Accounting Rule Change Draws Heat-wsj 12/19 ; 홍콩 증권거래 위원화 중국본토 화계기준 인정과 중국 역외 상장회사의 재무재표 투명성의 문제 제기

[처용]

By ALISON TUDOR

A shift in rules for accounting standards on Hong Kong's stock exchange is raising concerns that fraud may now more easily slip through the regulatory cracks, and drawing uncomfortable comparisons with problems among Chinese companies listed in the U.S. and Singapore.

View Full Image

European Pressphoto Agency

Hong Kong's stock exchange is allowing mainland Chinese companies to use Chinese accounting standards and employ auditors based in mainland China.

Hong Kong Exchanges & Clearing Ltd. has since Dec. 15 allowed mainland Chinese companies to use Chinese accounting standards and employ auditors based in mainland China to sign off on their books.

Relaxing the rules will cut costs for mainland companies seeking to list in Hong Kong if they choose to prepare one set of financial statements instead of two, China's Ministry of Finance and the Hong Kong exchange said in statements. But other implications of those changes are beginning to sink in among investors and other market watchers.

Chief among these: Just as global investors are increasingly turning to Hong Kong for exposure to China's growth story, they will no longer always be able to count on the comfort of a Hong Kong auditor signing off on financial statements—or more importantly, a local regulator to hold the auditors accountable.

State-driven efforts to improve corporate governance in China are bolstering the regulatory and accounting frameworks, but the private sector's track record hasn't kept pace, according to the Asian Corporate Governance Association. It says the mainland still lags behind Hong Kong in terms of corporate governance. Hong Kong registers 13 on Transparency International's corruption perceptions index. China is ranked 78, tied with Colombia, Greece and Lesotho.

On the other hand, the ACGA said in its latest report, Hong Kong should be showing greater leadership on corporate governance, as its capital markets have a longer track record and should be less concerned with the short-term expansion of the stock market by attracting trading volumes and listings away from Shanghai.

"Surely a better response to Shanghai would be to move up, not down, the market quality curve and continue to give investors strong reasons for investing in the Hong Kong stock market," the association said.

Karin Ri, head of Asia at Hermes Equity Ownership Service, owned by Britain's largest pension fund, BT Pension Scheme, opposed the change in the exchange's rules, calling it premature.

"We're worried about the quality of the IPOs," said Ms. Ri, who helps advise 19 clients globally with £60 billion ($93.12 billion) under management. Ms. Ri felt her objections, as well as those of other investors, had been drowned out by the numerous Chinese companies supporting the change.

"When something goes wrong, it is too late," she said.

By past measures, the impact of the changes could be significant. This year 68 of the 85 initial public offerings in Hong Kong were by mainland Chinese companies.

Until now, Hong Kong's Securities and Futures Commission could question the Hong Kong-based auditor of a mainland company. Now it must rely on mainland Chinese authorities to root out fraud.

This goes against the trend in other jurisdictions, where regulators are pushing for more diligent audits. In the U.S., where 21 of the 27 foreign offerings this year were Chinese, the U.S. "auditor of auditors," the Public Company Accounting Oversight Board, in July warned auditors not to rely on accounts prepared by mainland Chinese accountants and urged them to visit China to check up on the companies themselves.

After a series of scandals last year among Singapore-listed China stocks, known as S-chips, the Singapore exchange instructed auditors to conduct detailed examinations of bank balances. In one crackdown in April, the exchange ordered China Milk Products Group Ltd. to appoint a special auditor to show it had enough cash outside of China to settle its obligations to investors such as BlackRock Inc. after it defaulted on a convertible bond. The company said delays in repayment were due to the process of obtaining approval for the remittance of funds out of China from China's State Administration of Foreign Exchange. Trading in China Milk's Singapore shares has been halted since February.

Securities authorities in China said at the time that China Milk, which has its operations based in the northeastern city of Daqing, isn't Chinese, as the company is legally headquartered in the Cayman Islands, and they have no jurisdiction over its stock or bonds. "We are only responsible for protecting domestic investors," said an official in the international-cooperation department of the China Securities Regulatory Commission.

That could prove a bad omen for Hong Kong when it seeks help in China. An SFC spokeswoman declined to give details on how the cooperation between Hong Kong and China will work in practice.

Extra homework can pay off for those willing to put in the hours. Muddy Waters LLC, a firm that conducts its own research on Chinese companies, said in a report that U.S.-listed Rino International Corp. had "cooked books" after extensive research into the differences between its U.S. filings and those in China. Earlier this month, the Nasdaq Stock Market delisted Rino after the company said reports for 2008 and 2009 weren't reliable. The company didn't appeal Nasdaq's decision and didn't respond to requests from Nasdaq staff seeking more information related to Muddy Waters' findings. It said the company's audit committee is conducting an investigation into the report's findings.

New-York based investor Kerrisdale Capital hired an investigator to look into the operations of New York Stock Exchange-listed China Education Alliance, Inc. and concluded the company was fabricating its U.S. financial statements. China Education Alliance disputed the investor's conclusions.

China Education Alliance and Rino are facing class-action lawsuits in the U.S. In Hong Kong, a proposal allowing multiparty litigation is still pending approval. Even in the event of successful legal action against a mainland Chinese company, enforcing it is a challenge if the companies' management and assets are in China.

One possible outcome may be that the market will place a higher value on companies employing a Hong Kong-based accountant.

"I'd pay a premium for a company using a local auditor which is clearly responsible to the local regulator," said Julian Mayo, co-head of portfolio advisory at emerging markets asset manager Charlemagne Capital in London.

Write to Alison Tudor at alison.tudor@wsj.com