For the last two years, Beijing and Washington have been embroiled in a showdown over rules for auditing Chinese companies whose shares are publicly traded in the U.S. In 2020, the U.S. Congress passed a bill that hit Chinese firms with an ultimatum: comply with U.S. audit rules for three consecutive years or be delisted from American stock exchanges by 2024.
Now, the timeframe for Chinese and American regulators to strike a deal on audits is running perilously short. The U.S. and China must agree on allowing American regulators to inspect the auditors of U.S.-listed Chinese firms “soon” if inspections have “any chance” to be completed by the end of this year, Securities and Exchange Commission Chair Gary Gensler said during a Wednesday address for the Center for Audit Quality, a public policy organization that represents U.S. public company auditors.
U.S. lawmakers are trying to accelerate the timeline to boot non-compliant Chinese firms from American stock exchanges starting in 2023. The long lead time required to conduct inspections of auditors in China and Hong Kong, plus stringent COVID-19 travel requirements, are additional factors that have expedited the timeline for U.S. and China to find a workable framework for audit access, Gensler noted.
Complete framework
Beijing and Washington’s audit showdown stretches back 20 years. In 2002, the U.S. passed the Sarbanes-Oxley Act, which stipulated that foreign companies listed on Wall Street must let American regulators inspect their books and auditors to protect investors from fraudulent financial reporting.
Only two jurisdictions have failed to comply these last two decades: China and Hong Kong. Beijing has denied U.S. access, citing concerns that audit papers might contain state secrets critical to China’s national security.
The SEC, alongside the Public Company Accounting Oversight Board (PCAOB), which oversees the auditors of public companies in the U.S., have held hundreds of calls with Chinese authorities to negotiate a framework for allowing American regulators to inspect the auditors of Chinese and Hong Kong companies. Should the U.S. and China fail to reach a deal, roughly 261 U.S.-listed Chinese companies with a combined market value of $1.3 trillion face delisting.
American investors would lose out if Chinese stocks delist en masse from New York. According to Goldman Sachs, U.S. institutional investors hold $200 billion of exposure to Chinese American Depository Receipts (ADRs), a security that lets U.S. investors buy shares in foreign firms.
Still, the U.S. is “not willing to have [American] inspectors sent to China or Hong Kong, unless there’s an agreement on a framework allowing [inspectors] to inspect and investigate audit firms completely,” Gensler said on Wednesday.
“Any framework needs to… have the specificity and accountability” required to fulfill the goals of the Sarbanes-Oxley Act and the Holding Foreign Companies Accountable Act (HFCAA), which says that Chinese firms would be banned from trading in the U.S. if they fail to comply with U.S. audit rules, he added.
Hard line
In recent months, China has indicated that it’s trying to find a compromise that’ll be palatable to the U.S. and aligned with its own goals. This April, China’s securities commission removed a rule implemented in 2009 that prevented American regulators from accessing the books of Chinese companies. China wants to separate U.S.-listed Chinese companies into three categories: those with non-sensitive, sensitive, and secret data, according to a recent FT report. This strategy would allow most private companies that don’t hold sensitive data to open their books to U.S. regulators and remain listed, Adam Montanaro, investment director of global emerging markets equities at investment firm abrdn, told Fortune in April.
But Washington has taken a hard line on China. Gensler has repeatedly emphasized that American regulators require unrestricted audit access for Chinese firms to remain listed on Wall Street. Gensler has expressed skepticism that a final deal can be reached between the U.S. and China. “It’s quite possible that there’s no deal here. I’m not particularly confident,” the SEC chair told reporters during a media briefing earlier this month.
“Going forward, will our markets include Chinese issuers? That’s up to our counterparts in China—whether they’re willing to comply with U.S. law. We look forward to ensuring investor protection, with or without China-based issuers,” Gensler said on Wednesday.
