What to watch next in the US-China ADR review dispute

The US and China have taken a significant first step towards preventing US-listed Chinese stocks such as Alibaba from being forced off US exchanges.

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BEIJING — The United States and China recently took a significant first step toward preventing U.S.-listed Chinese stocks such as Alibaba from being forced off U.S. exchanges.

What needs to happen next is a steady on-the-ground inspection in China by the United States with adequate support from Chinese authorities, analysts said.

“Many implementation details can probably only be figured out by the audit firms and [Ministry of Finance] ̵[ads1]1; together with [the China Securities Regulatory Commission] — through real audit trials under this unprecedented agreement,” said Winston Ma, an adjunct professor of law at New York University.

The US Public Company Accounting Oversight Board said its inspectors are set to arrive in Hong Kong in mid-September, shortly after “all audit working papers requested by the PCAOB must be made available to them.”

Audit working papers differ from the actual information about companies collected by accounting firms.

The working papers record the audit procedure, tests, information gathered and conclusions about the review, according to the PCAOB website. It is not clear what level of highly sensitive information, if any, will be included in the working papers.

What to watch next in the US-China ADR review dispute

The ability of the United States to inspect these working papers of Chinese companies listed in the United States has been a years-long dispute. US political and legal developments in the last two years have accelerated the threat that the Chinese companies may need to delist from US stock exchanges.

A turning point came in late August when the PCAOB and the China Securities Regulatory Commission signed a cooperation agreement that laid the regulatory groundwork to allow US inspections of audit firms within China’s borders.

That’s according to statements from both government agencies, which also said China’s Ministry of Finance signed the deal.

“I see this as a big ‘progress,’ meaning both sides were willing to take steps to move this forward,” said Stephanie Tang, head of private equity for Greater China and partner at Hogan Lovells.

“The subject or audience of this PCAOB investigation will be the audit firms,” she said, stressing that she is not an accountant.

Need for more clarity in implementation

China’s registered accounting firms are overseen by the Ministry of Finance, making it the leader on the Chinese side of the next stage, said Ming Liao, founder of Beijing-based Prospect Avenue Capital.

However, there is uncertainty surrounding the implementation of the agreement as it only established a framework, analysts said.

“Our accounting firms still don’t know how to proceed,” said Peter Tsui, president of the Hong Kong-based Association of Chinese Internal Auditors. That’s according to a CNBC translation of his Mandarin-language comments Thursday.

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He said questions remain about what information the companies should share to remain compliant with Chinese regulation.

“Give [us] some guidelines,” Tsui said.

Tsui said the inspections should go smoothly if it is just a matter of accountants on both sides and there is no political interference on the US side. He said the big four accountancy firms – KPMG, PwC, Deloitte and EY – are members of the association.

China’s Ministry of Finance has yet to issue a public statement on the audit cooperation agreement. The ministry did not immediately respond to a CNBC request for comment.

One development Prospect Avenue Capital’s Liao is watching is whether US President Joe Biden and Chinese President Xi Jinping will meet in person this fall for the first time under the Biden administration. That could speed up a final agreement on the audit dispute, he said.

“Ultimately, the resolution of the audit working paper issue depends on political interaction between China and the United States,” Liao said in Chinese, according to a CNBC translation. “With trust, this problem can be solved very easily.”

A decision by the end of the year

The PCAOB said it will make a decision in December on whether China continues to block access to audit information.

U.S. regulators will likely “start to know in October or November” what decision the PCAOB will make on whether U.S.-listed Chinese companies may be headed for delisting, Gary Gensler, head of the U.S. Securities and Exchange Commission, told CNBC’s David Faber late. August.

Alibaba and many other US-listed Chinese companies have in recent years started issuing shares in Hong Kong – seen in part as a way to hedge against a potential delisting from US exchanges. Since the Chinese travel company Didi went public in the US in the summer of 2021, Beijing has also increased its scrutiny of Chinese companies that want to go public abroad.

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The combined political uncertainty has slowed the flow of Chinese IPOs in the US, particularly by larger companies.

Since July 1, 2021, 16 Chinese companies have listed in the US, excluding special purpose acquisition companies, according to Renaissance Capital. Back in 2020, 30 China-based companies had listed in the US, the firm said at the time.

By value, the five largest US institutional holdings of US-listed Chinese stocks are: Alibaba,, Pinduoduo, NetEase and Baidu. This is according to Morgan Stanley research dated 26 August.

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