China is facing growing pressure to settle its audit agreement with the United States
China is facing growing pressure to settle its audit agreement with the United States

China is facing growing pressure to settle its audit agreement with the United States

After more than a decade of standing in the way of U.S. regulatory inspections of Chinese corporate auditors, Chinese authorities have been unusually vocal in recent months about their desire to address what has become a major stumbling block for overseas listed Chinese stocks such as for example.

Alibaba Group Holding Ltd.

and

Baidu Inc.

The change in tone has come as a three-year countdown for China to comply with the 2020 law on holding foreign companies accountable, which appears to be shortened. Entering into and executing any agreement would entail a lengthy process, and the new schedule could result in U.S. stock trading bans for some Chinese companies starting as early as March next year.

The China Securities Regulatory Commission, the agency that coordinates the Chinese government’s response to the negotiations, has issued several statements this year signaling that progress has been made in negotiations with their US counterparts.

In a statement to The Wall Street Journal on Tuesday, the CSRC said: “China and the United States maintain close communications and are committed to reaching cooperation agreements that comply with both countries’ laws and regulations. Overall, the negotiation process is smooth.”

The Securities and Exchange Commission and the US Public Accounting Authority, on the other hand, have been more cautious about the prospect of any agreement being reached and then implemented.

“We continue to meet and engage with the Chinese authorities, and speculation about a final agreement is still premature,” the PCAOB said in a statement to the Journal, referring to the People’s Republic of China. “It is important to note that reaching an agreement, while an important and necessary first step, will not only meet the requirements of the HFCAA,” the statement said.

The key question is whether China will allow the PCAOB to routinely inspect the auditors of U.S. listed Chinese companies, a 20-year-old requirement under U.S. law for all companies whose shares are traded on U.S. stock exchanges. China has long argued that unhindered access to audit papers could threaten the country’s national security, as some of the companies are state-owned, deal with state-owned companies or have large amounts of data on Chinese citizens.

Beijing’s expansive view of what constitutes a national security risk is one of the causes of the stalemate. For example, unadulterated information from large Chinese companies could provide insight into the nation’s economy that is not visible in China’s tightly controlled official data.

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The HFCAA entered into force in 2021 and bans U.S. securities trading from companies whose auditors cannot be inspected by the PCAOB for three consecutive years. It allows Beijing until the spring of 2024 to comply.

However, bills that would shorten the deadline by one year has been adopted by both Parliament and the Senate. This means that the legislation is likely to be included in a broader “China law” that is still under negotiation and which aims to increase US competitiveness vis-à-vis China. SEC President Gary Gensler supports the shortened schedule.

If the bill is passed later this year and China-based auditors still cannot be inspected, Chinese companies could be delisted from March 2023, when their 2022 annual reports are published. The CSRC said the proposed acceleration of the timeline “is not conducive to protecting investor interests or to addressing audit oversight issues.”

The SEC has identified 148 companies as incompatible following the release of their latest annual reports, including Chinese e-commerce giants

JD.com Inc.

and

Pinduoduo Inc.

and restaurant operator

Yum China Holdings Inc.

“There is a good chance that the accelerated timeline could be adopted as part of a comprehensive China bill or as a stand-alone measure by the end of the year,” said Clete Willems, a Washington-based partner at Akin Gump Strauss Hauer & Feld and former trade dealer in the Trump administration.

This means that Beijing realistically only has weeks left to conclude an agreement with Washington that will allow PCAOB representatives to travel to China and start the inspections, as these inspections can take several months to complete, industry experts and people said. who is familiar with the matter.

“The purpose of the bill is not to kick companies off the stock market. The purpose is to apply PCAOB supervision, ”said the US Rep. Brad Sherman (D., California), who introduced the House version of the Accelerated Timeline Law. A shortening of the timeline “will lead to faster negotiations,” he said in an interview.

In recent closed meetings with Chinese companies and international investors, the CSRC said it was working towards the goal of reaching an agreement by the end of June, according to people familiar with the matter.

“Right now, the United States has the biggest lever to force China to negotiate an agreement than ever before,” said Shaswat Das, who was PCAOB’s chief negotiator on audit oversight of Chinese authorities from 2011 to 2015. “The HFCAA has laid the groundwork for recent discussions between PCAOB and Chinese authorities that are likely to result in an agreement being reached this summer, ”said Mr. Das, who is now a lawyer at King & Spalding LLP in Washington.

However, China’s policy of eradicating Covid-19, keeping its international borders closed and throwing megacities into barricades could also delay the timeline for inspection on the ground by U.S. officials.

Even if an agreement is reached that will allow U.S. regulators to inspect auditors in China, the PCAOB will need adequate access to corporate audit papers before it can be established that China as a jurisdiction complies with the HFCAA.

“An agreement without successful execution will not comply with U.S. law,” PCAOB said in the statement, adding that it “must have the unlimited ability to choose” which auditors and their clients’ audit papers are to be inspected.

The scope and depth of such inspections was a contentious point in previous rounds of negotiations. In pilot projects conducted during 2016, China provided heavily edited audit papers and prevented PCAOB from accessing the records of the most valuable U.S. listed Chinese companies, including Alibaba. Chinese officials were also present at interviews conducted by the PCAOB during the inspection, potentially disrupting the process. Eventually, negotiations broke down.

There are currently more than 250 Chinese companies listed on US stock exchanges. The PCAOB does not have to inspect all of their audit papers in the initial phase, but it must be able to examine a meaningful sample to establish that China as a jurisdiction complies with the HFCAA.

Overall, it can be a painstaking process, even if China makes concessions in areas it was not willing to before.

“The clock is ticking, and unless China shows more flexibility than it has shown today, the delisting of some or all of its companies is inevitable,” he said. Willems.

Write to Jing Yang at [email protected] and Paul Kiernan at [email protected]

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