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

March 2, 2012 Posted by China Briefing Reading Time: 3 minutes

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.

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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.