‘Big Four’ Accounting Firms Face New Regulatory Challenges in China

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Mar. 2 – As their joint venture (JV) agreements in China approach their expiration dates, the Big Four global accounting firms had hoped that they would be allowed to extend the terms of their JVs. However, according to a variety of sources, Chinese authorities have been adamant in using the expiry milestone to force the four to convert into the same mode of practice as local firms.

Such new regulatory requirements could mean the four firms must transfer their JV structures into limited liability partnerships and their partners must have Chinese accounting qualifications.

It is worth mentioning that the direction Chinese regulators wish to go is in line with international practices. The Big Four in most countries are owned by local partners, operating more like a franchise than a typical multinational corporation. However, the policy change still brings the four firms serious challenges, especially when China’s accounting industry is still very young.

There is also difficulty in converting the existing non-Chinese auditors at the Big Four in accordance with China’s requirement, since the country’s accounting exams are among the toughest and are all offered in Chinese. The pass-rate of those exams is well below 20 percent, according to Reuters.

The United States has tried to negotiate with China about offering the accounting tests in English, but failed in that direction, according to a recent blog post by Paul Gillis, a member of the U.S. Public Company Accounting Oversight Board Standing Advisory Group.

Western countries are paying keen attention to the potential change for the Big Four in China, as the overhaul comes at a delicate time when Chinese companies listed overseas (especially in U.S. stock markets) are facing a rash of audit scandals and are becoming high recommendations by short-sellers. Any reduction in the audit capacity of the four firms would increase Western regulators’ and investors’ concerns over the integrity of Chinese auditing.

There are also concerns at the Big Four’s global headquarters that they may have less control over their Chinese practices, if those are dominated by Chinese-qualified partners in the future.

“If the change in the structure of audit firms loosens their ties to the United States, the challenges for the SEC enforcement program in China will increase,” said William McGovern, partner at the Hong Kong unit of law firm Kobre & Kim. The U.S. Securities and Exchange Commission (SEC) has previously met a setback when requesting audit information from the Chinese unit of Deloitte Touch Tohmatsu (Deloitte), one of the Big Four firms which did the audit work for the U.S.-listed company Longtop. According to the SEC, the information asked was necessary for its investigation into Longtop’s possible fraud; however Deloitte said it could not comply with the SEC subpoena as this could breach China’s state secrecy rules.

As time starts ticking for the Big Four, the firms are now busy negotiating with Beijing, hoping the authorities will make some compromises and allow them to retain the roles of their foreign partners for a few more years during the transition period.

The authorities can consider granting a Chinese Certified Public Accountant license to some of the Big Four’s partners from Hong Kong and Taiwan, based on recognizing their foreign credentials. Such a solution will not only allow those foreign partners to finish out their careers, but also enable local partners to gain further experience and become more prepared for the future leadership of the firms, writes Gills in his blog.

Three of the “Big Four” firms – Deloitte, KPMG and Ernst & Young – will see their 20-year JV arrangements expire later this year. PricewaterhouseCoopers’s JV agreement will come to an end in 2017, as it formed a new JV at the time of the Price Waterhouse/Coopers & Lybrand merger.

Related Reading

Setting Up Joint Ventures in China (Third Edition)
This guide walks you through, step-by-step, each of the key points of setting up a joint venture in China. It includes a complete draft of both a JV contract and articles of association as well as an overview of JV laws, negotiation issues, land use rights, IP protection and technology transfer, in addition to tips on staff hiring and HR. It also describes tax and audit responsibilities in addition to buying out a JV partner and liquidating.

International Audit Firms in China May Face End of Joint Venture Periods

20 Responses

  • Eddy says:

    “Three of the “Big Four” firms see their 20-year JV arrangements expire later this year.”

    So they better hurry up preparing for the exams… with its 20% score rate…

    Looks to me as yet another way to move the inner details of a company, “the engine” over to Chinese who are very very likely to adhere far better to the Chinese “unwritten rules of business and law”

  • Frankie Fook-lun Leung says:

    It is obvious the market for non-chinese speaking expatriates of foreign nationalities is shrinking fast. On the contrary, the demand for PRC professionals is getting better.

  • Frankie Fook-lun Leung says:

    IN the recent past, accountants who are qualified in Hong Kong or overseas were sought-after to go to China. Now the reverse is happening. Chinese nationals who are qualified in China and with some overseas experiences are in big demand. Two years ago, I together with many professionals from Hong Kong were invited to train Chinese nationals. Now, Chinese professionals are paid handsomely to come to Hong Kong and overseas to tell us how the Chinese system operates. Hong Kong and American college students flock to China to undergo internship to learn about the Chinese ways of doing things.

  • The issue is that the Chinese auditing “system” is highly flawed and subjected to political interference, a serious lack of transparency and out and out fraud. Auditors working to that system may well find themselves compromised. While I agree that Chinese auditors are in demand, restricting the exposure to international standards diminishes the ability for Chinese auditors to gain exposure to that and subsequently increases the risk for investors. I think this is going to be one huge car crash with Hong Kong’s integrity bang in the middle. – Chris

  • Frankie Fook-lun Leung says:

    The Chinese accounting profession is still very young and inexperienced, especially in dealing with sophisticated and western practices. However, under the current atmosphere, it is politically incorrect to say that in their face. Many of us outside China who are candid with them are not very popular. What can we do? May be honesty is not the best policy when you are confronted with the Chinese system.

  • Frankie Fook-lun Leung says:

    Like the legal profession, the trend for most developed jurisdictions like USA, UK, Canada, Singapore and Hong Kong, to get qualified there is no nationality restriction. China is going against this trend. China must realize although it may take pride in her adherence to a strict sovereignty ideal, yet if a profession does not allow professionals who are better qualified and experienced than your own and you restrict them from working in your country, the country will suffer. Look at Hong Kong and Singapore, they have an open door policy and permit foreigners to practice, the professional quality improves. There are more jobs even available for locals. It is not a zero sum game.

  • Frankie Fook-lun Leung says:

    One of the probable outcomes is that the Big Fours may choose to set up a separate legal entity for China and let the rest of the world be detached from the Chinese operations to avoid these measures implemented in China. I can’t think of a better way of doing it.

  • @Frankie Fook-lun Leung: There also seems to be ethnicity ranked above professional competence in this instance. You’ll be seeing related news about Chinese lawyers shortly. Thanks – Chris

  • Frankie Fook-lun Leung says:

    To qualify as a lawyer in China, you have to be a Chinese citizen. There is an additional requirement recently introduced that an applicant has to swear allegiance to the country. Hence non-chinese cannot be a Chinese lawyer.

  • Frankie Fook-lun Leung says:

    China has become very assertive in exercising her sovereignty. That’s the way they see the trend. There is an element of guarding their financial interest too. The precipitating cause may be the US Security & Exchange Commission’s recent action in put pressure on Deloitte’s Shanghai office that makes the Chinese government retaliate.

  • Frankie Fook-lun Leung says:

    It seems that there is no longer any level playing field since Chinese nationals can get qualified in western countries and become partners without nationality restrictions but foreign individuals cannot qualified as Chinese professionals because of nationality and language requirements.

  • Frankie Fook-lun Leung says:

    These regulations will affect other professional firms besides the Big Four. The Big
    Four hire more professionals than other service firms. They are the main targets. Once it starts, other professional firms will get the message. China should not be too concerned about losing her sovereignty and control over professional firms in her country. The market is big enough and professional development is not a zero sum game. I think many foreign professional firms may have to reorganize their China operations to cope with these new changes.

  • @Franbkie – yes, only Chinese nationals can practice law in China. We wrote about a recent case involving dual nationality here: http://www.china-briefing.com/news/2012/06/05/nationality-row-over-qualifications-for-china-lawyers.html

    It seems the Chinese wish to restrict the audit services industry to the same nationality guidelines too. An example of an industry becoming more regulated against foreign investment, not less. – Chris

  • Frankie Fook-lun Leung says:

    I once wrote an article in the Asian Wall St. Journal called To be oi not to be, the problem of being Chinese. So far Hong Kong, Macau and Taiwanese can sit the Chinese lawyers qualifying examination but none so far as I know has become a Chinese lawyer. You are right on two issues. Chinese nationality is not a very well-defined subject matter. Secondly, the trend is restricting qualifying condition based on nationality and not widening the definition.

  • Frankie Fook-lun Leung says:

    It is primarily a matter of face. China can’t admit to the world that their nationals aren’t qualify to practice a profession in their own country. In the 1980s and 1990s, China opened her doors for foreign experts to come. Granted some of them are charlatans and exploited China’s ignorance and inexperience. Now the table has turned and China is more than active in asserting her sovereignty. Look at their publicity surrounding their sending spaceships to the outer Space.

  • Frankie Fook-lun Leung says:

    One strategy these Big Fours can adopt is to work among themselves to present a common front to the Chinese authorities to resolve the issues. United we stand, divided we fall.

  • I think its rather more to do with the fact that the Chinese government don’t want the US or anyone else to know exactly how much they fund their SOE’s in breach of WTO obligations.

  • Frankie Fook-lun Leung says:

    China is obsessed with sovereignty. She can sacrifice economic advantages to save face. To tell them there is no capable Chinese to head an accounting firm on China’s soils is an insult. In America or elsewhere, only a capable professional regardless of nationality can head a business entity unless it serves national or defense interest. To China, that is an insult. China still thinks like a bunch of Boxers (Boxer Uprising) or Manchurian mandarins defeated in the Opium Wars. You can’t argue with them on such an emotive subject.

  • Now the SEC in USA is now suing the Big Four and another major international audit firm over the Chinese companies listed in the New York Exchange.

  • Frankie Fook-lun Leung says:

    Chins is more sophisticated in its arguments saying looking at Ernest & Young and KPMG whose senior accountants committ grevious frauds and offense like insider trading. Even in a so-called regulated environment as USA, such criminal activities cannot be prevented. Why point your finger at the Chinese. There is an upsurge of nationalitic feelins and rejection of univesal standards as championed by western countries.

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