US ratchets up pressure on Chinese firms to share audits as failure to comply could lead to delistings from American bourses

Public Company Accounting Oversight Board announces rule to comply with Holding Foreign Companies Accountable Act
Chinese firms could face delisting in 2024 if they fail to provide access to their audits after Trump-era law passed last year

Banking & finance

Chad Bray

Published: 7:00pm, 14 May, 2021

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A US accounting oversight board proposed a draft rule to speed the implementation of a Trump-era law that would force publicly traded Chinese companies to delist from American bourses in three years if they do not share their audits for review.

The Public Company Accounting Oversight Board (PCAOB) said on Thursday that the rule change would provide a framework to determine whether local authorities inhibited its inspections of foreign accounting firms that audit US issuers. The public has until July 12 to comment on the proposed rule.

“The rule addresses situations where overseas authorities have denied the PCAOB the access it needs to conduct its mandated oversight activities,” PCAOB chairman William Duhnke III said in a statement.

The proposed rule change came just days after a group of influential Chinese law professors said the Holding Foreign Companies Accountable Act was “discriminative and unfair” to US-listed Chinese companies and Yum China’s top lawyer said the law could “weaken the global role of the US capital markets”.

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The US law requires foreign companies to delist their shares if they do not allow the PCAOB to review their audit working papers for three consecutive years. The act was signed into law in December in the waning days of the Trump administration after receiving strong bipartisan support in the US and could force Chinese firms to leave American bourses in 2024.

The US Securities and Exchange Commission (SEC) made a similar move in March, asking for public comment on its own rule changes to implement the law.

Following the collapse of Enron, public companies listed in the US have been required to submit their audits for review under the Sarbanes Oxley Act, which was passed in 2002.

While Chinese accounting rules have moved closer to international accounting standards in recent years, there remain key differences in US generally accepted accounting principles (GAAP) and Chinese accounting rules, such as valuation of certain assets.

In the waning days of his administration, former US President Donald Trump signed the law that could force Chinese companies to delist from American bourses. Photo: AFP

Beijing previously denied permission for PCAOB to review the audits of US-listed mainland firms on national security grounds.

American officials are pressing US-listed Chinese firms to open their books, saying not doing so exposes US retail investors to potential frauds, such as the US$310 million accounting fraud that led to the delisting of Luckin Coffee.

In April, Fang Xinghai, vice-chairman of the China Securities Regulatory Commission (CSRC), placed the continued disagreement at the foot of US officials, saying progress had been made in recent years with the PCOAB to reconcile the oversight board’s demands with China’s national security requirements, only to have the US political landscape change “drastically”.

The PCAOB said more than 200 accounting firms from about 40 foreign jurisdictions are currently subject to inspection because they audit US-listed companies. It can conduct inspections of audit papers in all of those jurisdictions, except those related to Chinese firms and the Chinese operations of Hong Kong companies, the oversight board said.

A group of Chinese law professors, including professors from Peking University Law School, Tsinghua University Law School and the Institute of Law at the Chinese Academy of Social Sciences, said this month that the law is “obviously aimed” at Chinese companies, rather than foreign companies in general, and includes the “extremely unusual” requirement that companies disclose directors and executives who are members of the Chinese Communist Party.

Yum China said the Holding Foreign Companies Accountable Act could “weaken” the role of US capital markets globally and hurt retail investors. Photo: Bloomberg

“Such requirement clearly contradicts the market-based principles of US capital markets and the professionalism of US financial regulation, which reflects an inappropriate inclination to overpoliticise securities regulation,” the professors said in a May 3 letter to the SEC.

The law could force several New York-listed Chinese tech giants and other companies to make a tough decision on whether to abandon their US listings, with several US-listed Chinese companies seeking secondary listings in Hong Kong in the past 18 months as a potential hedge.

Yum China Holdings, the operator of KFC and Pizza Hut in the mainland, said the law could force it to delist and trigger a large amount of its capital stock to move out of the US.

“This may lead to unintended consequences for US investors, and in particular retail investors. While shares of the company trade on the Hong Kong stock exchange, there are logistical challenges for retail investors in repositioning their shares to the Hong Kong stock exchange,” Joseph Chan, Yum China’s chief legal officer, wrote in a May 4 letter. “More broadly, we are concerned that the act may promote numerous going private transactions if wholesale trading prohibitions and delistings were to occur.”

The shares of several big technology companies with dual listings in both the US and in Hong Kong also fell sharply in early trading in the city on Friday following the PCAOB announcement.

E-commerce giant JD.com fell as much as 5.6 per cent, while Chinese internet and artificial intelligence giant Baidu declined as much as 3.6 per cent.

The Holding Foreign Companies Accountable Act is one of several moves made by former US President Donald Trump’s administration to restrict the access of Chinese companies to American capital markets.

Trump signed an executive order in November 2020 that forced the delisting of three of China’s biggest telecommunications companies and CNOOC Limited, a unit of China National Offshore Oil Corporation (CNOOC), over purported ties to the Chinese military.

American investors, including pension funds and university endowments, have until November 11 of this year to fully divest their holdings in any designated Chinese military companies following the executive order.

Trump’s successor, President Joe Biden, has been reviewing the investment ban. Bloomberg reported this month that the White House was not expected to remove those restrictions.

The heightened scrutiny of Chinese firms by the US, has done little to discourage companies from continuing to seek US listings.

The number of China-based companies listed on US equity markets rose by 14 per cent in the past seven months, according to a report by the US-China Economic and Security Review Commission, a congressional advisory body.

As of May 5, there were 248 Chinese companies listed on major US exchanges, an increase from 217 in October. During that time, 17 Chinese were delisted from American bourses.

This article appeared in the South China Morning Post print edition as: U.S. puts squeeze on Chinese companies to reveal audits