What to consider next in the US-China ADR audit dispute

What to consider next in the US-China ADR audit dispute
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The US and China have taken an important first step to prevent US-listed Chinese stocks like Alibaba from being forced off US stock exchanges.

Holger Gogolin | iStock | Getty Images

BEIJING – The US and China recently took a significant first step in holding US-listed Chinese stocks Alibaba from being ousted from US stock exchanges.

What needs to happen next is a smooth U.S. on-site inspection in China, with proper support from Chinese authorities, analysts said.

“Many details of the implementation can probably only be found out by the accounting firms and the accounting firm [Ministry of Finance] – along with [the China Securities Regulatory Commission] – through real-world review processes under this unprecedented agreement,” said Winston Ma, associate professor of law at New York University.

The US Public Company Accounting Oversight Board said its inspectors were scheduled to arrive in Hong Kong mid-September, shortly thereafter “all examination working papers requested by the PCAOB must be made available to him”.

Audit working papers differ from the actual information about companies collected by accounting firms.

The working papers document the audit process, tests, information gathered and conclusions from the review, according to the PCAOB website. It is not clear how much, if any, highly sensitive information would be included in the working papers.

SEC Chairman Gary Gensler breaks agreement with China on audit inspections

The US ability to see these working papers for US-listed Chinese companies has been a dispute for years. Political and legal developments in the US over the past two years have accelerated threats that Chinese companies may have to be delisted from US stock exchanges.

A turning point came in late August when the PCAOB and Chinese securities regulator signed a cooperation agreement that laid the regulatory basis for allowing US inspections of accounting firms within China’s borders.

That’s according to statements from both government agencies, which also said that the Chinese Treasury signed the deal.

“I see this as a major ‘progress,’ meaning both sides were willing to take steps to move this forward,” said Stephanie Tang, head of private equity for Greater China and a partner at Hogan Lovells.

“The subject or audience of this PCAOB investigation would be the accounting firms,” ​​she said, stressing that she is not an accountant.

Need for more clarity in implementation

China’s registered accounting firms are overseen by the Ministry of Finance, making it a leader on the Chinese side for the next steps, said Ming Liao, founding partner of Beijing-based Prospect Avenue Capital.

However, according to analysts, there is uncertainty about the implementation of the agreement because it only sets out a framework.

“Our accounting firms still don’t know how to proceed,” said Peter Tsui, president of the Hong Kong-based Association of Chinese Internal Auditors. That’s according to a CNBC translation of his comments in Mandarin on Thursday.

He said there were still questions about what information companies should share to comply with Chinese regulations.

“Give [us] some guidelines,” Tsui said.

Tsui said the inspections should go smoothly if it’s just about accountants on both sides and there’s no political interference on the US side. He said the big four accounting firms – KPMG, PwC, Deloitte and EY – are members of the association.

The Chinese Ministry of Finance has yet to release a public statement on the audit cooperation agreement. The ministry did not immediately respond to a CNBC request for comment.

One development Prospect Avenue Capital’s Liao is watching is whether US President Joe Biden and Chinese President Xi Jinping will meet in person for the first time under the Biden administration this fall. That could speed up a final agreement in the exam dispute, he said.

“Ultimately, solving the problem of the examination working papers depends on the political interaction between China and the United States,” Liao said in Chinese, according to a CNBC translation. “With trust, this problem is easily solved.”

A decision by the end of the year

The PCAOB said it will determine in December whether China is still impeding access to exam information.

U.S. regulators will likely “learn in October or November” what decision the PCAOB will make on whether U.S.-listed Chinese companies may be headed for delisting, Gary Gensler, chairman of the U.S. Securities and Exchange Commission, told CNBC’s David Faber August .

Alibaba and many other US-listed Chinese companies have started issuing shares in Hong Kong in recent years — partly as a way to hedge against a possible delisting from US stock exchanges. Since the US IPO of the Chinese ride-hailing company Didi in the summer of 2021, Beijing has also been taking a closer look at Chinese companies that want to list abroad.

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The combined political uncertainty has slowed the flow of Chinese IPOs in the US, particularly by larger companies.

According to Renaissance Capital, as of July 1, 2021, 16 Chinese companies are listed in the US, excluding special purpose entities. Back in 2020, 30 China-based companies was listed in the USA, the company announced at the time.

By value, the top five US institutional holdings of US-listed Chinese stocks are: Alibaba,, Pinduoduo, NetEase, and Baidu. This comes from a research by Morgan Stanley from 8. 26.

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