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Hong Kong to adopt independent audit oversight regime

The Hong Kong government has gazetted a proposed reform which if enacted would make the local Financial Reporting Council (FRC) the regulator of auditors of public interest entities (PIEs) in Hong Kong. The Financial Reporting Council (Amendment) Bill 2018 will be introduced to the Legislative Council on 24 January 2018 and is expected to be effective from 1 August 2019.

Professor of practice at Peking University's Guanghua School of Management Paul Gillis explained in a blog post, that this process began in 2014 after the European Union withdrew regulatory equivalency from Hong Kong citing its ineffective system of audit self-regulation.

“Although most members of the profession publicly supported the proposed legislation, privately they have been resisting it, which is why the process has taken so long,” Gillis wrote.

The bill widens the FRC’s existing mandate giving it oversight of the Hong Kong Institute of Certified Public Accountants (HKICPA) which will now have to comply with the FRC’s directions.

The institute will continue to perform statutory functions such as registration, setting requirements and standard setting for ethics, audit and assurance, subject to oversight by the FRC.

However registration of Chinese and Hong Kong firms with the USA regulator, the PCAOB, has been a contentious topic in recent years, as these firms were prohibited to turn over working papers for inspection. There is no suggestions in the current proposals that firms will have to turn over working papers as a condition for registration in Hong Kong.

HKICPA president Eric Tong said that the institute has long supported the aim of having an independent regulator for company audits, and for that role to be taken by the FRC. However, he warned that directing specific actions should not be exercised by the FRC without following a due process that is no less robust than the HKICPA's existing processes such as public consultation.

The HKICPA also voiced some concerns with regards to the governance, oversight powers, funding, sanctioning and the regulation of non-Hong Kong auditors, which they feel the bill doesn’t address.

The crux of the question is the link with mainland China, as Gillis explains: “Hong Kong is likely to win many of the IPOs from China in 2018 (thanks in large part to gutting corporate governance rules that previously sent them to New York). A resolution needs to be reached on regulating Chinese companies listed overseas. The USA has failed, and while Hong Kong has a chance to fix this, I expect they will not.”

While the HKICPA stated that the success of the FRC hinges on having sufficient personnel of quality, it questioned the government’s proposed threefold increase of the FRC’s budget to HK$ 90m (USA$ 11.5m).

“Judging from our own experience in regulation, inspection and discipline, the figure seems very high considering the number of PIE auditors under the purview of FRC. The Government needs to be more forthcoming and transparent with the funding parties, to ensure everybody is comfortable that their respective contribution is reasonable and fair,” the institute stated.

“The CPAB [Canadian regulator] has a budget of C$16.6 million (HK$104 million) and regulates a market half the size of Hong Kong,” Gillis opposed. “To size the budget of FRC comparable to Canada would require HK$225 million). The proposed budget is far too small for the FRC to be an effective regulator and the CICPA pushback on the undersized budget is self-serving and shocking.”

FRC Hong Kong chairman John Poon said: “The FRC is ready to tackle, with adequate resources, any additional challenges that may arise in the new era. This much awaited reform, i.e. from self-regulation to independent oversight, will bring Hong Kong’s auditor regulatory regime in line with other major capital markets worldwide.”

The FRC said that it aims for the reforms to meet the membership requirements of the International Forum of Independent Audit Regulators (IFIAR), achieve regulatory equivalence with the European Commission (EC) and strengthen cooperation with other independent audit regulators globally.

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