WASHINGTON – The U.S. and China have reached a tentative agreement to allow U.S. regulators to inspect the audits of Chinese companies whose stocks are traded on U.S. exchanges. In a long-festering dispute, U.S. regulators have threatened to boot a number of Chinese companies off the New York Stock Exchange and Nasdaq if China doesn't permit inspections.
The deal announced Friday by market regulators in the U.S. and China is preliminary. Securities and Exchange Commission Chairman Gary Gensler said, “The proof will be in the pudding.”
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“While important, this framework is merely a step in the process,” Gensler said in a prepared statement. “This agreement will be meaningful only if (U.S. regulators) actually can inspect and investigate completely audit firms in China. If (they) cannot, roughly 200 China-based issuers will face prohibitions on trading of their securities in the U.S. if they continue to use those audit firms.”
An agreement would mean that U.S. investors will maintain access to shares of important Chinese companies while at the same time being protected by the integrity of company audits.
“This is unequivocally positive news and a major step toward averting mass delisting of Chinese companies in the U.S.," analyst Tobin Marcus at Evercore ISI said in a note to clients. However, he said, “a deal is only the first step toward avoiding delisting. What ultimately needs to happen is that (U.S.) Inspectors need to show up and complete inspections." He said the inspections could take months.
The U.S. regulators plan to have inspection teams on the ground in China by mid-September. The Public Company Accounting Oversight Board is due to determine by year's end whether the Chinese government is continuing to block access to the audit books. A negative finding could result in U.S. actions such as stock trading bans.
Although it's preliminary, the agreement is a rare instance of accord at a time when relations between the U.S. and China are fraught by sparring over trade, the war in Ukraine and human rights. The tension was ratcheted higher by U.S. House Speaker Nancy Pelosi's recent trip to Taiwan, the self-governing island that China claims as its territory. The Chinese responded to the visit by Pelosi, second in line to the U.S. presidency, with military drills around the island.
U.S. regulators had warned that without an agreement, some 200 companies including Alibaba Group, the world’s biggest e-commerce competitor, might be ejected from U.S. exchanges or face trading restrictions. The Americans said that other governments have agreed to allow such audit reviews, which are required by U.S. law, and that China and Hong Kong are the only holdouts.
Three of China’s biggest state-owned companies announced this month they would remove their shares from the New York Stock Exchange but gave no indication that the action was related to the audit dispute. PetroChina Ltd., China Life Insurance Ltd. and China Petroleum & Chemical Co. cited the small volume of trading of their shares in the New York market and the expense of complying with regulations in a foreign market. The companies said their shares still would be traded in Hong Kong, which is Chinese territory but open to non-Chinese investors.
The dispute over audits of Chinese companies dates back more than a decade. Scores of Chinese companies were suspended or kicked off U.S. exchanges, most of them for failing to file timely financial reports. At least two dozen were hit with SEC fraud or accounting charges, but investigations stalled because the companies’ audit papers were in China — beyond the SEC’s reach.
Under terms of the new agreement, U.S. accounting inspectors in the PCAOB would have independent discretion to select any Chinese company audit for inspection or investigation, and they would get direct access to interview all personnel of the audit firms whose work is being inspected. The inspectors could see complete audit work papers with no redactions.
In Beijing, the China Securities Regulatory Commission called the agreement an important step in “resolving the issue of common concern of audit and regulatory cooperation.” Investors and companies on both sides will benefit from keeping Chinese shares trading on U.S. exchanges, the commission said.
The terms the commission outlined would give Chinese officials a role in any possible investigations. China won the right to conduct similar reviews of U.S. audit firms where relevant, according to the Chinese regulators, allowing Beijing to portray the agreement as mutually positive rather than an instance of China giving in to American pressure. China has yet to express any need to carry out such reviews of its own.
Chinese regulators also would be allowed to participate in interviews with audit personnel.
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McDonald reported from Beijing.
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