After more than a decade of standing in the way of US regulatory inspections of Chinese companies’ auditors, authorities in China have been unusually vocal in recent months about their desire to resolve what has become a major drag on overseas-listed Chinese stocks like Alibaba Group Holding ltd.
and Baidu Inc.
The change in tone has come as a three-year countdown for China to comply with the Holding Foreign Companies Accountable Act of 2020 looks increasingly likely to be shortened. Striking and executing any deal would entail a lengthy process, and the new timetable could see US stock-trading bans for some Chinese companies starting as early as next March.
The China Securities Regulatory Commission, the agency coordinating Chinese government responses to the talks, has issued multiple statements this year signaling that progress has been made in negotiations with their US counterparts.
In a statement to The Wall Street Journal on Tuesday, the CSRC said: “China and the US maintain close communications and are committed to reaching collaborative arrangements that comply with both countries’ laws and regulations. Overall, the negotiation process is going smoothly.”
The Securities and Exchange Commission and the US accounting regulator, the Public Company Accounting Oversight Board, on the other hand, have been more cautious about the prospect of any deal being reached and then implemented.
“We continue to meet and engage with PRC authorities, and speculation about a final agreement remains premature,” the PCAOB said in a statement to the Journal, referring to the People’s Republic of China. “It is important to note that reaching an agreement, while an important and necessary first step, will not alone satisfy the requirements of the HFCAA,” the statement said.
The core issue is whether China will allow the PCAOB to routinely inspect the auditors of US-listed Chinese companies, a 20-year-old requirement under US law for all companies whose shares trade on American exchanges. China has long argued that unfettered access to the audit papers could threaten its national security, as some of the companies are state-owned, do business with state-owned companies, or hold large amounts of data on Chinese citizens.
Beijing’s expansive view of what constitutes a national-security risk is one reason for the impasse. For instance, unadulterated information from large Chinese companies could provide insights into the nation’s economy that aren’t apparent in China’s tightly controlled official data.
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Separately, YJ Fischer, director of the SEC’s international-affairs office, said in a speech Tuesday: “Any claim that audit work papers cannot be produced because they contain national-security materials is questionable at best.” She added that attempts to solve the problem have failed.
Given the challenges, Ms. Fischer said a possible workaround might be for China to voluntarily delist a subset of companies that it considers sensitive while bringing the remainder of firms into compliance with PCAOB standards. The Journal previously reported such an option was being considered.
“The SEC has offered to work with Chinese authorities in whatever decision they make, including ensuring a smooth transition for China-based issuers if they have to leave US markets,” Ms. Fischer said.
The HFCAA took effect in 2021 and bans US trading of securities of companies whose auditors can’t be inspected by the PCAOB for three consecutive years. That gives Beijing until spring 2024 to comply.
However, bills that would shorten the deadline by a year have been passed by both the House and the Senate. That means the legislation would likely be included in a broader “China bill” that is still under negotiation, and which aims to boost America’s competitiveness against China. SEC Chairman Gary Gensler supports the shortened timetable.
If the bill passes later this year, and China-based auditors still can’t be inspected, Chinese companies could be delisted starting from March 2023, once their 2022 annual reports are published. The CSRC said the proposed acceleration of the timeline is “not conducive to protecting investor interests, nor to resolving the audit oversight issues.”
The SEC has identified 148 companies as noncompliant following the release of their latest annual reports, including Chinese e-commerce giants JD.com Inc.
and Pinduoduo Inc.
and restaurant operator Yum China Holdings Inc.
“There is a good chance that the accelerated timeline could be enacted as part of a comprehensive China bill or as a stand-alone measure by the end of the year,” said Clete Willems, a Washington-based partner at Akin Gump Strauss Hauer & Feld and former trade negotiator in the Trump administration.
That means Beijing realistically may have only weeks left to reach a deal with Washington that would enable PCAOB representatives to travel to China and start the inspections, as those inspections could take several months to complete, said industry experts and people familiar with the matter.
“The purpose of the bill is not to kick companies off the exchange. The purpose is to apply PCAOB oversight,” said Rep. Brad Sherman (D., Calif.), who introduced the House version of the accelerated timeline bill. Shortening the timeline “will lead to faster negotiations,” he said in an interview.
In recent closed-door meetings with Chinese companies and international investors, the CSRC said it was working toward the goal of reaching a deal by the end of June, according to people familiar with the matter.
“Right now, the US has the greatest leverage to force China to negotiate a deal than ever before,” said Shaswat Das, who was the PCAOB’s chief negotiator on audit oversight with Chinese authorities from 2011 to 2015. “The HFCAA has laid the groundwork for recent discussions between the PCAOB and Chinese authorities that will likely result in a deal being reached this summer,” said Mr. Das, who is now a lawyer at King & Spalding LLP in Washington.
China’s policy on stamping out Covid-19, keeping its international borders closed and throwing megacities into lockdowns, however, could also delay the timeline for on-the-ground inspection by US officials.
Even if a deal is reached that would allow US regulators to inspect auditors in China, the PCAOB would need sufficient access to companies’ audit papers before determining that China as a jurisdiction is compliant with the HFCAA.
“An agreement without successful execution will not satisfy US law,” the PCAOB said in the statement, adding that it “must have the unfettered ability to choose” which auditors and their clients’ audit papers to inspect.
The scope and depth of such inspections was a contentious point in previous rounds of talks. In pilots conducted during 2016, China handed over heavily redacted audit papers and barred the PCAOB from accessing the records of the most valuable US-listed Chinese companies, including Alibaba. Chinese officials were also present in interviews that the PCAOB conducted during the inspection, potentially interfering with the process. Eventually, the negotiations broke down.
There are currently more than 250 Chinese companies that are listed on US exchanges. The PCAOB doesn’t have to inspect all of their audit papers at the initial stage, but it needs to be able to examine a meaningful sample to determine that China as a jurisdiction is HFCAA compliant.
Overall, it could be a painstaking process, even if China makes concessions on areas it wasn’t willing to before.
“The clock is ticking, and unless China shows more flexibility than it has shown today, the delisting of some or all of its companies is inevitable,” said Mr. Willems.
Write to Jing Yang at Jing.Yang@wsj.com and Paul Kiernan at email@example.com
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