Washington and Beijing reached an agreement for U.S. accounting regulators to inspect China-based audits, laying the groundwork for a monthslong process that could prevent numerous Chinese companies from being booted off American stock exchanges.
The deal, which was negotiated over many months, comes after a decadelong standoff between regulators in the two countries over the audit working papers of New York-listed Chinese companies. It appears to mark a rare concession from Beijing at a time when the U.S. and China are locked in disagreements over issues such as trade and human rights.
The agreement allows Public Company Accounting Oversight Board inspectors to travel to Hong Kong or mainland China for inspections. U.S. regulators said they expect American inspectors to be on the ground by mid-September. They will have to work swiftly to complete an assessment of whether China is compliant with U.S. law by the end of the year, officials cautioned.
China had previously denied U.S. regulators routine access to companies’ audit working papers on the grounds of national security. In a departure from what officials have said previously, the Chinese stock regulator said on Friday that audit working papers generally do not contain state secrets, individual privacy, companies’ vast user data or other sensitive information.
While both sides used optimistic language to describe the agreement, the two nations appeared to differ on what the agreement said about the detailed process for U.S. regulators to inspect Chinese audits. Officials from the U.S. Public Company Accounting Oversight Board and the U.S. Securities and Exchange Commission said they agreed with their Chinese counterparts to not make the language of the deal public.
One point that remained unclear was whether U.S. regulators would be able to conduct their investigations without Chinese officials present.
Calling the agreement a “first step” forward, the PCAOB said China granted the regulators “complete access to the audit work papers, audit personnel, and other information we need to inspect and investigate any firm we choose, with no loopholes and no exceptions.”
“The real test will be whether the words agreed to on paper translate into complete access in practice,” according to the statement from PCAOB’s chairwoman Erica Williams.
The PCAOB said complete access would mean U.S. regulators will be able to interview and take testimony from “all personnel associated with the audits the PCAOB inspects or investigates.”
The Chinese side, calling the agreement an important step “in addressing the shared concern of auditing cooperation,” emphasized that the U.S. regulators would only conduct inspections with the assistance of the Chinese. The U.S. regulators will also have to communicate with the Chinese counterparts about their plans before the investigations, the statement from China said.
That appeared to clash with PCAOB’s statement, which said: “The PCAOB has sole discretion to select the firms, audit engagements and potential violations it inspects and investigates—without consultation with, nor input from, Chinese authorities.”
The Chinese statement said the assistance from the Chinese regulators would also involve Hong Kong-based accounting firms that have audit data storage in mainland China, suggesting that U.S.-listed Chinese companies and their accounting firms might have to transfer their audit working papers and other data from mainland China to Hong Kong.
According to PCAOB and SEC officials, the reason the agreement involves transferring working papers from mainland China to Hong Kong is because Hong Kong’s Covid-19 protocols make it easier for PCAOB inspectors to get in. Quarantine times to enter some Chinese cities would make it difficult to complete inspections in time.
The agreement was signed by the PCAOB, the Chinese Securities Regulatory Commission and China’s Ministry of Finance.
More than 200 U.S.-listed Chinese companies are facing the prospect of being booted off American stock exchanges starting in early 2024, if their auditors can’t be inspected by the PCAOB for three consecutive years. Around 160 companies—including Alibaba Group Holding Ltd. , JD.com, and Baidu Inc. —have so far been identified as noncompliant with the Holding Foreign Companies Accountable Act, which took effect last year.
There were 261 Chinese companies listed in the U.S. with a combined market value of roughly $1.3 trillion as of March this year, according to the U.S.-China Economic and Security Review Commission.
“This agreement will be meaningful only if the PCAOB actually can inspect and investigate completely audit firms in China. If it cannot, roughly 200 China-based issuers will face prohibitions on trading of their securities in the U.S. if they continue to use those audit firms,” said SEC Chairman Gary Gensler in a statement Friday.
The U.S. delisting threat has been a major drag on the shares of Alibaba, Baidu and many other Chinese companies. American depositary receipts for Alibaba, JD.com and Pinduoduo Inc. were all up more than 8% in Friday morning trading after the deal was announced. The Nasdaq Golden Dragon China Index, which includes dozens of U.S.-listed Chinese companies’ American depositary receipts, was up more than 6%.
In anticipation of the potential delisting from U.S. bourses, some Chinese companies have pursued alternative or primary listings in Hong Kong. Earlier this month, five Chinese state-owned companies said they would delist their American depositary shares by early September.
Regulators in the U.S. and China in the past decade had repeatedly attempted to resolve the audit deadlock. Following a brief breakthrough in 2013 when China allowed the PCAOB to inspect the audit work of four Chinese companies that were being investigated, ensuing negotiations on broader inspection fell through.
Talks broke down at one point in 2015 after China refused to let U.S. authorities inspect the audit papers of Alibaba and Baidu, two of the most valuable U.S.-listed Chinese companies. Washington also found Chinese authorities’ subsequent proposals unacceptable, including conducting investigations in the presence of Chinese officials and redacting information that U.S. regulators deem necessary.
Part of the urgency in reaching a deal stems from a proposal in Congress to accelerate the deadline for China to comply from three years to one.
Sen. John Kennedy (R., La.), one of the sponsors of the HFCAA, on Friday reiterated his call for an earlier deadline to protect American investors. “It’s not time to give China any benefit of the doubt,” Mr. Kennedy said.
—Jing Yang contributed to this article.
Write to Keith Zhai at keith.zhai@wsj.com, Paul Kiernan at paul.kiernan@wsj.com and Michelle Chan at michelle.chan@wsj.com
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