A joint statement was issued this week by the Ministry of Finance and the IFRS Foundation) about convergence of Chinese Accounting Standards (CAS) with International Financial Accounting Standards (IFRS). Both parties agreed that a single set of high quality global accounting standards is a good idea.
On November 25, 2005, Sir David Tweedie of the International Accounting Standards Board signed a memorandum with the Ministry of Finance declaring that CAS had substantially converged with IFRS. The agreement was premature in my view since several significant differences remained, but the political pressure on Tweedie to bring China into the IFRS fold was immense. In 2006, China launch a successful initiative to amend IFRS related party disclosure rules to exclude companies under state ownership, effectively converging IFRS with CAS on this point. In 2009, China announced it would fully converge CAS with IFRS by 2011 in accordance with a G20 agreement related to the financial crisis. It didn’t happen. But the Tweedie agreement was sufficient for China to get Hong Kong to accept CAS financial statements for Chinese companies listed in Hong Kong.
Ernst and Young (EY) Hong Kong lost an important case in Hong Kong that may have widespread impact on the profession and the securities markets.
The South China Morning Post reports that the Court of First Instance on Friday rejected EY's plea that it could not hand over to the Securities and Futures Commission the auditors' working papers relating to mainland listing candidate Standard Water as they constituted a "state secret".
This case was particularly embarrassing for EY, since its Hong Kong affiliate served as accountant of record for Standard Water’s proposed IPO, despite doing nearly no audit work. Instead, the audit was done by EY’s mainland affiliate. When SFC asked to see the working papers, EY said they did not have them – a violation in itself, and that its mainland affiliate, EY Hua Ming, had refused to turn them over citing state secrets. EY was finally cornered in Court and had to admit they actually had the work papers on a computer that had been brought to Hong Kong, but said that China’s state secrets laws prohibited them from turning the papers over to SFC.
A new front has opened in the dispute between China and the United States over audit regulation. China has blocked the PCOAB from required inspections of auditors of U.S. listed Chinese companies based on arguments of state secrecy and national sovereignty. Chinese regulators have argued that they cannot allow the inspections of audits where the working papers might include state secrets. An attempt to set up a pilot program apparently fell apart when U.S. and Chinese negotiators were unable to agree on which companies could be excluded from an inspection program. PCAOB Chairman James Doty in remarks to the Standing Advisory Group of the PCAOB suggested that the problem is the myriad of Chinese bureaus that have a say in the matter.
The new front is in banking. Kering SA, owner of the Gucci brand, has sued counterfeiters in U.S. courts and has issued subpoenas to the Bank of China for information about transactions of the counterfeiters. Despite orders from a federal judge, the Bank of China has refused to turn over the information, saying that to do so would violate Chinese law.
Bloomberg reported this week that a final agreement between the PCAOB and Chinese regulators over inspections of Chinese audit firms has fallen through. The article says that the Chinese had so narrowed the terms of inspections that the PCAOB decided it was not worth pursuing the deal.
The PCAOB is the regulator of accounting firms that audit US listed companies, and its most important function is to periodically inspect the accounting firms to make certain that they are following US auditing standards. China has not allowed the PCAOB to conduct inspections in China, even of international firms, since it considers allowing foreign regulators to enforce foreign laws on Chinese soil to infringe on its national sovereignty.
There are no good options left for the PCAOB. Successful short seller attacks indicate that fraud and auditing failures continue to be a problem in China. The only real tool left in the PCAOB toolbox is to deregister the accounting firms that it cannot inspect. But this option would quickly lead to the delisting of Chinese companies from US markets, including companies like Alibaba and Baidu.