Countdown Starts on Chinese Company Delistings After Long U.S.-China Audit Fight

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The three-year countdown will accelerate the disintegration of the world’s two largest economies

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In late 2020, then-President Donald Trump signed a law that bans the trading of securities in foreign companies whose audit working papers cannot be inspected by US regulators for three consecutive years. The passage of the Holding Foreign Companies Accountable Act followed nearly a decade of unsuccessful attempts by regulators in the US and China to resolve increasingly differing expectations on how such audit inspections would be conducted.

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The Securities and Exchange Commission is working out details of how the law will be implemented and is finalizing related regulations. Its president Gary Gensler has said that the clock has started ticking this year.

The SEC expects US regulators to flag Chinese companies in 2022 if they do not get access to audit work involving those companies’ 2021 financials, a person familiar with the matter said.

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In anticipation of the results, some investors have exchanged their American depository receipts in Chinese companies for shares that trade on the Hong Kong stock exchange.

New York fund manager WisdomTree Investments swaps ADRs of Alibaba Group Holding in late 2020 Ltd.

For Hong Kong-listed shares of the e-commerce giant, in some exchange-traded funds. Quantitative investment expert Liqian Ren said the firm is monitoring Hong Kong trading volume to determine whether it should convert other companies’ ADRs.

Wim-Hein Pals, head of the Emerging Markets equity team at Netherlands-based asset manager Robeco, said they converted all Chinese ADRs to Hong Kong-listed stocks last year and earlier this year. Chinese ADRs now represent only 1.5% of their emerging markets portfolio of approximately $1.4 billion.

“We see liquidity moving slowly but steadily into Hong Kong over the next few years. More and more investors will move to Hong Kong-listed names, and ignore their US-listed stocks,” predicted Mr. Pals.

According to data from the Hong Kong Stock Exchange, since Alibaba’s historic secondary listing in Hong Kong in late 2019, 15 more US-listed Chinese companies have added so-called homecoming listings in the Asian financial hub. Recent data shows that the majority of trade still takes place between Chinese ADRs.

For years, US regulators said they had never found transparency in auditing firms’ work on Chinese companies, because China was not regularly handing over the papers they needed or was not negotiating in good faith.

The Chinese side said on several occasions that it opposes the “politicization of securities regulation” and welcomes dialogue to find a solution.

For data-heavy Internet companies, which make up the bulk of US-listed Chinese companies, audit working papers can include raw data such as meeting logs, user information and email exchanges between companies and government agencies, among other things. In the US, oversight is conducted by the Public Company Accounting Oversight Board, which is overseen by the SEC.

China has also said that a foreign government’s access to such details for data-heavy tech companies could jeopardize the security of the state. Earlier this year, Chinese officials wanted ride-hailing giant Didi Global Inc.

Businesshala previously reported that to close its New York listing until they could address the issues in the audit working paper.

In return, US officials have said that China has used national security logic to not open companies’ books.

The audit standoff has long been a contentious issue in cross-border relations between the two countries. For more than a decade, the PCAOB, which essentially acts as an auditor of auditors, oversees China-based audit firms as well as mainland Chinese affiliates of the Big Four accounting firms. is struggling.

In 2013, the US and China had a brief breakthrough. Both sides agreed to allow PCAOB to inspect the work done by auditors of US-listed Chinese companies that were being investigated by regulators.

The China Securities Regulatory Commission later submitted the audit papers of the four companies to PCAOB for review. The 2013 agreement paved the way for the two sides to talk about a comprehensive set of inspection protocols.

In late 2015, officials from the two countries met in Beijing to try to establish those protocols. After two weeks of talks, the talks broke down. A deal breaker: Chinese officials were unwilling to let the US inspect Alibaba and Baidu’s audit papers Inc.,

The two most valuable Chinese companies listed on US exchanges.

PCAOB’s chief negotiator at the time, Shashwat Das, said he understood from prior talks with China that access would be granted, and took his response—that he needed to first consult with other ministries and the State Council—as a sign. Not communicating in good faith as they were.

Paul Gillis, a professor of practice at Peking University’s Guanghua School of Management and a former member of the PCAOB Standing Advisory, said the Chinese side expected the US to eventually come around to “regulatory parity”, an arrangement that China had with the European Union. is of. Group. “It basically means that the US will accept the work done by the Chinese regulator as if they did it themselves,” he said.

This was not acceptable to the US, said people familiar with the thinking of the SEC and PCAOB.

US and Chinese officials later tried to resume talks, but could not agree on key issues. An important point was the restriction of information to China that US regulators deemed necessary. In 2017, when PCAOB attempted to oversee an audit of a China-based company, the Chinese did not produce the working papers demanded by the US and repurposed others, According to the letter of an inspection board to government officials.

In the absence of a resolution, the Holding Foreign Companies Accountable Act was introduced in March 2019.

In April 2020, the CSRC proposed a joint oversight framework under which US officials could conduct inspections and investigations with Chinese officials based in China and access audit papers of companies deemed relevant by the Chinese side.

According to the Inspection Board’s letter, the proposal was seen as imposing “significant limits” on the PCAOB’s ability to conduct inspections.

about the same time, but coffee Inc.,

An upstart rival of Starbucks Corp. in China admitted to fabricating revenue and spending. Accounting fraud hardened the resolve of many politicians to push through a bill to enforce stricter auditing standards.

Lucky had to face embarrassment even to go back home after bursting. The CSRC publicly criticized the company, but refrained from taking any regulatory action, as Luckin is registered in the Cayman Islands and listed in the US.

CSRC submitted a revised proposal to PCAOB in August 2020. It is not clear what happened after that.

In June of this year, the Senate passed another bill that, when enacted, would reduce the three-year timetable to two years.

In August, CSRC President Yi Huiman said that promoting Sino-US cooperation on auditing oversight is one of the regulator’s top priorities for the remainder of this year.

The threat of delisting gives US officials a significant advantage at the negotiating table against the Chinese side. “If America is going to have any success at the negotiating table, this law has to be enforced,” said Mr. Das, who is now a lawyer at King & Spalding LLP in Washington.

Dawn Lim at [email protected] and Jing Yang at [email protected]


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