chinese, according to a CNBC translation. “With trust, this problem can very easily be solved.”
A decision by the end of the year
The PCAOB said it would determine in December whether China was still blocking access to audit information.
U.S. regulators “will likely start to know in October or November” what decision the PCAOB will take on whether U.S.-listed Chinese companies could head for delisting, said Gary Gensler, chairman of the U.S. Securities and Exchange Commission. United, to CNBC’s David Faber in late August.
Alibaba and many other U.S.-listed Chinese companies have in recent years begun issuing shares in Hong Kong, in part seen as a way to hedge against possible delisting from U.S. stock exchanges. Since the IPO of Chinese company Didi in the United States in the summer of 2021, Beijing has also increased its scrutiny of Chinese companies seeking to list overseas.
The combined political uncertainty has slowed the flow of Chinese IPOs to the United States, especially of large companies.
As of July 1, 2021, 16 Chinese companies are listed in the United States, excluding special purpose acquisition companies, according to Renaissance Capital. In 2020, 30 China-based companies were listed in the United States, the company said then.
By value, the five largest US institutional portfolios of US-listed Chinese stocks are: Alibaba, JD.com, Pinduoduo, NetEase and Baidu. This is according to Morgan Stanley research dated August 26.