‘Golden Dragon’ face-off: US-China market stoush is approaching its climax

The confrontation between the US and China over access to the audits of Chinese companies listed in the US is getting ever closer to a crunch point.

It was the Trump administration that championed legislation enacted late last year that would force the delisting of Chinese companies if they fail to hand over audit information, including the auditor’s working papers, and allow the US Public Company Accounting Oversight Board (PCAOB) to examine it. The PCAOB was established after the collapse of Enron to improve the integrity and quality of US public company audits.

China is insistent that any foreign regulator wanting to inspect the accounts of a Chinese company must obtain the approval of its own authorities.Credit: AP

The legislation was passed against the backdrop of the escalating tensions between the US on a wide range of fronts, from trade imbalances to human rights and the treatment of Hong Kong.

It also, however, followed a string of accounting scandals involving Chinese companies and the failure of a 2017 trial to produce a formula for audit co-operation that was acceptable to both countries’ authorities.

China, perhaps unsurprisingly, isn’t keen on its companies complying and has directed – on national security grounds – that any foreign regulator wanting to inspect the accounts of a Chinese company must obtain the approval of its own authorities.

The changeover to the Biden administration has, if anything, hardened the US stance, albeit that there have been developments this year that have reinforced the US position.

The relatively new Securities and Exchange Commission chairman, Gary Gensler, this week warned Chinese companies listed in the US – companies with combined market capitalisations of more than $US2 trillion ($2.8 trillion) – that either they complied with the laws and provided access to the PBOAC or they’d be kicked off the US exchanges.

Gensler, after the debacle of the Didi listing last month and amid a frenzy of new Chinese regulations this year directed at the big end of its tech sector, has widened the dispute beyond access to audits.

The SEC is now requiring greater disclosure by Chinese companies listed in the US and has suspended any new Chinese company initial public offerings until they better disclose their risks, including the impact of Chinese regulation and the potential risks of future regulation. There were about 70 Chinese IPOs in the pipeline when Gensler froze it.

The SEC also wants better disclosure of the implications and risks of the structures Chinese commonly used to circumvent Chinese capital controls to raise capital in the US.

SEC chairman Gary Gensler has turned up the heat on Chinese companies listed in the US. Credit: AP

They commonly use a “variable interest entity structure, or VIE, interposing an entity based in tax havens like the Cayman Islands between the Chinese corporate structure that owns and operates their business and the US-listed entity that gives investors an economic interest but no ownership in the business.

There’s been little disclosure of what those unconventional structures and the lack of ownership of the underlying assets and cashflows of the business or conventional shareholder rights might mean for US investors, particularly if there are more disruptive regulatory interventions in China.

China’s regulatory assault on its big tech companies like Alibaba, Tencent, ride-sharing giant Didi and its edtech companies has caused turmoil in the markets for the 280-odd Chinese companies and more than a 100 Hong Kong-based companies listed in the US.

Just days after it listed and raised $US4.4 billion, for instance, Didi’s share price was halved after China’s Administration of Cyberspace launched an investigation into the company on national security grounds and ordered its removal from app stores. Alibaba’s share price has also nearly halved since the planned $US34 billion IPO of its Ant Group was yanked at the last minute late last year. The “Golden Dragon” index of the larger Chinese companies listed in the US has lost about 45 per cent of its value in six months.

None of what the SEC is seeking would be particularly controversial elsewhere but the tensions, competition and mutual suspicion between the US and China make the issue a particularly difficult and delicate one.

The “pause” in new Chinese IPOs in the US, the increased disclosure requirements and the tougher talk from Gensler are having an effect in China, perhaps concerned about the potential for the stand-off to undermine foreign capital flows and damage its ambition of becoming a global financial centre.

This week China’s State Council – its most senior level of government – announced guidelines for increasing cross-border co-operation on accounting issues while still protecting its national security interests. The China Securities Regulatory Commission said a week ago that it hoped to create the conditions for co-operation with the US on audit supervision.

Given the extent of China’s conviction that allowing the PBOAC full access to the working papers of its auditors could provide the US with access to its state secrets (it sees Chinese consumer data as a vital national security and commercial asset) it is difficult, however, to see how it could make the concessions necessary to placate the SEC.

None of what the SEC is seeking would be particularly controversial elsewhere but the tensions, competition and mutual suspicion between the US and China make the issue a particularly difficult and delicate one.

The audit law requires companies to be prepared to submit to three successive years of PBOAC audits and the enhanced disclosures have to be made in the annual reports of US-listed entities for this financial (calendar) year that will be issued early in 2022. That means, as Gensler put it this week, that the clock is ticking ever louder.

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