Reuters, by Rachel
Armstrong, Tue Feb 28,
2012
(Reuters) -
The Big Four global audit firms, which dominate the Chinese market, are
negotiating with Beijing to lessen the impact of forced changes that could mean
only accountants with Chinese qualifications can be partners in their audit
practices.
The overhaul
comes at a delicate time for an audit industry reeling from a rash of
accounting scandals at Chinese companies, particularly those listed in
high-profile overseas markets such as the United States.
Any
reduction in the audit capacity of KPMG, Deloitte Touche Tohmatsu, Ernst &
Young and PricewaterhouseCoopers (PWC) would increase foreign regulators' and
investors' concerns about Chinese auditing.
"The
Big Four play a critical role in the integrity of financial markets, it's
essential they have the right to practice in China," said Paul Gillis,
visiting professor of accounting at Peking University and author of the China
Accounting Blog.
The foreign
joint venture arrangements signed in China 20 years ago by KPMG, Deloitte and
Ernst & Young expire later this year. PWC's joint venture expires in 2017,
but it is also involved in restructuring discussions.
China's
Ministry of Finance (MOF) is using the expiry milestone to force the global
auditing giants to form special group partnerships, which in theory would mean
all partners would need to hold notoriously tough Chinese accountancy
qualifications.
But China's
young accounting industry means there aren't yet enough experienced
Chinese-qualified accountants to run these businesses, say people close to the
Big Four, who did not want to be identified as they are not authorized to talk
to the media.
"The
Chinese authorities have indicated for some time that the four will have to
convert into the same mode of practice as local firms when the joint venture
terms end," said Winnie Cheung, chief executive at the Hong Kong Institute
of Certified Public Accountants (HKICPA).
The Big
Four dominate China's accounting industry, having won much of the lucrative
work to audit the books of the country's state-owned enterprises when they
first listed.
In 2010,
their audit practices, excluding their consultancy businesses, had combined
revenue of more than 9.5 billion yuan ($1.5 billion), according to the Chinese
Institute of CPAs (CICPA). However, their market share has slipped in recent
years to around 70 percent of the revenue among the top-10 auditors, down from
85 percent in 2006.
Including
consulting, the four firms say they each employ around 10,000 people in Greater
China, which includes Hong Kong and Taiwan.
BIG FOUR
LOBBYING
A firm
dominated by Chinese-qualified partners would raise concerns at the Big Four's
global headquarters as they'll have less control over their China practices.
The joint ventures agreed in 1992 allowed foreign-qualified partners to dominate
the practices.
The four
are now pushing for many of their foreign-qualified partners to be allowed to
retain their roles during a 'grandfathering' handover period.
"The
Big Four will want to get enough foreign partners into a deal so they can still
control it for a few more years," said Peking University's Gillis.
"Although
they will be delaying the inevitable, it will at least give them a few more
years control until they migrate to a completely Chinese-owned and controlled
entity," he added.
Over the
last five years, the firms have collectively doubled the number of
Chinese-qualified CPAs they employ, according to the CICPA, but many of their
partners gained their qualifications in Hong Kong, the United States or Europe.
An email
circulated by management at one of the Big Four firms on February 22, seen by
Reuters, said the finance ministry was demanding a break-down of all the
qualifications held by the firm's China partners.
"This
is a complex process and the MOF have been requesting a great deal of
information to understand our practice," it said, adding the firm planned
to send the data last week.
"The
question for the authorities is; are the firms mature and ready enough to just
have local qualified partners?" said Cheung at the HKICPA. "They
should also think about diversity and expertise, the advantages of allowing a
certain number of non-locally qualified partners in the transition of the joint
venture to a local firm."
KPMG, Ernst
& Young, Deloitte and PWC all declined to comment for this article.
Partners at the firms told Reuters they could not discuss the matter publicly
as the MOF had insisted the negotiations be confidential.
Neither the
MOF nor CICPA responded to faxes asking for comment.
SCANDAL-TAINTED
Overseas
regulators will be watching events keenly.
The U.S.
Public Company Accounting Oversight Board is in negotiations with the MOF and
the China Securities Regulatory Commission (CSRC) about being allowed to
inspect firms that audit Chinese companies listed in the United States.
The U.S.
Securities and Exchange Commission (SEC) has struggled in some of its
investigations into alleged fraud at U.S-listed Chinese firms, partly due to
the fact auditors in China haven't been able to provide them with key
information.
Last year,
several Chinese companies were de-listed in the United States after being
caught up in accounting scandals, some of which were highlighted by
short-sellers such as Muddy Waters.
One
high-profile blow-up, Longtop Financial Technologies Ltd LGFTY.PK, showed the
difficulties that auditors in China can run into.
Deloitte
resigned as the software company's auditor last May, alleging Longtop tried to
falsify its financial statements and bank confirmations. The auditor noted in
its resignation letter that Longtop management had threatened Deloitte staff
and tried to stop them leaving company premises when the discrepancies were
uncovered.
But the SEC
is struggling in its investigation of Longtop management as Deloitte's Shanghai
office said it cannot provide U.S. authorities with its audit work papers. The
SEC has gone to the courts to try and force Deloitte's hand, but the auditor
says it cannot comply as this could breach China's state secrecy rules.
"If
the change in the structure of audit firms loosens their ties to the U.S., the
challenges for the SEC enforcement program in China will increase," said
William McGovern, partner at Kobre & Kim in Hong Kong.
A report
last week from the Canadian Public Accountability Board on the audits of
Canadian Chinese companies found many auditors in China failed to apply procedures
that would be "considered fundamental" in Canada.
While the
Big Four were caught up in a number of recent Chinese accounting scandals, most
were at mid-cap companies audited by smaller audit firms.
China's
accounting exams are among the toughest around. The pass-rate is well below 20
percent and all papers are in mandarin, making it even tougher for non-Chinese
auditors at the Big Four to try to convert.
The
difficult exams and the economy's rapid growth over the past two decades means
there is currently a shortage of qualified accountants in China.
The CICPA
wants to have 250,000 members by 2015, up from around 180,000 today, and aims
to boost the number of people in the accounting industry nationwide to 12
million.
A wider
part of the ministry's plan for the industry is to develop 10 big domestic
accounting firms, reducing their reliance on foreign auditors. The MOF wants at
least three local audit firms to be among the world's top 20.
"China
recognizes the expertise of the Big Four and the need for them as far as the
worldwide market is concerned, but they want to expand and help the growth of
local firms to the size and expertise and quality that is required to support
the country's increased importance," said HKICPA's Cheung.
($1 = 6.2978 yuan)
(Reporting
by Rachel Armstrong in SINGAPORE, additional reporting by Dena Aubin in NEW
YORK; Editing by Ian Geoghegan)
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