Mainland auditing scheme threatens transparency standards

The dispute over mainland secrecy laws shows that investors are right to be concerned

PUBLISHED : Tuesday, 04 September, 2012, 2:27am
UPDATED : Tuesday, 04 September, 2012, 10:08am

It is time for us to review the almost two-year old rule allowing mainland auditors to audit Hong Kong-listed mainland companies. 

When the stock exchange introduced the new rule in December 2010, many lawmakers and brokers  expressed concern  that investors would not be adequately protected.  They especially feared our securities watchdog would not be able to gain access to audit papers held by mainland auditing firms and thus be unable to conduct investigations into instances of alleged misconduct.

Before such rules were introduced, mainland firms applying to list in the city had to appoint Hong Kong-based auditing firms, which under  Hong Kong law must provide assistance and information to the Securities and Futures Commission when required. In a bid to  appease concerns about the  relaxation of auditing rules, the  Ministry of Finance later  signed a pact with the Hong Kong Financial Reporting Council,  saying it would provide assistance in enforcement.

So has the new system worked? On August 27, the SFC  filed a writ in the High Court seeking a court order requiring Ernst & Young to provide information regarding mainland firm Standard Water. The company applied to list in Hong Kong in November 2009 but Ernst & Young resigned as auditor in March 2010. Standard Water later withdrew its listing application.

Despite nine notices from the SFC, Ernst & Young failed to hand over its   accounting working papers citing the fact that the relevant information is with its mainland joint venture Ernst & Young Hau Ming  and  subject to state secrecy laws. This meant they could not be taken out of the mainland.  
The High Court on September 11 will rule on whether Ernst & Young can use mainland state secret laws  as a reason for not providing requested audit papers to the  regulator.

If the ruling confirms that the SFC cannot access these papers, the government should do an immediate review of the rules allowing mainland auditing firms like EY Hau Ming to audit Hong Kong listed companies or listing hopefuls.

How can the regulator investigate alleged misconduct and enhance investor protection in such a situation? The Hong Kong regulator has asked mainland regulators to help but still cannot get the information.  Plugging the loophole in such cases is not just important for Hong Kong investors but also for  the mainland firms. In fact, many investors are worried over the quality of  new mainland listings.   Poor auditing transparency makes it hard for  investors to feel comfortable investing in mainland firms audited by mainland auditors.

If that happens, it will be a lose-lose situation for all parties.