Hong Kong could regain some of its luster as a gateway between China and the rest of the world -- for accounting.
The Hang Seng Index rose on Friday after a report that Hong Kong would be the inspection center for the accounts of Chinese companies that want to remain listed in the United States.
The Hong Kong benchmark rose 1.0%, driven by "H share" overseas Chinese stocks. In mainland China, the CSI 300 index opened with a 0.6% advance, though mainland stocks slipped into the red and finished down slightly, with a 0.2% drop.
Securities regulators in Beijing are arranging for U.S.-listed Chinese companies and their mainland accounting firms to transfer their audit working papers from the mainland to Hong Kong, according to The Wall Street Journal.
This would make eminent sense. It would help resolve a standoff between the U.S. Securities and Exchange Commission and Chinese regulators. Chinese law currently bars overseas entities, even the Hong Kong arms of the Big Four accounting firms, from accessing mainland Chinese accounts for fear they will reveal "state secrets."
Easing Securities and Exchange Commission (SEC) access to Hong Kong accounting firms and granting the Hong Kong firms access to Chinese accounts would keep the working papers of Chinese listings on what is technically Chinese soil. It's crazy that, say, PwC in Hong Kong currently can't view the audits compiled by PwC in mainland China. Just let that happen. Hong Kong's advantage is that it still functions according to its own legal system originally based on British law, even though it's a system that is increasingly looking like that in the mainland due to interference from Beijing.
It would sustain Hong Kong's raison d'être -- to be a capitalist, laissez-faire, in-between point between Communist China and the Western world. Hong Kong has been surrendering that role due to the much-detested National Security Law imposed on the city by Beijing and Hong Kong's strict quarantine rules. As quarantine eases, with a three-night hotel stay the current mandate, this new system would be a welcome boost to the economy and the accounting profession at a time my adoptive hometown is losing its way.
The 'secret' sauce
The Chinese Communist Party considers an extremely broad category of data and information to be "state secrets." Even the basic internal operations of state-owned enterprises could be construed as secret machinations if they help overseas observers get a better picture of the real state of the Chinese economy, for instance. It's widely acknowledged that China's Gross Domestic Product figures are heavily massaged, so gaining full access to a utility's inner workings might reveal exactly how much.
Not that the SEC is interested in doing any of that kind of math. It just wants to ensure that Chinese companies provide the same kind of accounting detail that U.S. companies already must provide.
It is overseas-oriented Chinese companies, which are increasingly listing in Hong Kong as well as New York, which would benefit the most from being able to maintain their U.S. stock counters. Chinese tech companies in particular are keen to diversify their shareholder base away from the momentum-driven mainland markets, where access to trading is restricted for foreign investors.
That explains why Hong Kong stocks advanced today while mainland markets are little-moved. There would be no change for companies listed in Shanghai and Shenzhen that have no overseas listings.
Tech companies with U.S. listings may be the trickiest companies for the Chinese leadership to handle. I explained last month that Chinese regulators are reportedly readying a three-tier system for Chinese listings: companies with non-sensitive data; companies with sensitive data; and companies with "secretive" data.
Under that system, non-sensitive companies easily would be allowed to remain listed overseas and "secretive" companies would have to delist. But many tech companies would probably fall in the "sensitive" category, with reams of data on consumers that n aggregate would be useful and valuable. This would be the sticking point, as the SEC says there can be no exceptions to its rules.
Already exiting
Five Chinese state-owned enterprises announced earlier this month that they will delist from U.S. markets. It's considered the first step for Beijing in deciding which companies it is happy to see continue as listed abroad.
The oil giants PetroChina (PTR and HK:0857) and Sinopec (SNP and HK:0386), the Sinopec subsidiary Sinopec Shanghai Petrochemical (SHI and HK:0338) and the world's second-largest aluminum smelter, the Aluminum Corporation of China (ACH and HK:2600), better known as Chalco, said they would voluntarily delist this month, alongside the massive life insurer China Life Insurance (LFC and HK:2628).
Those five companies, all with hefty levels of state ownership, will maintain their listings in Hong Kong and in mainland China. Their U.S. listings should cease to function next month, 10 days after they file to delist.
Those old-time stocks are no great loss to U.S. investors. All five say they have seen very little U.S. trading. But Chinese new-economy companies such as e-commerce giant Alibaba Group Holding (BABA and HK:9988), its rival JD.com (JD and HK:9618) and Web browser operator Baidu (BIDU and HK:9888) would be sorely missed by investors who want to tap the China story"
As it now stands, all U.S.-listed Chinese companies will need to delist from U.S. markets starting in 2024. The SEC has already cited 163 Chinese companies as non-compliant with their accounting and they're given three years to rectify the situation, after which they would be kicked off U.S. exchanges.
The SEC has been concerned for years that its accounting wing, the Public Company Accounting Oversight Board (PCAOB), has no access to the paperwork of Chinese accounting companies. As such, it's unable to vet their work despite a string of accounting scandals among U.S-listed Chinese stocks.
Congress passed the Holding Foreign Companies Accountable Act into law at the end of 2020 as a result. It is not specifically aimed at Chinese companies, requiring all U.S. foreign listings to allow access to their accounts. They will also need to stipulate whether they are owned by a foreign government or national body.
But the new law does have some China-specific stipulations, too. It requires Chinese companies to identify any board members who are also members of the Chinese Communist Party (CCP) and to provide any language written into their company charters that refers to the CCP. The CCP has recently been inserting language into Chinese company charters stating that it is the ultimate authority over the company, able to override decisions made by the management, board or investors.
There's no word on how Beijing will handle those requirements. The situation would be most fraught for state-owned enterprises that appear to be independent but are controlled by the Chinese state. Entirely private-sector companies should have no trouble complying, although it may be a sticking point to identify board members who are Communist Party members.
Still, creating a Hong Kong access point to Chinese accounts would be a good start. Today's rally in the top overseas-oriented Chinese companies should sustain if there's further progress on this front. Alibaba nudged ahead 2.1% in Hong Kong trading today, for instance. But with Alibaba trading down 41% in the last year despite positive business numbers and far from alone in that sort of performance, they could do with some good news.
