If Chinese authorities could have their way, all public companies in that country would begin complying with “CSOX”—China’s version of governance and financial reporting akin to the Sarbanes-Oxley Act in the United States—by the middle of next summer, as planned.
But many experts tell Compliance Week that actual implementation of the new regulations within that timeframe is little more than a pipe dream.
Five powerful Chinese bureaucracies jointly issued the CSOX standards, the Basic Standard for Enterprise Internal Control, in June with the intent that they become effective in July 2009. But because many companies in China are state owned and conflicts of interest are so rife, experts say there’s no way companies could possibly address them to a meaningful degree by next year.
Millinger
“The intent is positive,” says Steve Millinger, managing partner, China, at Heidrick & Struggles. “China clearly aspires to catch up to, and even surpass, global best practices in corporate governance. However, China is a system that can be described as the ‘rule of man’ versus the ‘rule of law’ … designed to protect the interests of the state,” he says.
TJ Wong, dean of the business administration faculty and an accounting professor at the Chinese University of Hong Kong, agrees. “I have a general skepticism about these sorts of new regulations, especially for state-owned enterprises that are not listed,” he says. “We should not be fooled by politicians that say this will instantly improve everything.”
Wong further suggests that, “China is really eager to comply with international standards, so it can claim that it has done so, but it can’t meet these standards given the ownership structures and the current enforcement systems that are in place.”
“I have a general skepticism about these sorts of new regulations, especially for state-owned enterprises that are not listed … We should not be fooled by politicians that say this will instantly improve everything.”
— TJ Wong,
Accounting Professor,
University of Hong Kong
That’s because no current ownership structures or enforcement systems exist. Unlike Sarbanes-Oxley in the United States and Japan, both of which threaten serious legal implications against boards and managers for non-compliance, CSOX is more akin to a rule that is enforced by regulators, who have little incentive to apply what they’ve written.
Low
In addition, most industries in China are already heavily regulated. State companies have their own bureaucracy, as do banks, insurance companies, listed companies and many firms in sensitive industries. “The biggest problem for state-owned companies is that there are too many interested parties, and no one has ownership of the process,” says Christopher Low, managing director of Protiviti’s China Practice.
Neither is the auditing market in China conducive for such regulations, says Wong. The Big Four and local firms of similar quality typically don’t handle the books of Chinese corporations. Rather, companies often seek out the cheapest and the weakest, usually accountants from the provinces or small cities, he says.
“Even for the listed companies, they don’t have the strongest incentives to hire the best auditors,” says Wong. “What they need is to get someone who can sign off on the statement cheap; there is no pressure to hire anyone better than that.”
He adds: “With that kind of low-quality auditing firm serving as auditor, the company can just follow the standards on the surface.” Although, he says, greater incentives to follow CSOX and to obtain a decent auditor might occur in the future, as more foreign investors pour money into local shares and as more companies list overseas.
THE BASICS
The following excerpt from KPMG’s China Boardroom Update highlights key elements of The Basic Standard.
The Basic Standard comprises seven chapters and describes the general provisions and the five control elements. These are internal environment, risk assessment, control activities, information and communication, and internal monitoring. The definitions for these are similar to those in the COSO framework.
In accordance with The Basic Standard, a Chinese enterprise should:
Include the above five control elements when establishing and implementing effective internal control.
Establish and implement internal control policies.
Establish a suitable business management information technology system with embedded controls.
Set clear policies on the rewards and disciplines relating to the proper implementation of internal controls. Effectiveness of internal control implementation should be treated as a key element of performance appraisals for departmental and staff levels.
Perform self-assessment of the effectiveness of its internal control on a periodic basis and issue control self-assessment reports.
Source
KPMG’s China Boardroom Update (Aug. 18, 2008).
Until then, however, the vast majority of companies will likely take a “form over substance” approach and only act as if they are meeting the rules, says Low. “If at the end of the day, there are no consequences, people may just do with issuing a bit of paper,” he adds. “Companies are evaluating that option now.”
Further complicating CSOX is that its “net is cast really wide” and is far more comprehensive than similar legislation in other countries, says Low. In the United States, for example, SOX focuses primarily on financial reporting processes and is designed mainly for listed entities. In China, on the other hand, CSOX covers operations, financial reporting, and compliance and is expected to apply to all medium and large companies (though only listed companies are covered next year).
In addition to being unrealistic and unworkable, CSOX suffers the same humdrum problems that plague most Chinese regulations. As is the case with many rules and much of the legislation issued in Beijing, documentation is sparse, leaving many companies struggling to figure out how exactly to stay on the right side of the law.
Even if many companies don’t comply, “it is unlikely we will find out,” says Wong. “And the government will not let you know how many do not follow these new standards.”
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