Auditing Takes Center Stage, Especially in China

Spread the love


The world of financial auditing is rarely the center of attention. In fact, most auditors operate under the simple premise that no news is good news. In China, auditing is at the center of a major problem for real estate developers and the China-focused stock markets in Shanghai and Hong Kong.

Auditors are required for any company raising capital on public debt or equity markets anywhere in the world. The auditor’s role is to double-check and confirm the financial statements of companies. Unglamorous and conflictual by definition, the work consists of verifying receipts, cash balances, and vendors to ensure the financial statements of companies present a fair and accurate picture of the corporate finances. Despite the nature of the work, it is vital to maintaining confidence in capital markets and that information transparency.

Last week, Chinese real estate developers were thrown into deep disarray when one of the major auditors PWC, previously PriceWaterHouseCoopers, announced their resignation as auditor from a significant number of real estate developers and announced plans to exit real estate developer auditing completely. This has caused many developers to delay their annual statements and face delisting until they bring their financial statements into compliance.

PWC did not resign because they have concerns about ethics but rather concerns about the legal and financial risk associated with being the auditor of record for firms facing bankruptcy. There are already examples of risk to auditors such as when Evergrande announced $2 billion in declared cash was seized by banks that was not reported as secured to guarantee a debt. We do not know whether Evergrande withheld this information or whether PWC omitted it from audit records, but PWC felt increasingly uncomfortable being the auditor of record for so many firms facing bankruptcy. 

Epoch Times Photo
A worker pushes a cart in front of a sign showing Evergrande Group’s China operation at a housing complex by the property developer in Beijing on Dec. 8, 2021. (Noel Celis/AFP via Getty Images)

The problem firms face is not simply their auditors walking away but that due to stock market rules, they will be delisted until they become compliant. Here is where it gets a little tricky.

Delisting from a stock market may sound like a punishment but watching how China routinely shuts down financial markets, whether in domestic stocks or foreign commodities trading at the London Metals Exchange, this seems like a preferred route for both firms and Chinese regulators. For a firm on the edge, being delisted for one to two years with little pressure from litigious securities lawyers or regulators pushing hard, this may be more welcome than feared.

There are two specific classes of stakeholders here that should be considered. First, what about the shareholders? For the most part, there is little that they can do. Trading is effectively frozen once they are delisted and definitely at anything close to the historical market price. With little or no recourse through the courts and the government actively warning institutional investors to not do anything, the shareholders are effectively stuck. This is the risk of investing in China. 

Second, the regulators and central planners in Beijing however are likely happy at the trading shut down. With an economy highly dependent on credit flows to boost real estate development and broader economic activity, they likely are not shedding tears at the end of public financial reports and auditors poking around such risky firms. If history is any guide, Beijing is likely to use a couple of shutdowns to sell off some firms to bigger and less bad developers.

There is a lesson here. China prides itself in having the trappings of an advanced market and economy. It woos the world’s largest banks promising them a slice of the vast Chinese market for help pressuring their home market to ease up on pressuring China. The reality however is that no one, not even the auditor really knows what is in a Chinese financial statement and that there is effectively no legal recourse. That is the fundamental story of Chinese firms and economy reliant on state favor, questionable data, and no rule of law. 

Warren Buffet once notably said that only when the tide goes out do you see who has been swimming naked. Investors overlooked a lot of problems for years when Chinese real estate was booming. Now that the tide is heading out, financial statements and rule of law matter.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.

Christopher Balding

Follow

Christopher Balding was a professor at the Fulbright University Vietnam and the HSBC Business School of Peking University Graduate School. He specializes in the Chinese economy, financial markets, and technology. A senior fellow at the Henry Jackson Society, he lived in China and Vietnam for more than a decade before relocating to the United States.



Source link

Leave a Reply

Your email address will not be published.

This site uses Akismet to reduce spam. Learn how your comment data is processed.