U.S. securities regulators reached a deal Friday with their Chinese counterparts to inspect the books of Chinese companies listed on American stock exchanges.
The deal could open the door for major Chinese companies like Alibaba Holding Group Ltd. BABA, -1.20% and JD.com Inc. JD, -1.22% to continue to raise capital from U.S. investors, though officials warned that this is only the beginning of a long process of ensuring compliance with new laws that require foreign firms to follow the same accounting regulations as their U.S. peers.
“While important, this framework is merely the first step in the process,” Securities and Exchange Commission Chairman Gary Gensler said Friday of the agreement, which empowers the U.S. Public Company Accounting Oversight Board to travel to China to inspect the records of Chinese auditors.
“This agreement will be meaningful only if the PCAOB actually can inspect and investigate completely audit firms in China,” Gensler added, in a statement. “If it cannot, roughly 200 China-based issuers will face prohibitions on trading of the securities in the U.S. if they continue to use those audit firms.”
The Holding Foreign Companies Accountable Act, passed unanimously by Congress in 2020 and signed into law by President Trump, prohibits trading an issuer’s stock unless the PCAOB is allowed by foreign jurisdictions to oversee their audits.
The law applies to all foreign companies, but is directed at China, the only country at that point which had failed to reach an agreement with U.S. regulators allowing the audit process that was required by the 2002 Sarbanes-Oxley Act, passed into law in the wake of the Enron and WorldCom accounting scandals.
After three years of noncompliance, the law requires U.S. exchanges to delist an issuers stock, and Gensler has said previously that the three-year clock began ticking in 2021.
The deal with China is not materially different than the agreements the U.S. has with other foreign jurisdictions, though it is more prescriptive, to ensure that China is unable to find ways to obstruct analysis of audit papers, SEC officials told reporters.
Earlier this month, several leading Chinese companies including PetroChina Co. Ltd PTR, -0.46% and China Life Insurance LFC, -1.99% announced they were voluntarily delisting from the New York Stock Exchange, but SEC officials said that even companies that have voluntarily delisted will be subject to enhanced scrutiny because they availed themselves of U.S. capital markets in prior years.
The deal comes during a period of significant economic stress in China, where the economy has been weighed down in recent quarters by declining real estate prices and funding stresses in the property sector.
As interest rates rise in the U.S. and elsewhere, China has also experienced “unprecedented’ outflows of capital from the country, according to a recent analysis by the Institute of International Finance. The deal could therefore provide a boon to Chinese companies who could benefit from foreign investment.
The Holding Foreign Companies Accountable Act also requires regulators to determine whether a foreign company listed in the U.S. is “owned or controlled by a foreign government.” That determination will be made separately from the PBAOC’s analysis of whether Chinese auditors are complying with transparency requirements, SEC officials said.