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Audit rotation in China

Caixin has an interesting article about audit rotation in China. All SOEs are now required to go through an audit tender process every three years, and an auditor cannot serve for more than five years. The big Chinese banks are now coming up for rotation, with Bank of China due to replace PwC next year, and the Agricultural Bank of China (ABC) scheduled to rotate away from Deloitte at the same time. The Industrial and Commercial Bank of China (ICBC) will drop Ernst & Young in 2014.

There is a lot at stake for the accounting firms. PwC charged Bank of China $34 million for the 2011 audit. The accounting firms would prefer not having audit rotation - they have fought auditor rotation proposals in the U.S. and the E.U. Yet, if they are forced to rotate, they hope to just shift the clients between each other. 

Chinese regulators have stepped in to disrupt those plans. According to Caixin, the Ministry of Finance called executives at ABC and ICBC and told them to include local firms in the bidding process. Bank of China's tender process is coming to a close, and no local firm was included. The bidding process creates a chicken and egg problem for local firms;  bidding requirements include deep experience in auditing banks, yet that experience is unattainable for local firms since they do not have any large banks as clients. The local firms that will be bidding are likely to be affiliated with the second-tier of global accounting firms, which includes BDO, RSM and Crowe Horwath. 

HK's SFC sues E&Y for workpapers

Hong Kong’s Securities and Futures Commission (SFC) has commenced proceedings against Ernst & Young Hong Kong (E&Y) for failing to produce working papers on Mainland based Standard Water Limited. SFC is the Hong Kong equivalent of the United States’ Securities and Exchange Commission (SEC).  

Standard Water applied for listing on the Stock Exchange of Hong Kong in 2009. E&Y, the reporting accountant, resigned in March 2010 and the company withdrew its listing application.

SFC asked E&Y for the working papers. E&Y did not comply, claiming that E&Y Hua Ming, its mainland joint venture, actually did the work. E&Y said that Mainland laws precluded them from giving the SFC the working papers. SFC sought the assistance of Mainland regulators without success. 

This case opens a new front in the regulatory wars and creates uncertainty in the H-share and Red Chip markets. The case appears to be virtually identical to the SEC case against Deloitte. Mainland regulators probably decided they needed to be consistent in their treatment of the Deloitte case with the SEC and the E&Y case with SFC. The SEC sought a six-month stay in its case against Deloitte citing efforts to reach a compromise; apparently SFC was not prepared to delay its case any longer. Or perhaps Chinese officials wanted another precedent to illustrate that they were not applying the rules only with respect to the United States.  

KPMG's PCAOB registration

KPMG’s filing with the PCAOB to continue its previous registration is now available on the PCOAB website. The registered firm is now listed as KPMG Huazhen, (Special General Partnership). KPMG filed on August 14th. The new firm was established on August 1. The filing is on Form 4.

KPMG declined to agree to certain requirements related to cooperation with the PCAOB and production of documents, citing foreign law as an obstacle. 

The most important part of the document, Exhibit  99.4 is not completed.  This is where KPMG would certify that (3) as part of that transaction, a majority of the persons who held equity ownership interests in obtained equity ownership interests in, or became employed by the new firm. I don’t believe they can answer this question positively, since the joint venture was owned by two  entities that are not  partners nor employees in the new firm.  

I do not know whether the PCAOB has to approve this application. KPMG Huazhen (Special General Partnership) does appear as a registered firm on the PCAOB website.

MOFCOM, Wal-Mart and the VIE

There is some news relating to variable interest entities (VIEs).

On August 13, 2012, the Ministry of Commerce (MOFCOM) approved Wal-Mart’s proposed acquisition of 33.6% share of Niu Hai Holdings, which gives Wal-Mart a controlling stake in the online direct sales business of Yihaodian, the largest e-supermarket in China.

Niu Hai is a Hong Kong company that apparently operates in China through a VIE much like other Internet companies in China. MOF allowed Wal-Mart to acquire an interest in Niu Hai, but on the condition that Wal-Mart not use the VIE to sell Wal-Mart’s products. What appears to be notable is that MOFCOM has specifically mentioned a VIE.

Stan Abrams of China Hearsay writes of three ways he could argue the meaning of this:

1. MOFCOM’s warning about the use of the Yishiduo VIE suggests that it is adopting a policy of closer scrutiny of such structures. Investors beware! (King & Wood’s Susan Ning supports this interpretation.)

2. MOFCOM’s specific acknowledgement that the target company for which it is giving an approval operates a VIE structure is as close to a formal recognition of the legality of VIEs that we are going to get. Investors celebrate!

KPMG and the PCAOB

KPMG held a press conference last week to announce the formation of its new limited partnership that will replace the joint venture it has used in China for the past 20 years. Stephen Yu, CEO of KPMG China observed that KPMG was the first to be granted a joint venture, which has grown from 30 employees in 1992 to around 9,000 today. The new partnership is called KPMG Huazhen, the same name that was used for its joint venture. 

The change to limited partnership form was forced by the expiration of the 20-year terms of the joint ventures. A special exception in China’s WTO accession allowed the Big Four to have unlicensed foreign partners in these joint ventures, an exception that expires with the joint ventures. Like most countries, China follows national treatment for accountancy, which means that locals and foreigners are treated the same. That means both locals and expatriates must have a local license in order to practice accounting; a license that most expatriate partners do not have. The Big Four and MOF negotiated in May that the Big Four could continue to have unlicensed foreign partners in the new limited partnerships that are replacing the joint ventures. Up to 40% of partners can be unlicensed locally this year, with the proportion reducing to 20% over five years. 

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