Beijing has very clear ambitions for their financial markets; they want to open up the country’s financial sector and transform Shanghai into a dominant international financial centre.

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Fund Managers and Regulators know that the landscape of the new developments in Beijing will affect the relative attractiveness of all other markets.

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Fearful of being left out of the People’s Republic of China (PRC) listing boom, the regional stock exchanges are competing heavily to attract PRC companies to list despite knowing that the quality PRC companies are likely to remain listed in Shanghai.

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The Stock Exchange of Hong Kong Ltd has released a consultation paper to seek the market’s views on proposals to allow PRC issuers in Hong Kong to use Mainland accounting standards for their financial statements and to be audited by Mainland audit firms.

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What this translates into is that these PRC companies would not be required to use Hong Kong accounting rules or a Hong Kong auditor despite being listed in Hong Kong.

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The basis for the reform is that an “increasing number of jurisdictions have adopted or are converging their national accounting standards to International Financial Reporting Standards (IFRS).

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Hong Kong Financial Reporting Standards (HKFRS) became fully converged with IFRS in the beginning of 2005 and the International Accounting Standards Board (IASB) indicates that more than 100 countries require, permit the use of, or have a policy of convergence with, IFRS”.

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These countries include the world’s major stock markets in Europe, Britain and the US.

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The consultation paper refers that in February 2006, the Finance Ministry announced the implementation of new Mainland accounting standards that brought substantial convergence between Mainland accounting standards and IFRS.

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With effect from Jan 1, 2007, all companies incorporated and listed on the Mainland stock exchanges must apply the new Mainland accounting standards.

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At the end of the year in 2007, the China Auditing Standards Board and the Hong Kong Institute of Certified Public Accountants signed a joint declaration on the convergence of Mainland auditing standards with Hong Kong auditing standards.

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They similarly declared their commitment to maintain convergence of their auditing standards on an on-going basis.

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In view of the joint declarations between the Mainland and Hong Kong, regulators in both jurisdictions have agreed to explore and develop a framework to facilitate acceptance of financial reports prepared under accounting standards and audited under auditing standards of one jurisdiction for listing in the other jurisdiction.

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The Hong Kong Exchanges and Clearing Ltd issued a press release on Aug 28 this year which states the following: “Implementation of the proposed framework should reduce compliance costs for Mainland incorporated issuers.

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“It should also promote more timely disclosure of information to investors and increase market efficiency”.

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And further: “If the proposed framework is implemented, the Mainland would operate a parallel scheme as a reciprocal arrangement. The Mainland scheme would be applicable to Mainland listings of companies incorporated or registered in Hong Kong that prepare financial statements using HKFRS, or IFRS and audited by Hong Kong audit firms using Hong Kong Standards on Auditing or International Standards on Auditing.”

The investment community has to respond to the consultation by Oct 23 this year and the proposal is that the scheme will start on Jan 1 next year.

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Institutional shareholders and in fact, all investors need to be extremely mindful on the financial reporting standard details.

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The more astute investment community has already commented in dialogue sessions that the requirements for segmental disclosure appear insufficient, and for certain sectors, such as banking and insurance, PRC accounting standards still seem to lack the requirement to disclose many pieces of pertinent information.

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Furthermore, investors are not assured whether the Hong Kong regulators would have the authority to investigate or take any action into the irregularities of accounting and financial reporting if this new proposal took effect.

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International investors go on to question:

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●  if there will be sufficient investor protection?

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●  why would compliance costs be reduced just by using Mainland accounting and audit standards?

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●  if information disclosure is likely to be in a more timely manner?

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There have been suggestions that there should be two sets of results being reported, as each set will provide complementary information to the other set.

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The downside to this is of course, going to be the costs involved and we are not sure that producing two sets of accounts would serve issuers or investors well.

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As a fund manager, we have some general concerns, particularly about potentially watered down disclosure requirements under PRC accounting standards which would make it even more difficult for investors to assess risks. We are also questioning whether the effectiveness of internal controls, which ensure proper financial reporting, can be ensured under the proposals.

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Finally, given the growing number of PRC issuers potentially listed on the HKSE and in the region, we are of the view that the proposals may lead to a decline in financial reporting standards, and increase the risks that investors face.

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The questions regarding the auditor and oversight/enforcement by the regulators are more significant than the underlying rules, provided the Mainland standards have converged to a large extent.