Capital Markets Alert
On August 26, 2022, the U.S. and Chinese governments reached a Statement of Protocol (“SOP”) Agreement regarding cooperation on inspecting the audit work papers of U.S.-listed Chinese companies. The SOP is the culmination of months of negotiations after a decade-long stalemate between U.S. and Chinese regulators over audit working papers for Chinese companies listed in the U.S.
Although China’s Ministry of Finance (“MOF”), China Securities Regulatory Commission (“CSRC”) and the U.S. Public Company Accounting Oversight Board (“PCAOB”) entered a Memorandum of Understanding on Enforcement Cooperation in 2013 and an agreement that addressed a pilot inspection of one mainland China firm in 2016, the U.S. Securities and Exchange Commission (“SEC”) and the PCAOB have been complaining that Chinese cooperation has not been sufficient since then for the PCAOB to obtain timely access to relevant documents and testimony necessary for the PCAOB to carry out enforcement matters. As a result, in December 2020, the Holding Foreign Companies Accountable Act (the “HFCAA”) was signed into law, and the SEC adopted final rules to implement the HFCAA in December 2021. According to the HFCAA and its final rules, roughly 200 China-based issuers will face prohibitions on trading of their securities in the U.S. in 2024.
The text of the SOP has not been made publicly available. While both China and the U.S. used optimistic language to describe the SOP, the two countries appear to differ on detailed procedures for U.S. regulators to inspect Chinese audit papers.
The SOP establishes a specific and accountable framework for the PCAOB to conduct inspections and investigations of PCAOB-registered public accounting firms in mainland China and Hong Kong.
Under the SOP, inspectors from the PCAOB will be able to travel to Hong Kong or mainland China to conduct inspections. The SEC Chair Gary Gensler said inspectors must be on the ground by mid-September to complete an assessment of China’s compliance with U.S. regulations by the end of the year.
The PCAOB fact sheet says that the SOP includes commitments from Chinese authorities on four issues:
On the other hand, the Chinese statement emphasizes:
As the Chinese statement appears to conflict with that of the PCAOB, which said: “The PCAOB has complete discretion in selecting firms to inspect and investigate, audit engagements and potential violations, without consultation with relevant Chinese authorities and without China provides opinions”, it is unclear whether U.S. regulators can conduct investigations without Chinese officials present.
DiDi, in December of last year, announced its plan to delist from the New York Stock Exchange and pursue a listing in Hong Kong. New York-listed Alibaba said in July of this year it would convert its Hong Kong secondary listing into a dual primary listing which analysts said could ease the way for the Chinese e-commerce giant to switch primary listing venues in the future.
On August 12, 2022, five U.S.-listed Chinese state-owned companies announced that they would voluntarily delist their American Depository Shares from the New York Stock Exchange, including oil giants Sinopec, its entity Sinopec Shanghai Petrochemical, PetroChina, China Life Insurance and Aluminum Corporation of China. All of them said the delisting of their shares would take effect in August or September.
“Listings and delistings are both common in capital markets.” CSRC commented in a statement, “According to these companies’ announcements, they have strictly observed relevant U.S. rules and regulations since listed on the U.S. markets, and the delisting decisions are made out of their business considerations. These companies are listed on multiple markets, and only a small portion of their securities are traded in the U.S. markets. The delisting plan will not jeopardize these companies’ fund-raising ability through domestic and overseas capital markets.”
Considering that the five SOEs announced delisting simultaneously and the two countries reached the SOP shortly thereafter, some suspect that the delisting of the five SOEs was to pave the way for the SOP so that the sensitive information held by the SOEs would not be disclosed to PCAOB while China allows the U.S. regulator to inspect audit papers of other listed companies.
PCAOB said its inspectors will arrive in Hong Kong in mid-September 2022 to begin their work, and, shortly thereafter, all audit work papers requested by the PCAOB must be made available to them. This means U.S.-listed Chinese companies and their accounting firms may need to transfer their audit working papers and other data from the mainland to Hong Kong because Hong Kong’s COVID-19 regulations make it easier for PCAOB inspectors to enter.
It is worth noting for U.S.-listed Chinese companies that the Chinese statement refers to China’s revised Regulation on Confidentiality and Archives Management for Overseas Listing (“Confidentiality Regulation”). CSRC published the draft amendment to Confidentiality Regulation for public comments on April 2, 2022, which has not become law. Compared to the existing rule, the new draft emphasizes the obligations of listed companies and accounting firms to keep national secrets confidential. Therefore, U.S.-listed Chinese companies and their accounting firms shall evaluate their compliance with the new draft rule and assess whether any unnecessary confidential and sensitive information have been included in the working paper.
What really matters is how the two countries will implement the SOP. If the cooperation could meet each country’s regulatory requirements, it would avoid mass Chinese stock delistings, though some with sensitive data may still choose to delist from the U.S. or seek primary listing in Hong Kong or mainland China. In the future, it is likely that the CSRC will review whether any Chinese company owns or processes sensitive data before its overseas IPO. Only those companies that could pass CSRC’s review will be listed in the U.S. and be subject to PCAOB’s inspection.
Please contact one of the listed authors or your regular Orrick contact if you have any questions.