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HK Audit regulatory reforms advance

Hong Kong government has published the results of its consultation to improve the regulatory regime for listed company auditors.  Hong Kong has long needed reform because the current system of self regulation clearly is not working. The Hong Kong Institute of CPAs is perhaps the most feckless of audit regulators worldwide. The European Union withdrew regulatory equivalency from Hong Kong with respect to audit regulation, which appears to have been the event that prodded Hong Kong into reform.

The proposal, which should now advance to enabling legislation (estimated 2016/2017), is to beef up the regulatory powers of the Financial Reporting Council (FRC), making it similar to other regulators like the U.S. Public Company Accounting Oversight Board or the Canadian Public Accountability Board. The new rules will apply only to auditors of public companies, although they could be expanded to cover other public interest entities.

The HKICPAs will retain certain responsibilities, like registration of CPAs, setting of standards, etc. I have no objection to this, especially with respect to the setting of standards since Hong Kong adopts international standards and local standard setting is ceremonial.

China opens escape route for VIEs

Yesterday the Ministry of Industry and Information Technology (MIIT) issued a pronouncement (2015) 196 announcing a pilot program that appears to allow 100% foreign ownership of e-commerce businesses.  

I had anticipated this development as a way to let foreign companies using the VIE structure to operate e-commerce a way out of the proposed crackdown on VIEs under the new foreign investment law. The proposed law may limit the use of VIEs to situations where the foreign parent company is ultimately controlled by Chinese. Many of the overseas listed companies have Chinese control of the offshore company, either through stock ownership, dual class share structures, or special control arrangements. MNCs operating in restricted sectors would not be able to restructure to be controlled by Chinese, and face a possible ban from China. 

The new MIIT rule provides an escape valve. It appears limited to companies operating in online data processing and transaction processing (operating e-commerce). It is unclear to me how far that definition will stretch. 

Yankee go home

The Ministry of Finance issued important provisional regulations on CPA practices carrying out audit services for PRC enterprises listed outside China. The rules were proposed a little over a year ago, freaking out Hong Kong CPAs who saw their livelihood disappearing. 

The new rules take effect on July 1, 2015. They will require foreign CPA firms that audit overseas listed Chinese companies to cooperate with a Chinese CPA firm that has at least 25 CPAs. An exception exists for companies with Hong Kong, Macau or Taiwan auditors that have more than 50% of the shares held be persons in those provinces that will be allowed to continue present arrangements. I think few public companies will qualify for the exception. 

I believe these rules were directed at the small US CPA firms that audit Chinese firms that mostly came to market through reverse mergers. Most of these firms clients trade thinly, if at all, on the OTCBB or Pink Sheets. Chinese regulators have expressed frustration that Chinese auditors have been tarred with the poor performance by some of these firms in detecting fraud. Many of the companies that use small US CPA firms are likely to have difficulty getting audits done under the new regulations. The auditor will have to align with a Chinese CPA firm yet still do enough work to be considered the principal auditor. The PCAOB has punished firms that outsourced the entire audit to a local firm. In any event, the economics of the business have changed, since the CPA firms are now going to have to share fees with a local firm. This may be the final straw that leads some of these firms to abandon the market.

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