WASHINGTON (Reuters) – China and the world’s largest audit firms face credibility risks under an order Beijing issued saying the firms must hire more Chinese citizens to manage operations there, analysts said.
Thursday’s order follows a string of accounting scandals at Chinese companies listed on U.S. stock markets and amid broader questions about China’s willingness and ability to conform with international business standards and rules.
As the world’s second largest economy, China has enterprises with global ambitions, but markets often question the accountability and transparency of these businesses. The new government order will do little to alleviate that skepticism.
China’s Ministry of Finance announced the audit industry’s so-called Big Four – PricewaterhouseCoopers, Ernst & Young, KPMG and Deloitte – must begin to hand over the reins of their Chinese practices to its citizens and accountants.
PricewaterhouseCoopers said it supports the programs and has been “localizing its China practice.” Ernst & Young said the new order is “in line with E&Y’s existing strategy.” KPMG and Deloitte could not immediately be reached for comment.
The China operations of the four firms are now led largely by expatriates. The Chinese order caps at 40 percent the number of foreign-qualified partners a Chinese Big 4 affiliate may have as of August, and at 20 percent by 2017. The rules also say each of the Big Four’s senior partners eventually must be Chinese citizens. All now are foreigners.
For the firms, finding enough qualified Chinese accountants to do the work will be a challenge in the short term, but not an insurmountable one over time, auditing industry analysts said.
In the long term, depending on the smoothness of the transition and the behavior of Chinese partners who take over, Chinese audits could be further called into question, they said.
“If the changes lead to greater turnover among partners, or a wholesale replacement of leadership by the local partners, there is risk that audit quality would be affected,” said Paul Gillis, professor of accounting at Peking University.
LOCAL CONTROL NORMAL
The Big Four firms have their main offices in the United States. Like most multinational businesses, the firms over the years have transferred control of overseas affiliates to local citizens, which is cheaper and, in some ways more efficient than maintaining a staff of costly expatriates in a foreign country.
That transition has been on track to occur in China, as well, but the government order is an attempt to make that happen faster, perhaps too fast, said Tom Selling, publisher of The Accounting Onion, a website on accounting issues.
“They’re basically asking to accelerate a natural process in a sub-optimal way,” he said.
Investors in U.S.-listed Chinese companies have been burned by a recent string of accounting scandals.
On Wednesday, U.S. securities regulators charged Deloitte’s China practice for refusing to provide audit work papers related to a U.S-listed Chinese company under investigation for accounting fraud.
The Big Four dominate China’s accounting industry. In 2010, their audit practices, excluding their consultancy businesses, had combined revenue of more than 9.5 billion yuan, according to the Chinese Institute of CPAs (CICPA).
Including consulting, the four firms say they each employ around 10,000 people in mainland China, Hong Kong and Taiwan.
Singapore’s accounting industry went through similar changes in the 1980s, as did Hong Kong’s in the late 1990s. In those cases, the local partners used their enhanced voting power to force out many foreign partners.
“There doesn’t seem to be any good news here for investor protection,” Selling said.
“There are real political overtones here,” he added. “The Chinese … see this as a way of protecting information and their companies, but there’s a big risk for them. The U.S. capital markets and the Big Four are still the gold standard. There’s a chance the Chinese are overplaying their hand.”
(Additional reporting by Rachel Armstrong in Beijing and Dena Aubin in New York; Editing by Howard Goller)