The China PCAOB Audits: Neither Dead nor Done

After a very long time it appears we finally have a deal between the PCAOB and the CSRC for audit inspections that would allow Chinese companies to stay listed in the US. This has come as a surprise to many, myself included, and after the announcement, lo the hot-takes did fly. So lets take a little step back and look at what’s actually happened, what all the fuss is about, and what might lie ahead.

The first question is interestingly probably the hardest to answer. After many years there’s not a new deal to allow the PCAOB to inspect the audit papers of Chinese auditing firms. The details and text of the new deal hasn’t been published so it’s quite hard to say much more, which is perhaps why there have been so many hot-takes.

What seems clear is that the reviews will initially take place in HK rather than on the mainland, which might not be ideal, but given the time-crunch to get the inspections done and the current restrictions on travel to the mainland it seems like a reasonable compromise. There have also been hints that inspections will move to the mainland at a later point.

The statements from the PCAOB and CSRC regarding other parts of the deal have some differences. If you ask some commentators these differences are apparently enough to declare the deal dead on arrival, or they constitute a clear point of conflict between the two sides. I suspect the truth is a little less spectacular, and the two sides are using the fact that the exact deal isn’t published to emphasise different parts to their domestic audiences. If you look at the statements they’re not inherently incompatible, and if they were, presumably the deal wouldn’t have been signed by the US part in the first place.

According to the PCAOB they will have access to any documents they request and need for their audit work, and will be able to conduct interviews when they want. According to the CSRC they will be providing the documents to the PCAOB and will be conducting the interviews together with them. This of course doesn’t mean there can’t be conflicts ahead, but the statements are hardly enough to declare the two interpretations of the deal incompatible.

There is room for some healthy skepticism, however. It’s important to remember that this isn’t the first deal to secure access to audit papers to allow the PCAOB to do their job. We had a MOU in 2013 to solve the issue of access to audit working papers, but this deal was declared dead by the PCAOB since it was unable to get the CSRC to follow through with sufficient access to conduct their audits. Lessons from this will clearly have played a part in these negotiations, and will be a key reason the PCAOB will take a wait and see approach now.

If we look at one of the key points myself and others made before the deal, the ability of the CSRC to drive through a deal with the other ministries that the PCAOB could accept, you could argue the concern has merely been moved. They’ve clearly managed to give the PCAOB an acceptable deal, but will it be able to actually follow through and provide the access?

In the end then the deal certainly isn’t dead, but it also only signals the start of the work and everyone is approaching it with some caution. It’s clear the CSRC wants the deal to work, and there have been repeated assurances that they want international listings to remain an option for Chinese companies going forward. These are all positive signals that there will at the very least be a willingness to make the deal work on their side, the question remains if that will be enough to produce everything the PCAOB will need.

For some investors and companies it might all be for nothing though. If recent reports are to be believed the Chinese government is looking to ban companies with sensitive data from listing overseas. Depending on how this is classified it would likely include all major internet companies, and many of the startups currently looking at their options. In effect, this would have the same effect as a PCAOB delisting for many of the companies foreign investors are interested in.

So in the end we might get both a PCAOB audit deal, and a mass delisting and exodus from US exchanges to HK. But maintaining access to US exchanges for companies without sensitive data is certainly a positive, and might push more Chinese startups to limit their scope of business and data-collection in order to qualify for such a listing.