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Any potential agreement to allow US regulators access to Chinese companies’ audit books is unlikely as the trade war rages on. Photo: Reuters

Trade war may scuttle China’s interest to share ‘state secret’ company audit reports with US

  • China now willing to share audit work on mainland firms with Hong Kong regulator, which will help improve financial transparency
  • Beijing sees much of the information in the audit reports as state secrets

Chinese authorities agreed this week to officially allow Hong Kong’s market regulator to see corporate financial records that are held on the mainland, marking another step to improve the financial transparency and accountability of Chinese companies listed in the city. But Beijing’s reaction to a similar situation with the US may be quite different under the complicated circumstances of the ongoing trade war, analysts said.

Hong Kong’s Securities and Futures Commission (SFC) has for years been asking to investigate mainland-based companies that may be involved in fraudulent activities by accessing their audit working papers, invoices and other underlying financial documents.

In 2014, the SFC had to take accounting giant EY to court to force it to reveal information on a Chinese utility company that had sought to be listed on the Hong Kong stock exchange. A Hong Kong High Court judge ruled in favour of the commission after EY had refused to comply, citing the mainland required that it kept the audit work secret due to national security concerns.

Similarly, the US Securities and Exchange Commission has been facing difficulties inspecting audits of Chinese firms listed in America despite a 2013 agreement signed with China on the cooperation in audit regulatory matters. Among the cases, a US judge ruled in favour of the regulator in 2014, with the China-based affiliates of the “Big Four” accounting firms agreeing to pay US$500,000 each in fines for failure to turn over work papers.

Hong Kong’s Securities and Futures Commission had to take EY to court in 2014 obtain information on a Chinese firm. Photo: SCMP

On the face of it, the two cases appear almost identical. But the progress since then had been quite different, analysts said.

“After the court ordered EY to produce the audit working papers to the SFC in May 2014, it seems as if the Chinese regulators already have an understanding with the SFC on how to deal with the disclosure of auditors’ working paper kept in China,” said Mike Suen, a partner at international law firm Withers.

The SFC on Wednesday signed a memorandum of understanding with China’s Ministry of Finance (MOF) and the China Securities Regulatory Commission, which will allow the SFC to request the Chinese authorities to provide audit working papers. This follows a May agreement between Hong Kong’s accounting regulator, the Financial Reporting Council, and a unit of China’s MOF, to assist in the city’s nine ongoing investigations.


“The signing of the MOU will further deepen the regulatory cooperation between the two sides, helping to improve the quality of annual reports of listed entities in Hong Kong, and fully protect the legitimate interests of investors on both sides, assuring the healthy development of the accounting industry and the prosperity and stability of financial markets on both sides,” said MOF’s vice-minister Cheng Lihua said in a joint statement.

In contrast, the US-China trade tensions may be pushing Beijing to forge closer relations with its financial partners, including Hong Kong, while moving to decouple from the US. This meant Beijing’s agreement with Hong Kong may not necessarily be replicated with the US, analysts said.

At stake are 156 Chinese companies, including 11 state-owned enterprises (SOEs), that are listed on America’s three largest exchanges with a combined market capitalisation of US$1.2 trillion.

In Hong Kong, about half of the 2,365 companies on its stock exchange are based in mainland China, including a number of SOEs, with a combined market capitalisation of HK$21.1 trillion (US$2.7 trillion), according to exchange figures.


“The US and China have had a separate set of negotiations going on for many years, and that has not led to China being willing to open up in any sort of significant way,” said Jamie Allen, secretary general at the Asian Corporate Governance Association.

“So I don’t think the Hong Kong agreement will just be replicated with the US, given the US-China trade war is clearly a major obstacle.”

The US and China have had a separate set of negotiations going on for many years, and that has not led to China being willing to open up in any sort of significant way
James Allen, Asian Corporate Governance Association

China’s vague definition of state secrecy laws has created corporate transparency problems. The nation’s determination to protect its sovereignty means it does not want to give the US regulator, the Public Company Accounting Oversight Board (PCAOC), access to what it considers state secrets.


“It’s a broader issue of sovereignty. I think China feels that a foreign regulator doesn’t have the right to come into China,” Allen said. “The US-China relationship is really just more complicated than the relationship between the US and other countries.”

A bipartisan group of politicians led by Republican senator Marco Rubio introduced a bill in June that, if enacted, would require that US exchanges delist Chinese firms that don’t open their audit books to American regulators. The US accuses China of intertwining the public and private sectors, and providing generous state subsidies to Chinese firms, to serve the Communist Party’s goals.

The enforcement page on the PCAOB’s website shows its international regulatory reach includes Australia, Canada, Colombia, Hong Kong, India, Malaysia, Mexico, Turkey, and Britain.


Analysts said the chance of the bill being passed was slim given the strong objections from US fund managers and financial investors, unwilling o turn their backs on fee-paying Chinese enterprises. At the same time, the potential risk to Chinese firms, and in turn the Chinese government, was significant, as the American capital markets represent a big portion of the world’s available investment funding for mainland firms.

SMIC delisted from the New York Stock Exchange in May. Photo: Imaginechina

Nevertheless, any movement towards a US-China decoupling could point to political motives.

Alibaba Group Holding, a New York-listed Chinese e-commerce giant that owns the South China Morning Post, is considering a second listing in Hong Kong to raise as much as US$20 billion in August. That follows the delisting of Semiconductor Manufacturing International Corp, China’s largest maker of semiconductors, from the New York Stock Exchange in May.

“[The MOU with Hong Kong] certainly adds pressure for a similar arrangement to be done with the US. However, the devil is in the detail and it will be up to both sides to iron out the relevant details such as maintaining the restriction on access for ‘national security issues’, the goalposts for such issues, and the clearing procedures,” said Clement Chan, managing director of assurance at accounting firm BDO.

“I do not believe the US will lightly accept any half-baked solution without giving it a hard try in getting a medium- to long-term, mutually acceptable solution,” Chan added.

This article appeared in the South China Morning Post print edition as: Doubts over US repeating city audit deal