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May 23, 2014

EY compelled by court to handover audit work to Hong Kong’s regulator

Hong Kong’s Court of First Instance has ruled today EY should handover the audit work of former China-based client Standard Waters to the city-state’s Securities and Futures Commission (SFC).

Standard Waters, a Mainland China privately-owned company, had applied for listing to the Stock Exchange of Hong Kong (SEHK) in November 2009.

SEHK’s rules require privately-owned companies listed in Hong Kong to have a local Certified Public Accountant (CPA) signing their audit reports.

EY was the reporting accountant and auditor for Standard Waters until March 2010, when it resigned and the Chinese company didn’t proceed further with its listing application.

The SFC requested EY to submit the audit working papers and accounting records of Standard Waters, but the auditor argued these documents were held in its Mainland’s joint venture partner EY Hua Ming office.

EY also maintained it couldn’t produce those documents due to China’s secrecy laws, which wouldn’t allow the auditor to handover state-sensitive information to a foreign regulator.

In a statement EY said it will review carefully the court’s judgment to decide whether or not it appeals the decision. Peking University professor of practice Paul Gillis wrote in his blog that it was questionable whether EY could be the principal accountant as it outsourced the entire audit to EY Hua Ming.

"Instead, the Mainland affiliate should have been the reporting accountant. But that wouldn’t work under Hong Kong rules," Gillis wrote.

Foreign auditors banCoincidentally, the Chinese Ministry of Finance (MOF) has recently launched a consultation aimed at preventing foreign auditors from carrying out the audits of Mainland Chinese companies.

If the proposals are passed into law, Hong Kong and overseas CPA practices would have to partner with one of the top 100 China CPA practices in order to audit overseas-listed Chinese enterprises.

As Gillis pointed out, that is what EY has done regarding Standard Waters.

The proposed rules would also affect overseas-listed companies, irrespective of their place of incorporation, with operating entities in China.

In particular, the proposals could affect the foreign auditors of all red chip and H-share companies that do not engage a local partner firm, according to the Hong Kong Institute of Certified Public Accountants (HKICPA).

Red chip companies are enterprises that are incorporated outside of the Mainland, controlled by Mainland Government entities and listed on the SEHK.

H-share companies are companies incorporated in Mainland China and whose listings in Hong Kong are approved by the China Securities Regulatory Commission.

"The proposals would have far-reaching business and regulatory consequences on the Hong Kong accounting profession and financial market," HKICPA told The Accountant.

The institute added that access to working papers prepared by Mainland CPA firms "would become a bigger issue" in clear reference to Chinese authorities’ reluctance to co-operate with foreign regulators on cross-border audit inspections.

The SFC said at the beginning of the legal proceedings in August 2012 it had consulted the relevant Mainland authorities about access to the documents and that both were "continuing to work closely together in relation to this issue".

Gillis, however, expressed surprise about the lack of cooperation agreements between the SFC and the Chinese regulator, in tune with the one struck by the US Public Company Accounting Oversight Board (PCAOB) and its Chinese counterpart.

"Chinese regulators might have been reluctant to give up any turf for fear that the precedent would work against them with the SEC […] Nevertheless, it seems highly unlikely the SFC will be seeing any Mainland audit working papers," Gillis wrote.

Related storyHong Kong’s regulator takes legal action against E&Y

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