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U.S.-China audit agreement ‘a major catalyst,' expert explains

Beijing offered a rare concession Friday, agreeing to allow U.S. accounting regulators to examine the audits of Chinese firms listed on American stock exchanges.

Major Chinese companies such as Alibaba and Baidu may be rewarded in return, as investors “see a re-valuation of” some of the largest tech names, according to KraneShares Chief Investment Officer Brendan Ahern, who manages the KraneShares CSI China Internet ETF (KWEB).

“The agreement is a major catalyst — it’s a major first step,” Ahern said on Yahoo Finance Live (video above). “The securities that we hold within KWEB are at half [price to earnings ratio], half the peg ratio relative to US internet companies. We should see a bit of re-rating there.”

The agreement between the Public Company Accounting Oversight Board (PCAOB) and China Securities Regulatory Commission (CSRC) establishes a framework for PCAOB inspectors to travel to mainland China and Hong Kong to investigate China-based audits of firms listed in the U.S. In a statement, SEC Chairman Gary Gensler said he expected inspectors to be on the ground by mid-September to begin their investigation.

“The proof will be in the pudding. While important, this framework is merely a step in the process,” Gensler said. “This agreement will be meaningful only if the PCAOB actually can inspect and investigate completely audit firms in China."

The landmark deal momentarily removes an overhang that has clouded the outlook of Chinese firms traded in the U.S. for years. The SEC requires foreign companies to adhere to PCAOB inspections and investigations of its audits. While “more than 50 jurisdictions have complied with the requirements” according to the SEC, China and Hong Kong have remained the outliers.

Chinese and U.S. flags flutter outside the building of an American company in Beijing, China, January 21, 2021. REUTERS/Tingshu Wang
Chinese and U.S. flags flutter outside the building of an American company in Beijing, China, January 21, 2021. REUTERS/Tingshu Wang

Chinese regulators have long maintained concerns about state secrets being shared in the process, but that has only heightened the pressure to comply in the US.

Since Congress passed the Holding Foreign Companies Accountable Act (HFCAA) last year, the SEC has identified roughly 200 US-listed Chinese firms that have yet to comply with PCAOB’s accounting standards, including Alibaba (BABA), Baidu (BIDU), and JD.com (JD). The firms now face the threat of delisting, if they don’t comply within three years.

“The vast majority of the 200 plus names listed, particularly large cap companies, the mid cap companies are audited by the China arms of the big four U.S. accounting firms. So the audit quality is not the question,” Ahern said. “Being able to adhere to this global standard, the great work of the PCAOB should not be a big deal.”

Many Chinese firms have already begun the move out of American exchanges.

Earlier this month, five of the largest state-owned enterprises, long considered among the most sensitive in terms of any audit paperwork, all disclosed intentions to delist on the same day. That led to speculation that a deal between regulators in both countries was imminent.

A resident, wearing a face mask following the coronavirus disease (COVID-19) outbreak, walks past a JD.com advertisement for the
A resident, wearing a face mask following the coronavirus disease (COVID-19) outbreak, walks past a JD.com advertisement for the "618" shopping festival displayed outside a shopping mall in Beijing, China June 14, 2022. REUTERS/Carlos Garcia Rawlins

Meanwhile, large tech firms including JD.com and NetEase (NTES) have sought secondary listings in Hong Kong, amid concerns about US regulatory pressure. This month, Alibaba’s Hong Kong-listed shares jumped on news that the Hong Kong Exchange had approved e-commerce giant’s application to seek out primary listing there.

Ahern said the listings have allowed companies to tap into the southbound Stock Connect, which allows Chinese investors to buy Hong Kong listed stocks.

The deal announced Friday is likely to provide an additional boost to major Chinese internet stocks that have traded at what Ahern described as a “significant valuation discount” because of the threat of delisting.

He added active emerging market mutual funds have a 2$ underweight to China, largely because investors have been hesitant to buy with the regulatory cloud hanging over them.

“Ultimately the Hong Kong listing along with the US listing allows companies to increase their market capitalization," Ahern said. “It allows them to have their cake and eat it too. I think it’s more of a net positive that the companies can be in the US, the largest capital market in the world, but also be listed in their backyard.”

Akiko Fujita is an anchor and reporter for Yahoo Finance. Follow her on Twitter @AkikoFujita

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