Cover Story: Cross-Border Cooperation Is Key to Fighting Securities Fraud, CSRC Chief Says
Amid the Covid-19 pandemic and mounting voices of protectionism and deglobalization, the rising tensions between China and the U.S. have cast a cloud over the prospects of U.S.-listed Chinese companies and China’s opening-up of its capital market.
After the financial reporting fraud scandal of Chinese Starbucks challenger Luckin Coffee, U.S. legislators made an issue of cross-border access to audit working papers involving U.S.-listed Chinese companies. The Holding Foreign Companies Accountable Act passed May 20 by the U.S. Senate would prohibit securities of a company from being listed on any U.S. securities exchange if the company fails to comply with the Public Company Accounting Oversight Board’s (PCAOB) audits for three years in a row. There are 247 Chinese companies listed in the U.S. with a total market capitalization of $1.6 trillion, about one-sixth of that of China’s A-share market.
In an exclusive interview with Caixin, Yi Huiman, chairman of the China Securities Regulatory Commission (CSRC), discussed the opening-up of China’s capital market and China-U.S. cross-border regulatory cooperation.
At the 2020 Lujiazui Forum, Chinese Vice Premier Liu He stressed that China will unswervingly deepen restructuring, expand opening-up and accelerate the introduction and implementation of related measures. Under the current circumstances, the pace of opening-up of China’s capital market will continue to accelerate, Yi said. On the other hand, strengthening international regulatory cooperation is an inevitable choice to adapt to the opening of global financial markets and risk prevention, he said. Among them, joint inspection is a common way of international cooperation on audit supervision.
“As long as the U.S. is truly willing to solve the problem, we can surely find a way to cooperate on audit supervision.” Yi said.
The CSRC will learn from global best practices, fully consider the developing stage of China’s capital market ― especially the characteristics of China’s market structure dominated by small and medium-sized investors ― and actively push forward, aiming to be “open, transparent and well regulated,” Yi said.
Hong Kong is irreplaceable as an international financial center, Yi said. China will comprehensively deepen cooperation between the mainland and Hong Kong markets, jointly cope with various external disturbances, risks and challenges, and safeguard Hong Kong’s status as an international financial center, Yi pledged.
Here’s a transcript of the interview:
‘Push forward effective cross-border regulation’
Caixin: Since the Luckin Coffee financial reporting fraud scandal was exposed, Chinese and foreign investors have been wary of Chinese stocks, fearing that if the related problems could not be solved, U.S.-listed Chinese companies could face delisting. What is the CSRC’s view on this issue?
Yi: Cross-border listing is a win-win choice under the environment of capital globalization. Chinese companies choose listing in the U.S., which was originally an important reflection of New York’s role as a global financial center. These listings play a very good role in further expanding the asset selection in the destination market and improving the investment returns of global investors. It is an all-win for everyone.
Luckin’s financial fraud scandal can by no means represent all Chinese companies listed in the U.S. Amid the post-pandemic abundant or even flooding liquidity globally, major financial markets may all face shortages of quality assets, and competition for high-quality listing candidates will be even more intense. Some political forces in the U.S. push for delisting of Chinese stocks, which will inevitably lead to lose-lose or all-lose results. This is not only what we do not want to see, but also what U.S. financial regulators and Wall Street do not want to see.
Capital seeks profits and is the smartest. We believe America will value New York’s attraction to high-quality assets and global investors. International investors will make informed choices based on what suits their best interests; U.S.-listed Chinese companies will also assess the situation and make appropriate responses according to their own circumstances.
The sustainable development of any international financial center depends on the trust from global issuers and investors. International financial centers are formed in the course of capital globalization. The status of a financial center reflects the strong financial strength and superior financial ecology of these countries and regions and also represents the trust and recognition of global investors in the investment environment and the investment value of listed companies. As one of the international financial centers, New York’s sustainable development depends on the trust of global issuers and investors.
According to the World Federation of Exchanges, as of the end of April 2020, 507 of the 2,152 listed companies on the NYSE were foreign companies, accounting for 23.6% of the total. Of the 3,141 companies listed on Nasdaq, 457 were foreign companies, or 14.5%. Foreign investors held about 25% of the market value of stocks in the U.S. financial market at the end of 2019, data from U.S. Treasury Department showed. The market structures of other global financial centers such as London, Tokyo and Hong Kong are similar to the U.S.
Caixin: How to push forward effective cross-border regulatory cooperation?
Yi: The CSRC highly values cross-border regulatory cooperation and has always been open and cooperative. It is the common responsibility of securities regulatory authorities of all countries to improve the information disclosure of listed companies and protect the legitimate rights and interests of investors. In cross-border securities regulatory cooperation, we adhere to the basic principles of following international practices, showing mutual respect, conducting effective communication and seeking mutual trust and win-win results.
Over the years, the CSRC has maintained active communication with the U.S. Securities and Exchange Commission (SEC) and the PCAOB. There have been many successful cases of cooperation. Despite the current political noise in the U.S., the CSRC will continue to strengthen cooperation with American regulators. In joint investigations of financial fraud and other illegal activities and violations of listed companies, we follow the principles of earnestly fulfilling cross-border regulatory cooperation obligations, providing law enforcement assistance in accordance with multilateral law enforcement cooperation arrangements of international organizations, jointly safeguarding fair market order and protecting the legitimate rights and interests of investors.
We understand and respect the U.S. regulatory idea of “easy access and strict regulation.” As for the regulatory problems in some U.S.-listed foreign companies such as Luckin Coffee, we believe that strengthening cross-border cooperation is the right way to solve the problems. Arthur Levitt, former SEC chairman, recently wrote an article proposing to strengthen cross-border regulatory cooperation between China and the U.S. We strongly agree with his views.
‘Joint inspection is feasible’
Caixin: Audit working papers are a key issue in the cooperation between China and the U.S. in audit supervision and regulation. Can China provide the U.S. with audit working papers and how to do it?
Yi: China has never prohibited or prevented accounting firms from providing audit working papers to overseas regulators. We understand that the essence of Chinese laws and regulations is that information such as audit working papers should be exchanged through channels of regulatory cooperation and in accordance with relevant provisions on security and confidentiality. This is also in line with international practice.
So far, the CSRC has provided the SEC and the PCAOB with audit working papers of 14 U.S.-listed Chinese companies, including three in 2019. We have long been in close communication with the PCAOB and have worked hard to find an effective path for cooperation on audit supervision. From the PCAOB’s visit in China in 2012 to our assistance in PCAOB’s pilot inspection of a Chinese accounting firm in 2017, both parties have tried many ways. During the pilot inspection, we also provided the PCAOB with the working papers of some audit projects. I would say that the cooperation was pretty smooth.
Caixin: The U.S. has signed regulatory cooperation agreements with many other countries in the world. Is there any global practice that China and the U.S. can learn from?
Yi: After years of practice and adjustment, we believe that “joint inspection” in accordance with international practice should be a feasible path. We hope we can continue cooperation with the U.S. in this direction on the basis of previous pilot programs.
Since 2019, we have told the PCAOB that we have agreed to carry out consultations on the “joint inspection” approach and have provided specific proposals to the PCAOB on many occasions. However, the U.S. has never given any positive feedback.
I think the PCAOB may be under some pressure in the current political climate in the U.S. The key to moving forward, then, is whether the U.S. really wants to solve the problem. We welcome the PCAOB to sit down for talks with us at any time. We believe that the basis of cooperation between us is greater than the differences. As long as the two sides proceed with the goal of resolving the issue and carry out consultations on an equal footing and in a professional manner, we will surely find a satisfactory and appropriate path for cooperation. We have full confidence to resolve our differences through cooperation.
Caixin: Will providing audit working papers solve all kinds of violation problems in cross-border supervision all at once?
Yi: Joint inspection and audit working papers are of course important in combating crimes in global capital markets, but they are only an important part or vehicle in cross-border regulatory cooperation. More importantly, a high degree of mutual trust between regulators should be built through full communication and collaboration, and on this basis, a joint law enforcement alliance should be established to combat cross-border securities crimes. Lack of trust and cooperation cannot solve the problem of effectively combating financial fraud.
Now, many professional issues in cross-border regulatory cooperation have been politicized by people with ulterior motives. In terms of professional supervision, China and the U.S. should first build mutual trust and convey confidence to the market. I always believe that given the current laws and regulations, there is no obstacle to cooperation, and we can certainly find a path for cooperation. As long as the U.S. is willing to sit down and talk, differences will surely be resolved.
Financial fraud is ‘a tumor’
Caixin: Is the current path clear for U.S-listed Chinese companies to return to the A-share market? Can those companies that fail to meet domestic listing requirements be allowed to list on the New Third Board? [The New Third Board is China’s over-the-counter market.]
Yi: Each country and region has its own set of listing standards and requirements. Recently, the CSRC issued the “Notice on Relevant Arrangements for the Listing of Innovative Pilot Red-Chip Enterprises in China.” [Red-chip companies are mainland companies incorporated outside the Chinese mainland and listed in Hong Kong.] The Shanghai and Shenzhen stock exchanges also issued regulatory arrangements and information disclosure guidelines for the listing of red-chip enterprises on the STAR Market and the ChiNext. From the current situation of U.S.-listed Chinese companies, some may not meet the domestic listing requirements.
Companies must have a profit model. If a company operates by burning money, telling stories, fueling speculation, but has no capability for continuity of operations and incurs long-term losses, it is not suitable to go public. This is a consensus among all regulators.
Caixin: Financial fraud by some foreign-listed Chinese companies has damaged the reputation of Chinese companies. What is your comment?
Yi: Such behavior is a tumor on the capital markets and is the target of both Chinese and foreign regulators. We should strengthen regulatory cooperation and work together to remove the tumor and hold those responsible for the fraud accountable. For Chinese companies that choose to list overseas, such as the U.S. and Hong Kong, their listing process does not need to go through any procedure required by the Chinese regulator. It is very difficult for us to know in advance which companies plan to go public overseas. Foreign investors should have taken this into account when trading these stocks and factored this into the pricing. Even so, we will strengthen cross-border regulatory cooperation with the destination’s regulators to jointly safeguard the legitimate rights and interests of investors from all countries.
Caixin: What can be expected from the London stock market?
Yi: London has built its status as an international financial center for historical reasons. Its financial infrastructure and investment institutions have a certain global influence. After Brexit, the U.K. is expected to focus on developing this strength to maintain the city’s global appeal.
The U.K. values financial cooperation with China and takes an active attitude in promoting the development of the Shanghai-London Stock Connect. The cross-border listed companies under the program have been listed locally and tested by the markets. Investors can be relatively reassured about the quality of these companies. The operation of the Shanghai-London Stock Connect is stable.
Of course, there are also issues of cross-border regulatory cooperation under the Shanghai-London Stock Connect. Companies listed in different markets must meet the regulatory requirements of public offering and information disclosure at the place of listing, which inevitably requires close cooperation between the regulatory authorities. We have many years of good cooperation experience with the British regulators. With the deepening of market cooperation between the two countries, we will strengthen cooperation in regulatory information exchange, information disclosure, audit supervision and other aspects.
‘We sincerely welcome overseas institutions to invest in China’
Caixin: Given the impact of the Covid-19 pandemic and the tensions between China and the U.S., will the overall opening pace of China’s capital market be affected?
Yi: The CSRC will resolutely implement the decisions and plans of the Central Committee of the Communist Party of China and the State Council and steadily advance the high-level opening-up of the capital market. During the Boao Forum in April 2018, Yi Gang, governor of the People’s Bank of China, announced a number of opening-up measures in the financial sector. Among them, five industry and market opening measures related to the responsibilities of the CSRC have been fully implemented, including relaxing foreign ownership in securities, fund and futures sectors to 51%, launching the Shanghai-London Stock Connect, and expanding the quota of the Shanghai and Shenzhen-Hong Kong Stock Connect programs.
During 2019 Lujiazui Forum, the CSRC announced nine policies and measures to further expand the opening-up of the capital market, six of which have been implemented, involving foreign ownership and controlling stakes, shareholder qualifications, fund custody qualification, H-share full circulation and the launch certain futures products. The three other measures have also made significant progress, with new regulations on the Qualified Foreign Institutional Investor (QFII)/ Renminbi Qualified Foreign Institutional Investor (RQFII) programs to be issued soon and the opening of the exchange bond market to be accelerated.
In the opening of markets and products, the QFII/RQFII quota limit has been completely removed, the interconnection mechanism of domestic and foreign markets has been continuously optimized; the range of international futures products has been expanded; and risk management tools have been increasingly enriched. Affected by the pandemic and the economic environment this year, the volatility in the global financial market has increased; the A-share market has shown increasing resilience; the Shanghai and Shenzhen-Hong Kong Connect programs operate smoothly; and foreign investment maintains a net inflow in general, which reflects global investors’ confidence in China’s macroeconomic expansion and steady progress in reform and opening of its capital market.
Since the beginning of this year, the opening of China’s capital market has not slowed down due to the pandemic and frictions between China and the U.S. Instead, it has accelerated. We lifted the restrictions on foreign ownership of futures, securities, and fund management companies in China ahead of schedule. The first phase of the China-U.S. economic and trade agreement was successfully implemented. So far, six global companies, including UBS, Nomura and JPMorgan Chase, have been approved for their majority-controlled securities joint ventures or fully owned units in China. This is a core part of the opening-up of the financial sector. Foreign securities, funds and futures companies enjoy equal treatment and fair competition with their domestic rivals in terms of market access and business scope, which is an important step forward in realizing national treatment in all respects.
I firmly believe that expanding the financial sector and opening the financial market to the world is not only an important way to optimize the market ecology and raise the level of the industry but also an important way to jointly address the current global risks and challenges. We sincerely welcome overseas financial institutions and investors to invest in China.
Caixin: Despite the recent net inflow of foreign capital represented by northbound capital from Hong Kong, the proportion of foreign holdings in the total market value of the A-share market is still relatively low, far lower than that in other countries and regions. What further measures will the CSRC take to attract foreign investment?
Yi: The CSRC will unswervingly and steadily advance the high-level two-way opening-up of the capital market. First, we will continue to improve the basic system of the capital market. This includes not only the ongoing reform of the capital market itself but also the improvement of cross-border investment and financing, transaction settlement and other systems. Second, we will continue to deepen all-level international cooperation. We will further optimize the Shanghai and Shenzhen-Hong Kong Stock Connect mechanism. We will further improve the Shanghai-London Stock Connect mechanism, broaden the cross-border ETF exchange mechanism, and strengthen China-Europe financial cooperation. At the same time, we will comprehensively promote regulatory improvement and risk prevention, improve cross-border capital monitoring and early warning mechanisms, and strengthen coordination and cooperation of cross-border supervision and information and data sharing so as to ensure the sound operation of the capital market in an open environment, aiming to be open, transparent and well-regulated.
The most important thing to attract foreign investment is the fundamentals of China’s economy and the long-term trend of development. Foreign investors will come to invest if they have confidence in China’s future economic development. As for the technical issues, including the transaction settlement system, risk management tools and trading habits, we will consider the demands of foreign capital to gradually improve them according to the overall market situation and development stage.
Caixin: Lack of effective risk-management tools is a common topic for foreign investors. Will the CSRC authorize overseas institutions to develop risk hedging products including A-share indexes?
Yi: To perfect the risk-management tools, expanding the onshore and offshore risk management tools is the direction of the CSRC’s next reform. The development of futures and derivatives markets should be in line with the current development stage and characteristics of the domestic capital market, and supporting regulatory measures and risk-control capabilities should be established. Only then will the roll-out of these risk-management tools be smooth.
The development of China’s capital market should learn from the best global practices. On the other hand, it should also consider the characteristics of the developing stage of China’s capital market, such as the A-share market’s investor structure. Data shows that more than 90% of the 160 million A-share investors are retail investors with less than 100,000 yuan ($14,200) in their accounts. This investor structure dominated by small and medium-sized investors isn’t expected to change in the short term. If we move too fast on derivatives, we are concerned that risks, even systemic risks, could rise. Therefore, futures products and derivatives in risk management tools can only move forward in a cautious and steady manner. The CSRC is also trying to strike a balance between protecting the interests of small and medium-sized investors and the interests of other parties.
For a mature capital market, a complete long-short mechanism is very important for the market to automatically seek balance. The development trend in the future is definitely the introduction of relevant risk-management tools, but under the current circumstances, being stable is achieving progress.
Caixin: In terms of bringing in, China’s financial sector has basically achieved national treatment for foreign institutions, but it is still difficult for Chinese institutions to go out. So far, no Chinese institutions have won an underwriting license in the U.S. What are the reasons?
Yi: On the surface, there are no barriers for Chinese companies to enter the U.S., but the actual regulatory requirements are very high. Especially after the 2008 financial crisis, there are more regulations on foreign companies trying to enter, some from the SEC and others from the Federal Reserve. Some large Chinese securities institutions have ties with banks. In the U.S., they would be treated as bank holding companies and must abide by the U.S. Bank Holding Company Act. They are supervised by the Federal Reserve, including business license approval and information disclosure. Therefore, the threshold of regulation is quite high, and that’s one of the reasons that some Chinese brokerage with better international business can’t obtain an underwriting license in the U.S.
The CSRC has also been in talks with the U.S. in recent years. Banks do not actually participate in the management of these brokers. They are independent businesses. We hope that the U.S. Federal Reserve and other regulatory authorities will take these realities into full consideration and support Chinese securities institutions in expanding their business in the U.S. The Fed has granted some exemptions in this regard. We will also actively push this matter forward.
Hong Kong is ‘the world’s Hong Kong’
Caixin: The recent situation in Hong Kong has made people worry about the future. Some even worry that Hong Kong will eventually be replaced as a financial center. What do you think?
Yi: Over the past four decades, Hong Kong has played an irreplaceable and unique role in the reform and opening-up of the mainland capital market. Taking advantage of its unique geographical advantages, the “one country, two systems” institutional environment, and on the back of the rapid economic development of the mainland, Hong Kong’s status as an international financial center is increasingly consolidated.
First, Hong Kong is an international financial center trusted by global investors. As of the end of April 2020, 137 of Hong Kong’s 193 banks are overseas institutions, among which American and British banks account for 34% of the total banking assets. Of the 165 insurance companies in Hong Kong, 70 are overseas institutions. Among the top 100 global banks and asset management companies, more than 70% have a presence in Hong Kong. World-renowned investment banks and asset management institutions ― including Morgan Stanley, Goldman Sachs, JPMorgan, UBS, Blackrock, Fidelity and Vanguard ― all have regional headquarters or important offices in Hong Kong. Among the world’s top 20 insurance companies, 15 operate in Hong Kong, including Prudential of the U.K. and Manulife of Canada.
Hong Kong is also an international financial center with Chinese elements. More than 50% of the companies listed on the Hong Kong Stock Exchange are mainland companies (including H-shares and red-chip companies), accounting for more than 70% of the total market capitalization.
We should see that Hong Kong is not only China’s Hong Kong, but also the world’s Hong Kong. In this sense, letting Hong Kong fully play its role as an international financial center is in the interests of China, the world and the new era. Under the principle of “one country, two systems,” the CSRC will further deepen cooperation in markets, institutional and product fields, jointly cope with various external disturbances, risks and challenges, and unswervingly safeguard Hong Kong’s status as an international financial center.
Caixin: How do you view the competition between Hong Kong and the Shanghai and Shenzhen stock exchanges?
Yi: We believe that moderate competition is conducive to development and innovation. If there is only one exchange, the quality of service will not improve. The three stock exchanges in the Chinese mainland and Hong Kong certainly compete with each other to a certain extent, but cooperation is still a mainstream trend. The development of the Shanghai and Shenzhen-Hong Kong Stock Connect is the best example. At the same time, each exchange has different characteristics. Which exchange companies choose to list is ultimately a market-based choice. It is a good thing that the three exchanges offer a wide range of options. As regulators, we are happy to see it happen, and we respect the market’s choice.
Caixin: There are some political issues that need to be resolved in Hong Kong. The market is worried that the function of Hong Kong's capital market will be affected. So should we speed up the development of the domestic capital market or give Hong Kong a preferential policy to further consolidate and enhance its status as an international financial center?
Yi: Hong Kong’s status as an international financial center is irreplaceable, and its unique functions need to continue to be performed well into the future. Hong Kong and Shanghai and Shenzhen are mutually reinforcing. There is no question of who will replace whom. We are fully committed to supporting Hong Kong’s status as an international financial center. This is firm and unwavering.
‘It’s more important to systematically punish fraud violators’
Caixin: Which laws are being amended to punish financial fraud by listed companies?
Yi: The CSRC will implement the call of “system establishment, nonintervention, zero tolerance” by Vice Premier Liu He, following the principle of zero tolerance, strong system, strict crackdown on financial fraud by listed companies. Financial fraud is a tumor in the capital market. The CSRC has never tolerated fraud and always severely cracks down on it. Recently, we investigated a number of major financial fraud cases with high market attention and bad influence, such as Kangde Xin and Kangmei Pharmaceutical.
China’s newly amended Securities Law, which took effect March 1, has sharply increased penalties for information disclosure violations. China’s Accounting Law has made strict requirements on accounting and auditing practices. The ongoing amending of the Criminal Law will also greatly increase the punishment on financial fraud crime.
Caixin: China has increased the maximum fine for securities fraud at listed companies from 600,000 to 20 million yuan. How effectively could these penalties deter violations?
Yi: How much administrative penalty for financial fraud is not the most important part. The subsequent civil compensation and criminal punishment constitute a whole punishment system, which is more important.
From the experience of developed countries, violators in capital market are afraid of going to jail, but they also are afraid of being sued by public investors for compensation. The CSRC will work with relevant parties to accelerate the implementation of a securities fraud litigation system with Chinese features. The CSRC will fully play the role of an agency to protect investors, not only enabling investors to get compensation but also effectively avoiding the abuse of the litigation system. On the other hand, we will continue to step up efforts to amend the criminal law, significantly raise the maximum prison term and fine standards for securities and futures crimes, and make offenders bear their due responsibility.
If the current litigation system with Chinese features can play an effective role, it can make up for the losses of small and medium-sized investors to a certain extent, which is better than just penalties on the listed companies and relevant responsible persons. At present, our representative litigation system follows the “default opt-in” rule under which plaintiffs can join a joint action implicitly, which means that financial fraud will face civil compensation claims from a large number of small investors. There will be several cases of investor lawsuits this year, which we believe will form a good market demonstration and deter future violations.
These efforts will contribute to the formation of a complete and organic system in which administrative law enforcement, civil compensation and criminal punishment are linked and supported, so as to effectively deter fraud violators, significantly improve the ecology of the market, and ensure the steady and long-term development of China’s capital market along the path of the rule of law and integrity.
Contact translator Denise Jia (firstname.lastname@example.org) and editor Bob Simison (email@example.com)
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