Will China's Accountants Take Over Your Business?

It’s not difficult to imagine why some finance professionals in Hong Kong are worried. From December 15, the city’s 160 H-share companies – enterprises incorporated in Mainland China but listed in the former British colony – will no longer need to hire a Hong Kong-based external auditor for assurance and reporting purposes in Hong Kong. The reports of these companies' external auditor in China, provided these practising accountants have been approved to join the scheme by the Ministry of Finance, will be enough to satisfy Hong Kong’s listing requirements.

 
Many of these H-shares are major accounts. They include China Construction Bank (CCB), Hong Kong’s largest company in terms of market capitalisation, and other giants such as Industrial and Commercial Bank of China (ICBC), Bank of China, Ping An Insurance, China Life Insurance, Bank of Communications, PetroChina, and Agricultural Bank of China. As of November 30, their combined market value reached HK$5.2 trillion (US$673.6 billion) – fully 25% of the stock market’s total market capitalisation.
 
And they may just be the thin edge of the wedge. There is another rich bloc of mainland-linked listed companies in Hong Kong: red chips, which are enterprises controlled by Mainland government entities but incorporated outside Mainland China, such as China Mobile and oil firm CNOOC. They account for another 46% of Hong Kong’s total market cap. For now, red chips are still required to hire a Hong Kong accounting firm to audit and report their financial results in Hong Kong, even though their major activities and subsidiaries are in China.
 
The Hong Kong Stock Exchange says it is aware of the negative effect of the rule change on local accounting firms, but it believes that the move is in the best interest of Hong Kong as a financial centre. In a report laying out its conclusions on the consultations held with various constituencies, it declared: “We accept that there would be an impact on the future employment of Hong Kong accounting firms, but we believe that the choice of audit firms is a commercial matter to be decided between the listed issuer and the audit firm.”
 
Good for CFOs
The regulatory change is good news for CFOs, of course. Preparing two sets of accounts can be expensive. CCB, for one, reported audit fees in 2009 of RMB157 million (US$22.9 million). That’s down 6% from the 2008 audit bill, but up 29% from 2007. According to the financial journal Caixin, KPMG Huazhen in China and KPMG Hong Kong wanted a hefty increase for the 2011 accounts, prompting CCB to call for competitive bids earlier this year.
 
In August, the bank announced it was switching to PricewaterhouseCoopers Zhongtian Certified Public Accountants as domestic auditor and PricewaterhouseCoopers as international auditor. “The audit expenses [for the 2011 accounts] shall not exceed RMB140 million,” CCB said in a regulatory filing. That’s 11% lower than the RMB157 million CCB reported paying in audit fees last year.
 
It is unclear whether the 2011 fees will now be adjusted downwards because of the reporting change in Hong Kong. However, the filing’s wording (“shall not exceed”) seems to indicate that there is leeway for the CFO to negotiate a further reduction.
 
It’s an issue that will almost certainly be on the agenda of 63 other H-shares that also have a listing in Mainland China, a list that includes ICBC, China’s largest bank in assets and the world’s 13th biggest. The other H-shares that have yet to list in the mainland have the option of switching to mainland accounting firms, which typically charge lower fees than their peers in Hong Kong.  
 
Accounting Fears
Not surprisingly, some in Hong Kong’s accounting sector express trepidation over the Hong Kong Stock Exchange’s rule change. In a survey of 100 of its members, CPA Australia Hong Kong China Division said that “56% of respondents believe the implementation of the New Framework will reduce business opportunities for the area of Public Practice in the Hong Kong accounting industry.”
 
The group called for “a special or temporary license to Hong Kong-based CPA firms to perform audit on Mainland incorporated companies listed in Hong Kong” and a pathway for these firms to apply to Chinese authorities “for approval to act as auditor or reporting accountant for a PRC incorporated company listed in Hong Kong.”
 
The stock exchange has not directly responded to these suggestions. But it says the reciprocal arrangement reached with mainland regulators “should alleviate the [business opportunities] concerns.” The agreement allows companies incorporated or registered in Hong Kong and listed in China to be audited by Hong Kong audit firms registered with the Hong Kong Institute of Certified Public Accountants (HKICPA).
 
“The reciprocal arrangement would provide Hong Kong audit firms and accountants with possible business and employment opportunities in the Mainland,” the exchange argues. The emphasis should be on “possible” at this point, since no Hong Kong incorporated or registered company is currently listed in China.
 
For the most part, however, Hong Kong’s accountancy sector appears resigned to the rules change. The HKICPA says the new framework represents a “natural evolution for the Hong Kong and China capital markets.” It accepts that the convergence of Mainland accounting and auditing standards with Hong Kong and international standards has been achieved and notes the “ongoing nature” of the convergence process.
 
In a submission to the exchange, KPMG said it recognises “the potential cost savings from allowing an entity to use is local accounting and auditing framework when filing in another jurisdiction.” However, it echoed the concerns of the investor community in Hong Kong on the importance of continuing convergence between the Chinese Accounting Standards for Business Enterprises (CASBE), which comprise the financial reporting standards and interpretations issued by the China Accounting Standards Committee, and International Financial Reporting Standards (IFRS).
 
KPMG also stressed the need for mainland auditors to have a depth of knowledge of the relevant Hong Kong requirements, such as the exchange’s listing rules. “It is therefore important,” the Big Four accounting firm stressed, “that the relevant regulatory authorities in Hong Kong . . . continue to be closely involved in monitoring [reporting standards and auditor knowledge] and give assistance to their Mainland counterparties to ensure that high standards of financial reporting by Hong Kong listed companies are maintained.”
 
Aftermath
What will happen after December 15? At the outset, nothing much. Contracts for audit engagements typically last for at least one year and terminating the services of auditors will likely require shareholder approval. But CFOs can plan to make some internal cost-saving changes, such as printing only one set of reports for both China and Hong Kong, instead of two separate ones.
 
And it’s not as if the rule change came out of the blue – the Hong Kong exchange had originally aimed to implement it in January this year. Some CFOs may already have taken the proposed change into account when making their audit plans and negotiating with accounting firms months ago. They could have agreed on a fallback arrangement, such as the Hong Kong firm doing non-audit advisory projects while the mainland firm conducts auditing and assurance.
 
The fact that only 12 mainland accounting firms has been named as eligible for the scheme also figures in the calculation. If the H-share company’s current mainland auditor is not one of those in the list (they include the China member firms of the Big Four and second-tier international partnerships, as well as large domestic audit firms), the CFO will have to keep the status quo and make changes only for the next financial reporting cycle.
 
Taking the broader view, what is significant about the Hong Kong exchange’s move is the implicit acknowledgment that China’s accounting standards and the skills, competence and integrity of its accountancy sector are now getting to be on a par with those in a global financial centre like Hong Kong.
 
The signal from Hong Kong is that the world’s most populous nation’s accountants and regulators are maturing to the point where they can now ensure that financial reporting complies with international standards and best-practice norms. If true, there are far-reaching implications not only for accountants but for businesses and capital markets in Asia and elsewhere.
 
About the Author
Cesar Bacani is senior consulting editor at CFO Innovation.
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