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PwC's exit as Kaisa auditor points to more deeply rooted risks

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Six trends shaping the industries and sectors we cover in 2021

Six trends shaping the industries and sectors we cover in 2021

Capital Markets View – January 2021


PwC's exit as Kaisa auditor points to more deeply rooted risks

PricewaterhouseCoopers'resignation asauditor of embattled mainland developer Kaisa Group Holdings Ltd. could be another case in pointhighlighting the potential compliance risk inherent in Chinese companies listedoffshore.

TheShenzhen-based company, which was the first Chinese developer to default on itsU.S. dollar debt in April 2015 and has since been mired in a debt restructuring,announced PwC's departure in a late night filing on Friday, July 15, and saidit hired Grant Thornton as replacement.

Kaisasaid it decided to end the business relationship because PwC was unable tocomplete the audit of its 2014 financial report by September as previouslyagreed, while PwC said it quit because it could not verify the accuracy of thefinancial information provided by Kaisa.

"Itis not very common for auditors to resign. If they do, it's mostly due toconcerns about accounting fraud," a person working for PwC told S&PGlobal Market Intelligence, asking not to be named due to the sensitivity ofthe matter.

Troublesat Kaisa began spilling overat the end of 2014, following the blockedsales in several of its projects and the resignation of ChairmanKwok Ying-shing, who was said to be under investigation for corruption. ThoughKwok returned aschairman in April 2015, his resignation triggered the company's loan defaultand led to the consequent debt crisis.

Tradingin the shares of the Hong Kong-listed mainland developer has been for roughly 16 months sofar, since March 31, 2015, after it failed to publish its financial results for2014.

ThoughKaisa has set a timetable to resume trading in January 2017, it can only do soupon the fulfillmentof five conditions, one of which is the publication of all outstandingfinancial results. If it does not submit the resumption proposal by the end ofthe 18th month of its trading suspension, its listing on the Hong Kong boursewill be canceled.

Additionally,Kaisa's failure to publish the audited financial statement for 2014 on thebourse's website by Dec. 31 would also trigger its bond default, to its debtrestructuringagreement with bondholders.

Newauditor Grant Thornton will have its work cut out for it, according to adispute resolution lawyer that spoke to S&P Global Market Intelligence.

"PwC'sresignation does not necessarily mean that Kaisa has been cooking its books. …But since it raised a number of significant issues in Kaisa's finances, the newauditor will have to investigate and verify those," said Liu Haitao, apartner at King & Wood Mallesons who specializes in commercial litigationand international arbitration.

Dueto the loose and immature regulatory environment in China, many domestic firmshave accounting irregularities, Liu said in an interview. Although very fewcompanies dare fabricate their financial figures, they often exaggerate theirgrowth potential or creatively conceal misconduct that would fall in "greyareas," according to Liu.

"Somepractices are not against the rules in mainland China, but will be brought intothe light when a company is under the supervision of overseas authorities afterthey list in a foreign market," said Liu.

Thoughthere could be incidents of outright fraud, a large portion of financialmisreporting incidents by Chinese firms in overseas markets are because ofignorance about the rules imposed on listed companies, he added.

Nonetheless,this approach has dogged Chinese companies' foreign listings in the past.

In2011 and 2012, more than 100 Chinese firms were delisted or suspended fromtrading at the New York Stock Exchange because of fraud and accountingscandals, with the plunge in share prices wiping out more than US$40 billion ofvalue, accordingto a McKinsey & Co report. Most of them were small-caps that gained accessto the U.S. markets in the previous years through reverse takeovers, a shortcutto listing status that allowed them to bypass the same level of scrutinyinvolved in a traditional IPO.

HongKong, another popular IPO destination for mainland companies, has not seen awave of scandals on a similar scale, but was still hit by some high-profilecases around the same time. For example, during the earnings season in early2012, Deloitte resignedas auditor of two Hong Kong-listed Chinese companies, children's apparel makerBoshiwa International and milk formula producer Daqing Dairy Holdings, whichare both now delisting.

Whilethere have been fewer financial misreporting incidents in recent years, the BigFour accounting firms working with Chinese clients have been on alert, TomFyfe, a partner and the Asia head of dispute resolution at Simmons &Simmons in Hong Kong, said in an interview.

"Ithink they have, for a number of years, been careful about them. They arecertainly alive to the risk and they will deal with it the best they can,"he said.