When the Hong Kong Stock Exchange announced in early December that it would list Chinese companies that use mainland accounting standards and auditors, the international investment community was surprised, to say the least.
One of the strongest and most reputable markets in the world had decided to welcome companies with financial statements prepared in a country plagued by quality scandals, conflict of interest, and outright corruption. If the food's not safe in China, the thinking went, why would you trust the numbers?
“There is cause for concern,” says T.J. Wong, dean of the business school at the Chinese University of Hong Kong and an accounting professor. “The local auditors just do not have the same quality levels.”
The accounting standards themselves aren't in question so much; Chinese accounting principles aren't a pure version of International Financial Reporting Standards, but they're close enough and the differences are well known, accountants agree. The problem is in how these rules are used. People worry that mainland Chinese accountants may not have the discipline, tradition, and general ethics to withstand political pressure or pressure from particularly large or well-connected clients, especially at the provincial level.
“The standards themselves may look alike, but they are being applied in very different contexts,” says Gary Biddle, professor of accounting at the University of Hong Kong. “Even when the standards are identical, they are going to be interpreted and applied differently. This is the crux of the matter.”
Enforcement is another concern. “When—and it's not an if—an audit issue arises, will the relevant authorities here in Hong Kong be able to pursue the mainland auditors to obtain their working papers and other relevant documentation?” Biddle asks.
The answer is no. In Hong Kong, local regulators can go after companies and their auditors if they discover irregularities. They have the full power of the law behind them and can freely conduct investigations. In mainland China, however, they have no standing. Hong Kong may technically be a part of China, but its jurisdiction ends at the border.
“The primary issue is not differences between Hong Kong and [Chinese] accounting standards,” adds Ray Ball, professor of accounting at the University of Chicago. “But differences in implementation and enforcement, which are likely to persist for the foreseeable future.”
Many international investors have long considered Hong Kong a place where they can touch the Chinese market but still enjoy better quality control and a respectable history of transparency and rule of law. Now cynics fear large, well-connected state-owned companies in China, audited by inexperienced and corruptible local accountants, lumbering into Hong Kong and tarnishing a previously respectable stock market.
“The standards themselves may look alike, but they are being applied in very different contexts. Even when the standards are identical, they are going to be interpreted and applied differently.”
—Gary Biddle,
Professor of Accounting,
University of Hong Kong
Defenders of the decision say the reality will not be anywhere near as dire as that vision. They say that Chinese companies listing in Hong Kong will have to be vetted not only by mainland authorities, but also by the Hong Kong authorities before they are approved for a listing. They also point out that companies taking advantage of new policy will have to use one of 12 hand-picked auditors doing business in mainland China; most are connected to reputable international firms, including all of the Big 4.
“The thing that people aren't focused on is the fact that it's not just any auditing firm in China,” says Mark Dickens, head of listing at the Hong Kong Stock Exchange. “It is one of 12 that have been specially recognized by the Ministry of Finance as being suitable to do this sort of work. They are believed to be highly qualified firms.”
Supporters of the new program also point out that the auditing profession in mainland China has developed a good deal in recent years. Local firms have hired extensively from the Big 4, invested heavily in training, and participated in international forums, seminars, and exchanges. “Of course people have concerns,” says Edmond Chan, a partner at PricewaterhouseCoopers, “but Chinese accounting firms have come a long way compared to 10 years ago.”
In some ways, mainland accountants (or the dozen selected auditing firms, at least) may even be superior to those in Hong Kong. In China, auditors are regulated by the Ministry of Finance; in Hong Kong, the profession regulates itself through the Hong Kong Institute of CPAs. While all indications are that the self-regulating arrangement works well, some consider mainland China's approach to be better. “The supervision of the auditing firms by the [Finance Ministry] is arguably more independent,” Dickens says. “Here we have a statutory self-regulatory body. Whereas they have an independent government agency.”
Dickens adds that the enforcement concerns are also a bit overblown. He says cooperation between the Hong Kong regulators and their mainland counterparts is already good, and that any infraction would be addressed through procedures established in memorandums of understanding exchanged by the relevant authorities. He notes that all the major financial regulators in China and Hong Kong have put their names on the program and have a stake in its success. It was not, he stresses, as if the Hong Kong exchange acted on its own.
Dickens suggests that what's happening is more a consequence of convergence than one of local politics specific to China and its territory. With accounting standards globalizing, and accounting practices harmonizing at the same time, it makes sense that companies from one economy be able to list in another without jumping through another set of very similar hoops. Companies from other markets, such as Singapore and London, already trade in Hong Kong using their home standards and audit firms, Dickens notes. In that case, he says, excluding China makes little sense.
“I don't think it's revolutionary at all,” says Chris Joy, executive director of the Hong Kong Institute of CPAs. “It's part of the natural evolution of the markets and part of the IFRS story. As international standards converge, there is more strength behind the argument that you should be able to recognize them across borders. That is happening elsewhere. The European Union doesn't demand that everything be rewritten.”
Proponents of the move also say that any potential damage has natural limits. The new program is, after all, optional. Companies must first decide to use mainland auditors, and then must sell the idea to their shareholders. If they choose the local route and the home country firm performs poorly, their share price will suffer. The market will largely prevent the cutting of corners and encourage mainland accountants to rise to international levels, says Nelson Lam, of Nelson and Co., a Hong Kong CPA firm.
“Chinese auditors need to demonstrate that they can take a fair enough line with companies listed on foreign stock markets,” adds Mark Wilson, a partner at RSM China CPAs, one of the 12 chosen mainland accounting firms. “They will need to take quality control seriously.”
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