U.S.-China Auditing Agreement and Issues for Congress
September 13, 2022
U.S.-China Auditing Agreement and Issues for Congress
On August 26, 2022, securities exchange officials from the
companies. Since 2002, most countries and U.S. regulators
United States and the People’s Republic of China (PRC or
have reached agreements over how and when foreign
China) announced an agreement on a preliminary auditing
accounting firms would be audited. China has remained an
framework. This “Statement of Protocol” between the U.S.
outlier, and PRC firms listed on U.S. stock exchanges have
Public Company Accounting Oversight Board (PCAOB)
not been in compliance with SEC auditing requirements. In
and the PRC’s China Securities Regulatory Commission
2009, the CSRC issued rules that limited U.S. regulators’
(CSRC) and Ministry of Finance (MOF) governs cross-
access to PRC firms’ audit documents, citing national
border inspections and investigations. It is to allow PCAOB
security concerns, further constraining access. PCAOB and
officials to review the work of PRC-based accounting firms
MOF signed a memorandum of understanding in 2013 and
that audit PRC-based firms listed on U.S. stock exchanges.
began a pilot inspection program in 2016. Early in the pilot,
PCAOB assessed China was not allowing sufficient access,
The agreement comes after nearly 20 years of efforts by the
resulting in an impasse.
U.S. government to gain auditing access in China. Some
experts have said the deal could be a breakthrough but
Holding Foreign Companies Accountable Act
depends on implementation. Others say that China could
In response to China’s refusal to allow PCAOB audit
still hinder PCAOB access, citing the sensitivity of
inspections and in an effort to protect U.S. investors,
corporate data to the PRC government, and past PRC
Congress passed the Holding Foreign Companies
approaches toward similar agreements. Securities and
Accountable Act in 2020 (HFCAA, P.L. 116-222). HFCAA
Exchange Commission (SEC) Chair Gary Gensler said the
requires the SEC to delist from U.S. exchanges PRC firms
deal is “a step in the process” and will be assessed on
that do not meet U.S. audit inspection requirements, starting
PCAOB’s ability to “inspect and investigate completely
in 2024. It includes provisions to:
audit firms in China.” Some Members have pressed the
SEC to implement U.S. requirements stringently. Other
Require the SEC to identify each issuer that retains a
Members have called for passing the Accelerating Holding
registered public accounting firm with a branch in a
Foreign Companies Accountable Act (H.R. 6285 and S.
foreign jurisdiction if PCAOB is unable to inspect the
2184—passed in the Senate), which would accelerate by
work papers of the auditor in the foreign jurisdiction.
one year the delisting of non-compliant PRC firms to 2023.
Require, during non-audit years, for the issuer to submit
to the SEC the percentage of their shares owned by
Background
governmental entities and to state whether governmental
Reliable audited financial statements and other disclosures
entities have a controlling financial interest.
communicate firms’ performance to investors, creditors,
Require covered issuers to disclose government
regulators, and the public. They are critical to sustaining
ownership and board of director members affiliated with
trust in U.S. capital markets and promote more efficient
the Communist Party of China (CPC) and organizing
allocation of capital between investors and firms. Federal
documents that include a CPC charter.
securities laws require companies listed in the United
Require the SEC to prohibit trading of securities of the
States, both domestic and foreign, to share critical
issuer if PCAOB is unable to inspect the work papers of
information about their performance on an ongoing basis.
the audit firm for three consecutive years.
They also require a qualified external auditor to provide
independent assurance to investors and other stakeholders
that the annual reports and financial statements are free of
The enactment of HFCAA likely prompted the PRC
material misstatements, whether caused by error or fraud,
government to reach an agreement with the PCAOB to
by giving an unbiased professional opinion on whether
avoid the delisting of PRC firms from U.S. exchanges as
disclosures are fairly stated in all material respects. For
the deadline set by Congress approaches. While China is
example, domestic firms are required to submit to the SEC
steering PRC firms to list onshore, U.S. capital markets
annual audited reports on Form 10-K, which provides a
remain important to China as a platform for PRC firms to
comprehensive overview of their performance, including
raise capital and invest overseas. U.S. capital markets are
audited financial statements. Foreign firms that participate
the largest and, many argue, the most efficient and liquid in
in U.S. capital markets must file a different, but
the world. U.S. equity market cap in 2022 was $52.2
comparable, set of financial reports, using form 20-F.
trillion, 2.6 times larger than China’s and Hong Kong’s
combined markets. Many U.S. investors seek exposure to
Congress created the PCAOB (P.L. 107-204) in 2002 to
PRC firms and China as a growth market. An estimated 200
provide oversight of the accounting firms that audit public
PRC firms valued at about $1.3 trillion are traded on U.S.
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U.S.-China Auditing Agreement and Issues for Congress
stock exchanges, constituting about 2.5% of the U.S.
Table 1. U.S. and PRC Statements on the Framework
market. These firms are audited by over 30 PRC-based
PCAOB and SEC
CSRC
auditors which are registered with the PCAOB and subject
to inspection.
Independent discretion
PRC role in “mutual” and
for PCAOB to select any
“reciprocal” cross-border audit
Preliminary Auditing Framework
issuer audits for
oversight cooperation and
The SEC has not publicly disclosed the agreement text,
inspection or
“thorough communications” to
reportedly at the request of the PRC government. The SEC
investigation.
plan inspections and
and PCAOB have at times not disclosed the details of their
investigations.
agreements with other countries. The U.S. and PRC
Audit firms, not listed firms,
governments have shared their understanding of the deal in
subject to oversight. A portion
separate statements which appear to diverge in some ways
of firms and selected
that could affect implementation (see Table 1). Areas to
engagements inspected annually.
watch include:
Direct PCAOB access to
PRC wil require PCAOB to
interview all personnel of
operate from Hong Kong.
China’s expectations of its role in “mutual” and
selected audit firms.
“reciprocal” cross
PRC authorities wil obtain and
-border audit oversight—including
transfer all materials and take
planning inspections and investigations—may allow it
part in interviews.
to influence the selection of firms, prevent the audit of
sensitive state firms, and delay investigations. Central
Unfettered ability to
China’s Data Security
government-managed state-owned firms are not among
transfer information to
Law, Personal Information
PCAOB.
the first batch of firms that PCAOB has selected for
Protection Law, provisions on
audit. China’s delay in reaching a deal is also creating
overseas listings, and other laws
time pressures on PCAOB to inspect firms by the end of
and regulations to govern access
and transfer of information.
2022, according to statements by PCAOB officials.
CSRC’s emphasis on selecting a sample of firms for
Ability to review all audit
PRC and U.S. regulators must
audit indicate it may resist the audit of certain firms. Its
paperwork without
reach agreement on the use and
emphasis that the audit is of the auditors and not the
redactions through “view
protection of certain types of
only” procedures for
listed firms may indicate China could try to limit access
sensitive data (e.g., personally
sensitive information.
to certain information about listed firms.
identifiable information).
CSRC statements that access to all documents, auditors,
Sources: CSRC, PCAOB and SEC official statements.
and personnel will be controlled by PRC regulators
Issues for Congress
highlight how this arrangement may allow the PRC to
Congress, not the SEC or the PCAOB, arguably has been
slow or influence the process or information available.
the driving force in requiring that PRC firms comply with
PRC discretion to determine what information is
U.S. listing requirements. Congress could defer to the SEC
sensitive or a state secret may allow it to restrict access
and PCAOB to implement the deal. Alternatively, Congress
to such information. PRC data laws and regulations and
may continue to play an active role in overseeing SEC and
the “view only” provision could further limit transfers to
PCAOB implementation of the agreement to ensure it meets
the PCAOB and SEC.
congressional expectations as outlined in HFCAA, and that
Requirements to operate out of Hong Kong keep
its provisions are enacted on time. Congress might consider
PCAOB officials at arms-length and arguably allows
whether to require the PCAOB and SEC to:
China to control information and interactions. China’s
Share or make public the full text of the deal to allow
Data Security Law limits cross-border data transfers,
Congress to assess the quality of its terms and whether it
including to Hong Kong and among firms’ operations in
meets U.S. requirements. The lack of public visibility on
mainland China and Hong Kong.
China’s commitments could impede oversight.
Branches of international auditors based in China—
Create requisite disclosure and enforcement
PWC Zhong Tian, Deloitte Hua Yong, and KPMG Hua
mechanisms, such as the process for de-listing PRC
Zhen—are administratively separate from their parent
firms, in the event implementation is insufficient.
and the Hong Kong branches of these firms. The China-
Outline the process by which PRC firms will disclose
based firms audit most of the PRC firms listed on U.S.
CPC affiliations of senior executives and board
exchanges. China may confine PCAOB’s work to the
members, and Party cells and operations in companies.
Hong Kong branches of these audit firms, while limiting
Report to Congress on whether requirements to operate
what mainland China branches can send to them.
in Hong Kong differ from U.S. agreements with other
A key provision of the HFCAA not addressed by the
countries or impede U.S. authorities and requirements.
preliminary framework, and to be handled through SEC
regulations, is the requirement for PRC firms listed on
Karen M. Sutter, Specialist in Asian Trade and Finance
U.S. exchanges to disclose members of the CPC in
Michael D. Sutherland, Analyst in International Trade and
senior executive and board positions and details of CPC
Finance
Party Committees established within a U.S.-listed firm.
Raj Gnanarajah, Analyst in Financial Economics
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U.S.-China Auditing Agreement and Issues for Congress
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