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Dec. 4, 2012, 11:30 p.m. EST
China listings may soon flee U.S., expert says
By Chris Oliver, MarketWatch
Reuters
HONG KONG (MarketWatch) — A mass exodus of Chinese companies listed on U.S. exchanges looks increasingly possible as an accounting rift between the two countries reaches a dangerous stage, a Chinese accounting expert says.
Paul Gillis, a financial author and professor of accounting at Peking University, believes the window to prevent a worst-case scenario of wholescale delistings of Chinese firms in the U.S. is rapidly narrowing.
He puts the odds of China companies having to pull up stakes from U.S. exchanges at 80%. In June he assigned a 20% probability of such an outcome, while seeing 70% odds that the “can is kicked down the road,” and U.S. and Chinese regulators find some way to defer the issue.
“We are in a very difficult position right now because there is an indication that diplomacy has failed,” Gillis said.
The Securities and Exchange Commission on Monday charged the Chinese affiliates of the big four U.S. accounting firms, plus another firm known as BDO, with violating U.S. securities laws by refusing to produce audit work papers.
The big four are Ernst & Young, PricewaterhouseCoopers, Deloitte Touche Tohmatsu and KPMG.
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Why audit firms in China won't hand over paperwork
The U.S. Securities and Exchange Commission, investigating alleged accounting fraud in China, has charged the Chinese affiliates of major accounting firms for refusing to produce audit work papers.
Specifically, the SEC charged that the audit firms violated the Sarbanes-Oxley Act, which requires overseas companies listed on a U.S. exchange use an auditor registered with the Public Company Accounting Oversight Board, or PCAOB.
The body exercises its oversight of the registered auditors by inspecting their audit papers. Since 2009, however, China has prohibited the locally based auditors — which audit the U.S.-listed Chinese firms, and are registered with the PCAOB — from sharing accounting papers with foreign regulators.
Chinese officials have argued that sharing such information would be in violation of their own laws involving state secrets.
Part of the reluctance, according to Macquarie analysts, may also be tied to national-sovereignty concerns and the view that “foreign governments should not be able to come onto Chinese soil and regulate Chinese citizens.”
A meeting between U.S. and China regulators last week “was the last chance to avoid a regulatory confrontation,” Gillis said, with the parties now at a crossroads that makes any future deal less likely.
Stakes are huge
The disappearance of Chinese listings from the U.S. could have tremendous financial consequences.
When ranked by value, the biggest 200 Chinese American Depositary Receipts have a market capitalization of $951 billion, according to July calculations by investment bank Macquarie.
Chinese companies listed solely in the U.S., meanwhile, have a combined market value of about of $101 billion, according to the research house.
Gillis said the SEC’s actions will take some time to play out. The next likely step, he said, is for an administrative trial judge to assess what sanctions to impose, a process that could take months.
Meanwhile, a change in the PCAOB’s charter that would oust accounting firms that don’t comply could take up to a year.
The end result, according to Gillis, is that “U.S.-listed Chinese firms will not be able to find auditors,” regardless of their fiscal health or probity.
In the event of unwind, smaller Chinese companies could be delisted with assistance from the China Development Bank, according to Gillis, who says these companies would likely eventually be relisted within a few years.
Many would likely be shuffled towards Shenzhen’s stock market, which is geared toward smaller companies.
American Depositary Receipts that represent shares of state-owned enterprises listed in Hong Kong could be regrouped back to Asia without major structural barriers, according to Macquarie.
Still, the shift could collectively take years to complete, as each company would require a separate listing prospectus.
Some market strategists were less pessimistic, however, saying cooler heads would likely prevail in the accounting dispute, achieving a compromise to prevent undermining financial links.
Uwe Parpart, chief strategist at Reorient Financial Markets in Hong Kong, said he was unaware of accounting irregularities at any of China’s larger companies with ADRs.
Such accounting irregularities have been a problem at of some smaller Nasdaq-listed China companies, Papart said, although he warned that the scale of such abuses had been somewhat sensationalized.
“Some of the U.S. short-sellers have vastly exaggerated the extent of the problem, although it would be foolish to deny that there’s a problem,” Parpart said.
