DiDi's stumbling debut on the American stock markets highlights a long-running, transnational battle that hasn't drawn much attention outside the green-eyeshade set — but could prove critical for Chinese companies seeking to tap U.S. capital markets and American investors hoping to bet on the growth of China's tech sector.
For years, regulators have sought more and better financial data on Chinese companies. The Sarbanes-Oxley Act of 2002 requires the Public Company Accounting Oversight Board, a nonprofit overseen by the Securities and Exchange Commission, to review the work of firms auditing public companies. But China has not allowed this to happen, American officials say.
Much is at stake. Chinese companies that trade on U.S. exchanges via American depositary shares are worth nearly $1.8 trillion. Chinese firms have raised more than $76 billion over the last decade, and 37 companies have listed in the U.S. this year alone, raising $12.9 billion, according to Bloomberg data.
While Chinese companies listing in the U.S. have auditors, they are often based overseas. What standards do they meet? The PCAOB, whose budget and standards are set by the SEC, doesn't know, since it hasn't been able to inspect any auditor's work in China satisfactorily since 2007.
Concerns about the quality of audits aren't theoretical: Sound financial reporting undergirds the safety of American stock markets — the liquidity and high reputation Chinese companies have pursued by listing their shares abroad. Luckin Coffee, which listed its shares on the Nasdaq in May 2019, paid a $180 million fine to the SEC in December to settle charges it fabricated $300 million in revenue.
Many auditors in China lack strong incentives to provide accurate audits of companies, said Anne Stevenson-Yang, co-founder and research director at J Capital Research. "The auditors are paid by companies they audit," she said. "Of course they have a disincentive to say negative things."
American securities regulators have complained about the lack of access to Chinese audits going back a decade or more. But things came to a boil in December, when President Donald Trump signed the Holding Foreign Companies Accountable Act.
That law requires the SEC delist publicly-traded companies that hire accounting firms the PCAOB cannot oversee, after the accounting board has been unable to inspect the firms' work for three consecutive years. That would affect DiDi and a number of other Chinese companies, though not until 2024 at the earliest. DiDi warned investors in its prospectus about potential delisting under the act if the PCAOB can't inspect it.
The bill also requires additional disclosures in SEC filings, including any ownership by government entities and the presence of Chinese Communist Party officials on a company's board.
In March, the PCAOB revealed that it lacked access to audits of more than 200 companies based in China and Hong Kong.
But Beijing wants Chinese companies to tighten up disclosures of information to entities abroad. The new Data Security Law passed in June bans companies from sharing information to overseas law enforcement and regulators without approval. And following the DiDi debacle, Chinese securities regulators are considering a change that would allow them to block a Chinese company from listing overseas — even if it's technically incorporated outside of China using a structure known as a variable interest entity, or VIE. DiDi used a VIE called Xiaoju Kuaizhi to go public; Alibaba, the most valuable Chinese tech company traded in the U.S., listed shares using a VIE; and the structure's use by Chinese tech firms dates back to Sina Corp's listing on the Nasdaq in 2000.
Congress could go further in restricting Chinese listings. In May, Sens. Marco Rubio and Bob Casey introduced a bill to prohibit IPOs on U.S. exchanges for Chinese companies not complying with U.S. regulations, specifically citing lack of PCAOB access to audits as an issue that would block a listing and citing the Luckin fraud incident. In June, Rubio called for the SEC to block the IPO of DiDi because it did not have the same auditing oversight of U.S. companies.
This impasse has stretched on for years. In 2011, Chinese and American regulators met for a symposium on audit cooperation, and the next year, China agreed to "observational visits" by the PCAOB. In 2013, the PCAOB signed a memorandum of understanding with Chinese officials.
The board now says the 2013 MOU isn't helping. "Chinese cooperation has not been sufficient for the PCAOB to obtain timely access to relevant documents and testimony necessary to carry out our mission," it writes.
For its part, the China Securities Regulatory Commission said in August, in response to a U.S. government report, that it's been "showing full sincerity of cooperation."
"It should be noted that the Chinese side has never prohibited or prevented relevant accounting firms from providing audit working papers to overseas regulators," Chinese officials wrote. The agency said in December that the Holding Foreign Companies Accountable Act's disclosure provisions were "obviously discriminatory."
In January, the NYSE was caught in a crossfire from Trump administration officials over delisting three Chinese companies: China Telecom, China Mobile and China Unicom. While that debate was over purported connections to the Chinese military, it highlighted the growing geopolitical risks of cross-border listings.
Beijing wants to maintain as much control of Chinese companies as possible and deems audit records state secrets, said Stevenson-Yang of J Capital.
Initially, gaining lucrative access to capital markets appealed to Beijing, but when capital started to flow outwards in 2015, everything changed, she said. "As money became more demanding, Chinese authorities said, 'We can get money within China. Why don't we do that instead?'"