Lawyers have serious doubts that an agreement reached between Chinese and U.S. regulators to allow U.S. authorities to vet audits of U.S.-listed companies will pave the way for unfettered access to Chinese issuers’ documents—a move that if successful, could ease commercial tensions between the U.S. and China.
And should practical implementation fail, that, coupled with a proposed law that would require the U.S. government to assess all outbound investments, could further damage the fractious relationship that currently exists between the two countries, they say.
The agreement signed last week by the China Securities Regulatory Commission (CSRC), China’s Ministry of Finance, and the U.S. Public Company Accounting Oversight Board (PCAOB), seemingly resolves a long-running point of contention between the two countries. China and Hong Kong are the only two jurisdictions in the world that forbid PCAOB inspections.
But it’s not yet clear that the agreement will deliver on its promise.
“The recent agreement between the PCAOB and the Chinese regulators is a major milestone but is only one of many steps that will need to be taken before all the relevant parties, including the Chinese companies listed in the U.S., can truly breathe a sigh of relief,” said Ropes & Gray Shanghai partner Eric Wu.
There’s a lot at stake for China, as more than 150 U.S.-listed Chinese companies face the threat of expulsion from American bourses by the U.S. Securities and Exchange Commission (SEC) as early as next year—a move that could potentially wipe out trillions of dollars worth of capital for Chinese issuers.
Stock prices of U.S.-listed Chinese companies jumped almost immediately after the agreement was announced—a sign that many saw it as a crucial step toward repairing the fractious relationship between the two countries.
“The positive here is that there seems to be a path forward. But the key will be the proper operationalization and implementation of the agreement going forward,” said Wu.
Soon after market players started to dissect the CSRC’s own public statement regarding the audit agreement, optimism began to fizzle. Lawyers have identified key “inconsistencies” between the announcements by the Chinese regulator and the PCAOB.
“There’s an element of ‘face saving’ at play here,” said one Hong Kong partner at a U.S. law firm. “China is now saying it is not allowing complete access (to the financial papers of U.S.-listed Chinese companies) because it would look bad if it did, but the U.S. is essentially saying it has won the battle.”
Per the agreement, auditors will transfer companies’ financial working papers to Hong Kong and PCAOB officials will travel to the city in September to inspect the documents.
The PCAOB says it has sole discretion to select the firms “without consultation with, nor input from Chinese authorities.” The CSRC’s statement contradicts that assertion, saying that audit work papers “will be obtained by and transferred through the Chinese side” and China will also “take part in and assist” PCAOB interviews of relevant personnel of audit firms.
Additionally, the Chinese regulator also stated that it may deem certain data, such as personally identifiable information, as “restricted” and limited to a “view only” review by select inspectors. On the flip side, the U.S. oversight board has stated that the agreement allows it to “see complete audit work papers without any redactions” subject to “ view only procedures “ for “targeted pieces of information.”
“It remains to be seen whether the PCAOB reviews under the new protocol will delve into issues deemed sensitive by Chinese authorities, whether Chinese authorities will respond, and whether their reactions are later framed as interference in violation of the new protocols,” said DLA Piper’s Singapore-based head of antitrust and competition for Asia, Nathan Bush.
“As a practical matter, the typical scope and methods of most audits may limit the circumstances in which “view-only” inspection of sensitive documents is genuinely warranted. However, frictions may arise in scenarios where audit work papers or statements of audit personnel implicate issues of particular sensitivity to Chinese authorities,” Bush added.
So far, the PCAOB has not relented in its expectation of unfettered access to the audit papers of Chinese issuers. The practical implementation of the agreement and the results will weigh heavily on future trade relations between the rival countries.
“It is always easier to set up a protocol for something to be carried out than carrying out the task itself,” said DLA Piper Beijing partner James Chang. “Whether the announcement will lead to positive results for China-based U.S. issuers to satisfy U.S. PCAOB requirements will be determined by how easily the PCAOB can carry out, to its own satisfaction, the audit firms review in the next few months.”
Will ‘Reverse CFIUS’ Do Further Damage?
The tension over the examination of public company audits is only one factor playing into U.S.-China tensions. Earlier this month, the U.S. drew the ire of China when American House Speaker Nancy Pelosi visited Taiwan. That triggered a series of retaliatory responses from the Chinese government, which sees the growing alliance between the U.S. and Taiwan as not just a threat but also an insult.
Pelosi’s visit, though unrelated, followed the initiation by the U.S. of new legislation that would require the assessment of outbound investments to certain countries, including China, for their impact on national security. Inbound investments have for a long time been scrutinized by the Committee on Foreign Investment in the U.S. (CFIUS). The newly proposed committee charged with assessing outbound investments, dubbed “reverse CFIUS,” will be tasked with prohibiting transactions it deems a threat to certain domestic capabilities.
Lawyers say this new level of scrutiny will significantly impact U.S. investments into China, particularly involving sectors that the committee is labeling “national critical capabilities.” So far, the sensitive sectors identified include supply chains for semiconductors, large-capacity batteries, critical minerals and materials, and pharmaceuticals, as well as technologies such as artificial intelligence and quantum information.
“Importantly, under recent proposals, the scope of covered activities potentially subject to notification and review would extend beyond traditional investment activity,” said Ama Adams, a Ropes & Gray anti-corruption and international risk practice partner and managing partner of the firm’s Washington, D.C. office.
“Thus, the potential impact for U.S.-China investment and trade in the short- to medium-term could be significant, as reverse CFIUS could regulate a broad swath of U.S. foreign investment in China, depending on how broadly key terms ultimately are defined by regulation if the bill passes,” she added.
According to the U.S. Congressional Research Service, China was the fourth-largest U.S. goods trading partner in 2021, with total trade valued at $657.4 billion. It was also the largest source of U.S. imports, valued at $506.4 billion. Top U.S. goods exported to China included semiconductor chips and equipment, agricultural products, aircraft, gas turbines, and advanced medical devices. Many of these will be substantially impacted by the enactment of the reverse CFIUS law.
All this adds to existing commercial strains, lawyers say. The appetite for U.S. listings by Chinese companies was doused abruptly last year when the Cyberspace Administration of China launched an investigation into the U.S.-listed Chinese ride-hailing dominant, Didi Chuxing, days after the company raised over $4 billion in New York.
The Chinese government later doubled down on its crackdown on overseas-listed data-heavy Chinese companies. Since then, only small to mid-sized Chinese companies have ventured to launch initial public offerings on American exchanges, while many other major pipeline listings were shelved.