By Shang-Jin Wei
NEW YORK ( Project Syndicate ) — After passing unanimously in the U.S. Senate on May 20, the Holding Foreign Companies Accountable Act is heading for the House of Representatives, and President Donald Trump is expected to sign it into law.
The law would require that all companies listed on U.S. stock exchanges submit to audits reviewable by the U.S. Public Company Accounting Oversight Board (PCAOB), and noncompliant firms could be delisted after three years. This has generated talk that all Chinese firms could disappear from US exchanges.
Some observers might question the wisdom of such legislation, on the grounds that it could hurt returns on U.S. household savings, financial-sector profits, and the global competitiveness of U..S stock exchanges.
With legislation that would force all Chinese firms listed on US stock exchanges to submit to the same regulatory oversight as American firms, US policymakers are calling China’s bluff. Far from confirming fears of a widespread delisting of Chinese firms, the law will likely improve the investment environment.
While these are legitimate concerns, a U.S. threat to delist Chinese firms could be worth the risk, leading not only to more credible disclosures, but also, perhaps surprisingly, to more listings by high-quality Chinese private-sector firms.
Truthful disclosure and severe punishment for noncompliance constitute the bedrock of sound capital-market governance. The U.S. applies the same criteria to all firms that seek a listing on a U.S. stock exchange, and oversight by the PCAOB is a key element of enforcing the rules.
When a listed firm makes a questionable disclosure, the PCAOB reserves the right under the 2002 Sarbanes-Oxley Act to inspect the underlying accounting documents of its auditing firm. If deficiencies are found, the auditing firm must amend its report and take steps to improve its procedures and practices. This enhances investors’ confidence in the listed firms’ disclosures.
But the Sarbanes-Oxley Act does not apply to other countries, some of which have laws or regulations that prohibit local auditing firms from turning over accounting documents to foreign regulators like the PCAOB. China is one of those countries. Belgium and France also make it difficult for the PCAOB to audit their local auditing firms, but the PCAOB expects to be able to resolve the access problem by negotiation.
There are about 150 U.S.-listed firms that are headquartered or operate principally in China. A few are majority state-owned — including China Life /zigman2/quotes/206573290/composite LFC -2.42% , PetroChina /zigman2/quotes/205108732/composite PTR -2.54% , China Telecom /zigman2/quotes/200463528/composite CHA -2.46% , China Unicom /zigman2/quotes/205476740/composite CHU -1.46% , and China Eastern Airlines /zigman2/quotes/205483076/composite CEA -3.88% — but around 90% of them are private-sector firms. Among these are dynamic and highly profitable companies such as Alibaba /zigman2/quotes/201948298/composite BABA -0.33% , Baidu /zigman2/quotes/209050136/composite BIDU -0.05% , and Bilibili /zigman2/quotes/207131615/composite BILI +1.01% .
In the past, the PCAOB has presumably tried to negotiate with Chinese authorities for access to auditors’ work product in China. But trying to compel China to grant such access has not been a policy priority because U.S. stock exchanges, investment banks, and money-management firms like to maximize the U.S. listing of Chinese firms.
After all, over the past 15 years, Chinese firms have dominated global initial public offerings, and U.S. stock exchanges have been competing fiercely with those in London, Singapore, Hong Kong, Shanghai, and Shenzhen for these listings. As the number of IPOs by U.S.-headquartered companies declines steadily (from around 300 per year in the early 1990s to fewer than 100 per year more recently), Chinese companies have become even more attractive to U.S. stock exchanges.
Similarly, U.S. investment banks earn fat commissions by taking firms public, and they have a home-field advantage when those listings occur on a U.S. stock exchange. Indeed, cajoling by U.S. investment banks is the main reason why so many Chinese companies have come to the U.S. in the first place.
And, for their part, money-management firms (or their clients) prefer — or, in some cases, are mandated — to hold U.S.-listed stocks.