Xie Yu, John McCrank, and Samuel Shen
NEW YORK/SHANGHAIInvestors in Chinese companies listed in the U.S. were relieved when Beijing and Washington finally reached a long-awaited audit agreement. However, legal experts and people who follow China warn that the two sides might still have different ideas about how the agreement should be understood and carried out.
Related: What to keep an eye on as US-China audit talks drag on
Since more than a decade ago, U.S. officials have wanted to look at audit documents of Chinese companies that are listed in the U.S. However, Beijing has refused to let U.S. regulators look at its accounting firms, citing national security concerns.
On Friday, however, the countries reached a landmark agreement that appeared to give the United States everything it desired: full access to China’s audit documents with no redactions for any reason; the right to take testimony from audit company staff in China and Hong Kong; and the sole authority to choose which companies the United States inspects.
Investors saw the acquisition as a big boost for Chinese companies that are listed in the U.S., but Monday’s share price gains were limited by a new round of risk aversion caused by fears of a long period of global interest rate hikes.
Legal experts warned that investors may be getting too excited too soon. They pointed out that the two parties’ subtle wording could cause problems when the agreement is put into action next month.
They said that the U.S. audit watchdog, the Public Company Accounting Oversight Board (PCAOB), would need some time to figure out if China was following the agreement honestly.
According to Hung Tran, a senior fellow at the Atlantic Council, a U.S. think tank, “to break the impasse and get an agreement for both parties is noteworthy.”
However, it will take some time to determine if the access, the method, and the actual inspection of auditing trails can be conducted in accordance with U.S. law.
Related: China’s audit agreement gives respite but few investment incentives.
According to a statement released by the PCAOB on Friday, the deal would allow complete access to U.S. regulators “if adhered to.”
Beijing’s statement, however, highlighted that the premise for bilateral cooperation is “equality,” and that the U.S. side must get documents through the Chinese regulator, as well as participate and allow the Chinese side to organise the interview and testimony taking.
The China Securities Regulatory Commission (CSRC), which praised the agreement as a big step forward for investors, businesses, and both countries, said that the audit problem will only be solved if collaboration “meets the regulatory standards of each side.”
SENSITIVE DATA
There are examples in which collaboration between the two parties has broken down.
Public statements from the past say that the PCAOB spent a lot of time and money negotiating a Memorandum of Understanding (MOU) with the Chinese government in 2013 to work together on audit enforcement, but in the end they decided they couldn’t get enough information access.
According to attorneys, much will rely on which of the more than 200 Chinese corporations listed in the United States the PCAOB chooses for investigation. Friday, PCAOB officials said that they had notified the selected firms and would start looking at their audit documents the following month. They did not say who the firms were, though.
The PCAOB spokesperson told Reuters that agency officials had said on Friday that the PCAOB would choose firms based on risk factors like size and industry, and that no company could expect to be treated differently.
Related: The Chinese government says that China and the U.S. are committed to making an audit deal.
If the PCAOB chooses well-known companies with a lot of sensitive data, tensions could rise quickly. However, lawyers say that the PCAOB is unlikely to give in to pressure from China because of how closely it is watched in its own country.
Marcia Ellis, a Hong Kong-based attorney at Morrison & Foerster, said that the deal’s audit paper access requirements were in conflict with China’s severe data security regulations.
A spokesperson for the U.S. Securities and Exchange Commission, which runs the audit watchdog, declined to comment. However, the agency’s head, Gary Genslery, warned on Friday that the agreement will only be important if U.S. authorities are given the promised access.
The CSRC did not reply quickly to a request for comment from Reuters.
For the PCAOB to say that China as a whole is compliant, all of the chosen businesses and audit firms must also be compliant.
Former head of the SEC’s office of foreign relations Paul Leder said that the PCAOB will not cut corners when putting this agreement into place.
“It is aware that both the SEC and Congress will want reassurance that the PCAOB has the same access to information when evaluating a Chinese audit company as it does when inspecting a U.S. business,” said Leder, who is now a counsel at Miller & Chevalier.
Even if the sale goes through, Morrison & Foerster attorney Ellis says that China will keep some companies from going public in the U.S. because of the ongoing debate over giving China access to sensitive data.
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“Even if the PCAOB problem is fixed, we think Chinese companies with sensitive information that haven’t listed yet will choose Hong Kong,” she said.