Zhang Mengying, journalist

An agreement to facilitate access to audit papers related to US-listed Chinese companies has helped to minimise risks of delisting, even if it will be some time before it becomes clear how the information sharing is working out.

In August, China and the US took the first step towards facilitating access to audit documents for US-listed Chinese companies through the Holding Foreign Companies Accountable Act (HFCAA). That month, the US Public Company Accounting Oversight Board (PCAOB) signed a statement of protocol (SOP) with the China Securities Regulatory Commission (CSRC) and the country’s Ministry of Finance covering inspections and investigations of PCAOB-registered public accounting firms in China.

Without the access that the new protocol facilitates, as many as 270 companies could be forced out from US stock markets by 2024

Direct access

The PCAOB said that the protocol facilitates access to audit information in three important ways. First, the PCAOB will have sole discretion to select the firms, audit engagements and potential violations it inspects and investigates. Second, PCAOB inspectors and investigators will be able to view complete audit work papers. Third, the PCAOB will have direct access to interviews and be able to take testimony from staff at audit firms.

The protocol has been a couple of years in the making and brings to a close a process that started in 2020, when the US Congress passed the HFCAA, which states that the US Securities and Exchange Commission (SEC) can prohibit stocks from trading if a company files audit reports for three consecutive years issued by accounting firms that the PCAOB is unable to inspect or investigate.

Without the access that the new protocol facilitates, as many as 270 companies could be forced out from US stock markets by 2024. These companies, combined, have a current market capitalisation of as much as US$2 trillion.

The CSRC has stressed that materials such as audit work papers that the US regulator needs to access will be obtained by and transferred through the Chinese side, says Gavin Guo, a partner at Merits & Tree Law Offices. The Chinese side will also take part and assist in interviews, gathering testimony from personnel of audit firms requested by the US side.

‘Many companies considering US listings have chosen to wait and see’

Following the signing of the agreement, Beijing sent a team of regulatory officials to Hong Kong in September to assist the US watchdog with audit inspections involving Chinese companies.

Implementation begins

‘The officials designated by Beijing aim to implement the cooperation method in the SOP agreement, which will include assisting in the transfer of the audit work material to the US side and participating in the review activities conducted by the US side,’ Guo says.

The PCAOB stated that the US watchdog would evaluate the actual implementation process of the SOP agreement and determine whether it has fulfilled its purpose of inspections and investigations by the end of 2022.

Guo expects the work by both sides in Hong Kong to be completed by November or December of this year. Still, given the uncertainty generated by the act, he has noticed a significant drop in the number of Chinese companies looking to issue shares in the US through 2022.

‘Many companies considering US listings have chosen to wait and see,’ he says. ‘These companies will only decide whether to list in the US or not after the PCAOB and SEC complete the review in Hong Kong and confirm the final results of audit cooperation with China.’

Be cautious

Guo thinks that, at this stage, companies should be cautious because negotiations between the two parties are ongoing.

‘Reaching an agreement is only the first step,’ Guo said, noting that there are always still concerns about how fully the agreement will implemented.

He thinks companies should not completely rule out the possibility that cooperation between the two sides could break down due to political or legal differences.

‘In this worst-case scenario, US-listed Chinese companies may still face the risk of delisting,’ he adds.

Confidentiality compliance

The current cooperation framework still calls for any audit papers to flow to US regulators through the CSRC. Guo says that US-listed companies and auditors should make sure they send audit work papers overseas only with the consent of the CSRC.

‘Listed companies should comply with China’s confidentiality regulations during their audits’

In April 2022, the CSRC published the Provisions on Strengthening the Confidentiality and Archives Administration of Overseas Securities Offering and Listing by Domestic Companies (Draft for Comments), in which it expressly requires listed companies and auditors not to disclose documents and materials involving state or work secrets of government agencies when providing information to a foreign authority.

‘Listed companies should comply with China’s confidentiality regulations during their audits and distinguish confidential information from non-confidential information,’ Guo says.

These suggestions also apply to companies preparing listings in the US.

As the US and China work towards a finalised agreement, the PCAOB plans to review the impact of the actual implementation of the SOP at the end of this year.

‘If the PCAOB concludes that the current cooperation with China meets its requirements, and if both parties have established a sustainable and enforceable cooperation mechanism, the delisting risk of US-listed Chinese companies will be significantly reduced,’ Guo said. ‘Otherwise, it may mean the breakdown of cooperation between China and the US, and the US-listed Chinese companies will face a greater risk of delisting.’