Deal Struck to Keep Chinese Companies on Wall Street: What Does It Mean?

We know little about the plan struck between Chinese and U.S. regulators to allow the inspection of the audits of U.S.-listed Chinese companies, other than that there is one. What looks nice on paper has a way of not panning out in China. Just ask Hong Kong, where our civil liberties – enshrined in the city’s constitution – lie in tatters, despite Beijing’s pledges to keep the city free.

The accounting wing of the U.S. Securities and Exchange Commission calls the deal on Chinese listings a “statement of protocol,” in other words a bit of rule setting, to allow open access to Chinese accounts for the Public Company Accounting Oversight Board (PCAOB). It says this is the “first step” in ensuring that Chinese companies provide the same level of access to audits that their U.S.-company counterparts already provide.

If all goes well, the agreement will allow Chinese companies to remain listed on Wall Street. But there was little in the way of a stock-market bounce in response. Alibaba Group Holding (BABA) and HK:9988 shareholders shouldn’t pop the champagne cork just yet.

The deal was revealed on Friday, as I’d indicated ahead of the trading day that it may. It promises to provide Hong Kong with new found relevance as not only a trading outpost and financial center but also Accounting Central for China. As it now stands, even a Hong Kong branch of the Big Four isn’t allowed to access the audits conducted by its Big Four subsidiary inside mainland China. With this deal, that would change.

The PCAOB goes to great pains to point out that it, and only it, will select which companies it investigates, without any input or “guidance” from the Chinese side. It will be able to view “complete audit work papers” as well as to interview and take testimony from whoever it wants to investigate.

“Whether the PCAOB can make a determination that China is no longer obstructing access depends on whether China abides by this agreement and allows for full and timely access to information,” the SEC entity says.

The Holding Foreign Companies Accountable Act went into effect at the end of 2020, and would result in delistings starting in 2024 of U.S.-listed foreign companies that don’t allow access to their audits. While the new law applies to companies from all foreign countries, the SEC notes it already inspects audit papers in 50 jurisdictions, but has fought a decade-long battle to push past China’s efforts to block such access. The Beijing government is concerned that audit access will somehow reveal “state secrets,” however that might be construed.

On the Chinese side, it is the China Securities Regulatory Commission, which is the counterpart to the SEC, as well as the Ministry of Finance that have signed off on the deal. Calling the deal the “China-U.S. audit oversight cooperation agreement,” CSRC officials painted the agreement as a “reciprocal” two-way street for “regulators from both countries to carry out regulatory cooperation in inspecting and investigating audit firms within their jurisdiction in accordance with applicable laws.”

No way we are bending over backwards to keep the SEC happy, in other words, although there has been no clamor on the Chinese side to get access to U.S. companies that are listed in Shenzhen or Shanghai. The Chinese say that the “two sides will communicate and coordinate in advance to plan for inspections and investigations,” which sounds an awful lot like Beijing wants the chance to censor and control the information before the SEC can access it. “The Chinese side will also take part in and assist in the interviews and testimonies of relevant personnel of audit firms requested by the U.S. side.”

Hmmm. So the SEC could suddenly say they want to interview A, B and C, and access audits X, Y and Z, but need to give the target Chinese companies, accounting firms and regulators full warning that they’re coming? And once they get there, the SEC will conduct interviews with Chinese nationals while Chinese Communist Party handlers sit in the room, taking notes?

“Audit work papers and other information that the U.S. regulator need access to will be obtained by and transferred through Chinese regulators,” the CSRC insists.

The picture painted by Beijing suggests input and judgment – you could also call it censorship – on the Chinese side. If not, why would Chinese regulators need to be a conduit, instead of the SEC going straight to the accounting firms?

In Washington, the deal on paper grants “complete access” to audit work papers, audit personnel, and any other information that the SEC demands on any company it wants to inspect, “with no loopholes and no exceptions.”

“But the real test will be whether the words agreed to on paper translate into complete access in practice,” PCAOB chair Erica Williams said in announcing the deal. “Now we will find out whether those promises hold up.”

Indeed.

Williams has told her team to get ready to hit the ground by mid-September “so we can put this agreement to the test.” Guess they’re giving their Chinese counterparts warning now!

I have had no doubt all along that there would be some kind of deal to allow Chinese companies to remain listed on Wall Street. One thing China will never be able to duplicate, as long as it has a rigged currency and strict currency border controls, is the depth and breadth of Western capital markets.

I’m not aware of any U.S. company that does not have operations in China that wants to list in mainland markets, which are essentially only accessible to investors inside China. Many a Chinese company, though, would like to get access to U.S. investors even if they don’t have operations inside the United States.

So while the Chinese paint this as a reciprocal deal, the flow of information is really only going to be one way. And there’s never been a concern that accessing the audits of a U.S. company is going to reveal state secrets. But China’s huge state-owned enterprise sector frequently blurs the line between what is a public company and what is a state-run business, while Asian entrepreneurs in general often treat their companies as their own private piggybank long after the company has gone public and accepted outside money.

Reuters is reporting today that the Alibaba e-commerce rival JD.com (JD) and HK:9618 as well as the Pizza Hut and Taco Bell operator Yum China Holdings (YUMC) and HK:9987 will be among the first group of companies that the SEC has asked to inspect. They and their accounting firms – Deloitte and KPMG, respectively – have already been alerted, the news agency states. Alibaba is also in the first group.

So it sounds like the SEC is gonna run a series of tests using the highest-profile, biggest Chinese companies listed in the United States. This makes eminent sense. Where it will get interesting is when the SEC demands quick access to a less-well-known company, particularly one that has a component of state ownership.

It is a series of accounting scandals involving Chinese companies in the United States that brought this issue to a head. Sniffing out scandal doesn’t normally involve warning the companies that you’re coming, please get your forged sales figures prepared!

The deal is very welcome news, and should be reassuring for the holders of the biggest private Chinese companies on Wall Street. It looks like they’ll be able to stay listed in the United States. What teething problems that the SEC encounters, starting in September, will be the true test.

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