Back in business: Why China is willing to cooperate on US stock audits

Authorities in the United States and China hit pause on their countries’ financial decoupling last month when they reached a deal that could save many Chinese companies from being booted off the U.S. stock exchange. 

By allowing U.S. regulators to inspect the Chinese companies’ audit data, Beijing not only helped its struggling private sector dodge disaster, but also delivered a tentative victory for international cooperation. Yet long-term forces driving the two economies apart remain powerful, experts say.

Since the Trump administration, both Washington and Beijing have cited security concerns in ordering big Chinese companies to decamp from Wall Street, and some companies may still leave voluntarily to avoid U.S. scrutiny of their data. Yet the agreement underscores that, even amid discord, cooperation is possible.

Why was the U.S. preparing to delist Chinese companies in the first place?

American financial regulators must inspect audits of Wall Street-listed companies to increase confidence in their financial data and protect investors. But for years, Beijing barred such inspections of audit firms in China and Hong Kong, citing national security concerns. All other governments whose companies list on U.S. exchanges accept the inspections, mandated by U.S. law.

In 2020, amid a U.S.-China trade war, worsening relations, and an accounting scandal involving China’s biggest coffee chain that defrauded investors of more than $300 million, Congress toughened the law by passing the Holding Foreign Companies Accountable Act (HFCAA) with broad bipartisan support. Under it, companies faced delisting if U.S. regulators couldn’t “inspect or investigate completely” the firms that audited them for three consecutive years. This put more than 200 Chinese companies at risk for delisting in 2024, hurting investor confidence and steeply lowering the value of Chinese firms on U.S. exchanges.

Facing the threat of losing access to U.S. capital markets, Beijing announced an Aug. 26 deal that would allow U.S. regulators to inspect the paperwork of China-based auditors, mainly big public accounting firms.

The agreement marks “an important step forward by regulators in China and the U.S. towards resolving the audit oversight issue … and lays the foundation for proactive, professional and pragmatic cooperation of the next stage,” the China Securities Regulatory Commission said in a statement.

What led to the breakthrough agreement, and will it work?

After a decade of negotiations, China likely made concessions to grant American regulators access to help buoy its U.S.-traded firms amid a broader push to bolster the country’s private sector and sagging economy, experts say.

“The U.S. markets are the deepest and most liquid pools of capital in the world right now,” says Jason Elder, a corporate finance partner at the law firm Mayer Brown LLP in Hong Kong. “So having access to those markets and that investor base … is valuable for global companies, including Chinese companies.”

Still, questions remain about whether China will fully implement the agreement, as official statements by both sides suggest they interpret key points differently. U.S. regulators with the Public Company Accounting Oversight Board, a nonprofit corporation established by Congress to oversee audits, arrive in Hong Kong this month to begin their work, reportedly starting with the books of e-commerce giants Alibaba Group Holding and JD.com Inc., among others.

“Access to U.S. capital markets is a privilege, not a right,” says Erica Y. Williams, chair of the nonprofit Public Company Accounting Oversight Board, in a statement on the deal. “Now we will find out whether those promises hold up.”

Some analysts suggest China will comply only partially with the U.S. rules, leading some companies to delist and others to stay, analysts say. Big, state-owned Chinese firms – with significant volumes of data and closer government connections – may be more likely to depart Wall Street for Hong Kong, says Hung Tran, senior fellow at the Atlantic Council, a U.S. think tank. Other smaller companies with less sensitive information could choose to stay.

“I think eventually there will be a split approach,” says Mr. Tran. “Large state-owned enterprises probably will be delisting voluntarily,” he says, similar to five such Chinese firms that quit U.S. exchanges just before the August deal. “They may have too much sensitive information to risk being disclosed to the U.S. authorities.”

Does this agreement signal a departure from the trend of financial and economic decoupling between China and the U.S.?

As Washington presses ahead with requiring Chinese companies to comply with U.S. law, the arena for financial engagement will remain, but may shrink if China’s security concerns prevail, experts say.

“Going forward, will our markets include China-based issuers? That still is up to our counterparts in China,” said U.S. Securities and Exchange Commission Chair Gary Gensler in a statement on the agreement.

Fundamentally, the tension between the two countries is rooted in the conflicting priorities of free-flowing capital and national security. It is unlikely to dissipate as geopolitical strains increase, experts say. In fact, it could worsen if the agreement falls apart, as did a similar pact in 2013, they say.

On one hand, China is eager to remain “a global player in the international capital markets,” which requires “strong linkages between the U.S. and Chinese economies,” says Mr. Elder.

Meanwhile, however, Beijing aspires to become an alternative financial powerhouse that sets its own rules, says Mr. Tran. “At the end of the day … China is trying to develop their financial system and markets to attract capital inflow and investment but on their terms and less subject to U.S. law,” he says.