1. Why does the US want access to audits?
The 2002 Sarbanes-Oxley Act, enacted after the Enron Corp. accounting scandal, requires that publicly traded companies make their audit work papers available for inspection by the Public Company Accounting Oversight Board, or PCAOB. According to the US Securities and Exchange Commission, more than 50 jurisdictions work with the board to allow the reviews while only two — China and Hong Kong — don’t. The discrepancy drew attention when Chinese chain Luckin Coffee Inc., which was listed on Nasdaq, was found to have intentionally fabricated a chunk of its 2019 revenue. In 2020, Congress passed the Holding Foreign Companies Accountable Act (HFCAA), which says companies can’t trade on US exchanges if American inspectors can’t review their audits for three consecutive years.
2. Where does enforcement of that law stand?
In March, the SEC started publishing its “provisional list” of companies identified as running afoul of the requirements. By the end of July the list had grown to more than 100 companies, including Alibaba, JD.com, Pinduoduo Inc. and China Petroleum & Chemical Corp. In all, the PCAOB said that in the 13-month period ending Dec. 31, 2021, 15 audit firms it oversees signed audit reports for 192 businesses based in China or Hong Kong — none of which can be reviewed by the regulator.
3. How has China responded?
In what could be a significant breakthrough, US and Chinese regulators announced on Aug. 26 that they had reached a preliminary agreement to allow PCAOB inspectors to access audit work papers and personnel. While the deal was heralded as a significant step, American officials are unlikely to declare whether they are satisfied with the access until December 2022. Ahead of the deal, several of China’s largest state-owned businesses announced plans to delist from the US, and tech giant Alibaba Group Holding Ltd. said it would seek a primary listing in Hong Kong, a signal that it could be preparing to exit US markets.
4. What’s behind the US pressure?
Critics say Chinese companies enjoy the trading privileges of a market economy — including access to US stock exchanges — while receiving government support and operating in an opaque system. In addition to inspecting audits, the HFCAA requires foreign companies to disclose if they’re controlled by a government. The SEC is also demanding that investors receive more information about the structure and risks associated with shell companies — known as variable interest entities, or VIEs — that Chinese companies use to list shares in New York. SEC Chair Gary Gensler has said that more than 250 companies already trading will face similar requirements.
5. Are some Chinese firms really controlled by the government?
Major private firms like Alibaba could probably argue that they are not, although others with substantial state ownership may have a harder time. The US-China Economic and Security Review Commission, which reports to Congress, says China considers eight companies listed on major US exchanges to be “national-level Chinese state-owned enterprises.” They are PetroChina, China Life, China Petroleum & Chemical, China Southern Airlines Co., Huaneng Power International Inc., Aluminum Corp. of China Ltd., China Eastern Airlines Corp. and SINOPEC Shanghai Petrochemical Co.
6. Why do Chinese companies list in the US?
They are attracted by the much bigger and less volatile pool of capital, which can potentially be tapped much faster. China’s own markets, while giant, remain relatively underdeveloped. Dozens of firms pulled planned initial public offerings in 2021 after Chinese regulators tightened listing requirements to protect the retail investors who dominate stock trading, as opposed to the institutional investors and mutual-fund base active in the US. And until recently, the Hong Kong exchange had a ban on dual-class shares, which are often used by tech entrepreneurs to keep control of their startups after going public in the US. It was relaxed in 2018, prompting big listings from Alibaba, Meituan and Xiaomi Corp.
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