U.S., China reach agreement on inspecting audit firms to avoid trading ban

American and Chinese officials signed an agreement Friday that allows the U.S. to inspect and investigate the audit firms of Chinese companies, an important step toward avoiding a trading ban on the securities of about 200 companies that previously refused to comply.

The agreement allows for officials from the Public Company Accounting Oversight Board to travel to Hong Kong in mid-September to begin their audit inspections, as required by U.S. law. However, U.S. officials say the agreement still relies on China's continued compliance.

"While important, this framework is merely a step in the process," said SEC Chairman Gary Gensler in a statement. "This agreement will be meaningful only if the PCAOB actually can inspect and investigate completely audit firms in China."

Congress passed the Holding Foreign Companies Accountable Act in December 2020, imposing a 2024 deadline for the U.S. and China to reach an agreement before issuing a trading ban for companies using audit firms that refuse PCAOB inspections for three consecutive years.

"Our dedicated teams of professionals have been preparing for this moment for months, and they are ready to work swiftly, but thoroughly, to carry out our inspections and investigations," said PCAOB Chairwoman Erica Y. Williams in a news release. "Whether our teams are able to complete that work without obstruction will inform the PCAOB's determinations at the end of this year."

According to a fact sheet from the SEC, the agreement requires that Chinese authorities allow the PCAOB to independently select audit firms and clients; view audit work papers without redaction; interview and take testimony from audit personnel in China and Hong Kong; and share information with the SEC.

"This agreement represents a first step in addressing a major gap in our audit oversight framework that has threatened American investors for over a decade. But as Chair Williams has said, it is only a first step," said Rep. Brad Sherman, chairman of the House Financial Services Subcommittee on Investor Protection and Capital Markets. "I look forward to working with and supporting the PCAOB in making sure that Chinese authorities and audit firms live up to their commitments under this agreement."

More than 50 jurisdictions around the world comply with U.S. requirements for audit inspections, the fact sheet states.

"It's a privilege for foreign issuers to access our markets — the largest, deepest, most liquid markets in the world," Mr. Gensler said in a statement. "Investors in U.S. markets should be protected — and have trust in a company's financial numbers — regardless of whether an issuer is foreign or domestic. Further, if foreign issuers want access to our public capital markets, they must be on a level playing field with U.S. firms."