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Can Asean avoid the US-China regulatory feud?

Thailand's Stock Exchange recently announced it will change its rules to allow listings by foreign firms and "aggressively" seek those from China and other "developed markets". Singapore Exchange has also created a framework for listing companies registered in China.

As Thailand and other Asean member nations seek to attract more China-based companies, they would do well to avoid the bitter fight of the past two years between US and Chinese capital market regulators.

In January, the US Securities and Exchange Commission (SEC) moved closer toward forcing China-based accounting firms to assist its investigations of potential reporting and accounting misconduct by Chinese companies that are listed on American exchanges.

The accounting firms have claimed that complying with the US SEC's demands would put them in violation of Chinese secrecy laws and explicit directions from the China Securities Regulatory Commission (CSRC).

Consequently, more than 400 China-based companies listed on US exchanges, with a combined market capitalisation of $185 billion (Bt6 trillion), risk having to find new auditors or face delisting. This dispute has created uncertainty for issuers and their investors.

The US SEC has been investigating possible financial reporting and accounting fraud against US investors by dozens of China-based US-listed companies, but has not been able to test the quality of the audits against the audit working papers in possession of China-based auditors. The China-based auditors have refused to cooperate because they have been told by the CSRC that cooperation with the SEC will likely result in severe criminal penalties being imposed on them in China.

The CSRC also has stated that the 2002 memorandum of understanding concerning cooperation between securities commissions (under the umbrella of the International Organisation of Securities Commissions, IOSCO), to which both the US SEC and the CSRC are signatories, is not legally binding and does not require exchange of information if violation of Chinese law would result.

The dispute is not specific to the US and China.

Since 2012, the Hong Kong securities regulator has been fighting Ernst & Young Hong Kong for access to documents prepared by its mainland joint-venture partner in support of a Chinese company's Hong Kong listing application.

For its part, the US SEC has refused to accept limitations on its ability to protect investors' interests while facilitating capital formation.

Recent outcomes in US courts bolster the SEC's position. Through a civil court action in the United States filed in September 2011, the SEC sought to force the accounting firm Deloitte's Mainland China affiliate (Deloitte Touche Tohmatsu CPA) to provide audit working papers. In 2012, it also sought to bar the Chinese affiliates of the "Big Four" accounting firms from participating in audits for US-listed companies because of their failure to produce audit working papers to the US SEC.

It was widely expected that the issue would be resolved diplomatically. It was, but only in part.

In January, the US SEC and Deloitte Touche Tohmatsu CPA filed a joint motion to dismiss the civil court action because a "substantial volume" of requested documents in relation to one China-based company was produced as a result of a case-specific deal reached between the US and Chinese governments during the Strategic and Economic Dialogue held in July 2013.

But there was no diplomatic resolution of the US SEC's administrative proceedings against the Chinese affiliates of the Big Four accounting firms.

In fact, that fight escalated in January when a US administrative law judge barred the China-based accounting firms from participating in audits of US-listed companies for six months.

In February, both the sanctioned firms and the SEC appealed the decision. The CSRC has warned the US of "consequences" and expressed disappointment considering the "big picture of China-US regulatory co-operation".

For now, the US SEC seems to have the edge as the cases go through the judicial process.

But one sign of a renewed diplomatic effort came from recent comments by the chairman of the US overseer of auditors of US-listed companies (the Public Company Accounting Oversight Board), who referred to a possible agreement with China in 2014.

A diplomatic approach that pre-empts such disputes and the resulting uncertainty is preferable and also in the interest of the Asean members seeking to attract the listings of China-based companies and their future investors.

This fight between the US and Chinese capital market regulators over the listing country's extraterritorial application of investigation and enforcement powers when they conflict with the issuer's home jurisdiction shows the potential challenges for regulators in Asean to effectively supervise and enforce their disclosure rules and investigate reporting and accounting fraud at foreign-based issuers. It also shows the real risks to maintaining investor confidence in certain foreign-based companies.

Asean recently reaffirmed its commitment to creating an economic community by 2015, greater capital market integration and enhanced cross-border access to investors and issuers. The six countries that participate in the Asean Exchanges collaboration have a formidable combined market capitalisation of US$2 trillion and offer more than 3,000 listed companies.

Asean members and China share a clear interest in developing access to Asean's capital markets by issuers and investors alike. As they have made investor protection a key part of this development, they should seek to resolve these potentially thorny regulatory issues before they lead to disputes.

The resolution should guarantee the listing country's full use of its regulatory toolkit as extended through the IOSCO cooperation mechanism. Five of 10 Asean countries are full signatories, including Thailand, Malaysia and Singapore, whose exchanges are connected through the Asean Trading Link.

The protection of investors against reporting and accounting fraud at foreign-based issuers and the maintaining of investor confidence will be vital if Asean's capital markets are to achieve sustainable growth.

Karin Zarifi is an independent consultant to the Securities and Exchange Commission Thailand and formerly a lawyer with the Enforcement Division of the UK Financial Services Authority (now UK Financial Conduct Authority). The personal views expressed herein do not reflect or represent the SEC Thailand.


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