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US-China Audit Deal Faces First Test as Inspectors Head to Hong Kong

(Bloomberg) -- After a decades long impasse that led to a threat to kick about 200 Chinese firms off New York stock exchanges, US inspectors may soon get their first look under the hood of some of China’s largest corporations, if all goes as planned.

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US Public Company Accounting Oversight Board inspectors may arrive in Hong Kong as early as this week to start checking the audit working papers of US-listed Chinese firms under a deal reached last month, according to people familiar with the matter. The PCAOB officials then have to decide whether they have gotten sufficient access to sign off on Chinese firms as compliant.

The historic on-site visits are slated to start with inspecting the working papers of Alibaba Group Holding Ltd. and Yum China Holdings Inc. among other firms. A team will be assigned to the auditing file of each company to review the most recent financial documents, check internal control systems and interview audit personnel, two people familiar with the matter said earlier.

Audit inspections of publicly traded firms in the US were mandated by law in 2002, but China has long denied giving full access despite there being hundreds of listed Chinese firms worth more than a $1 trillion. A US law passed in 2020 then ratcheted up pressure with threats of delistings, forcing a rare compromise by Beijing after years of insisting that allowing access to working papers could harm national security.

While the preliminary deal marked progress, the standoff has already roiled markets. Two weeks before last month’s agreement, five major state-owned firms, including China Life Insurance Co. and PetroChina Co., said they would delist, while ride-hailing giant Didi Global Inc. was forced to delist amid pressure from Chinese regulators who feared the firm’s vast troves of data would be exposed to foreign powers. Alibaba has said it would seek a primary listing in Hong Kong to hedge against the threat of getting kicked out of New York.

PCAOB Chairperson Erica Williams said in a statement Aug. 26 after signing the deal that she had directed the agency’s inspection team to be on the ground by “mid-September so we can put this agreement to the test.”

The first group of names to be reviewed are among the largest and most actively traded US-listed Chinese firms, all of which have employed global auditors. Unlike multiple state-owned firms that are voluntarily exiting New York exchanges, these privately controlled firms also have powerful US investors.

Questions

Questions emerged immediately in the wake of August’s agreement as the two sides offered conflicting messages over how it will be implemented. While the PCAOB said it had the sole discretion to select the firms, audit engagements and potential violations, Chinese regulators said any access to companies and working papers would be done with Chinese participation and assistance.

Audit firms including Deloitte LLP, PricewaterhouseCoopers LLP, Ernst & Young LLP and KPMG LLP have been organizing to arrange for potential visits and assigned teams for the inspectors. Hong Kong was selected as the site for the inspections because it has less strict Covid quarantine rules.

It’s unclear if PCAOB officials will be granted a waiver to Hong Kong’s three-day hotel quarantine and the subsequent four days of monitoring.

Hong Kong inspections pose their own challenges since most documents are stored in mainland China. While most working papers are stored electronically, audit firms have debated how to transfer files to Hong Kong from mainland databases. Some have explored mailing them on CDs and another option would be to unlock the Chinese cloud for access in Hong Kong, people familiar with the process said last month. The audit firms have also summoned relevant staff back to Hong Kong.

A PCAOB spokesperson declined to comment for this article, as did representatives from the big four accounting firms.

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