23 July 2019
The Financial Reporting Council, chaired by John Poon, is envisioned to become Hong Kong's independent accountancy watchdog. Photo: HKEJ
The Financial Reporting Council, chaired by John Poon, is envisioned to become Hong Kong's independent accountancy watchdog. Photo: HKEJ

Hong Kong aims to set up independent accountancy watchdog

Hong Kong’s Financial Reporting Council (FRC) is mulling over an overhaul to make local auditors shift from a self-regulatory to an independent regulatory regime. That would put Hong Kong on par with other major financial centers.

The city’s financial community has achieved consensus in that direction. But it remains unclear where the financing will come from and whether the overhaul of accountancy watchdog will be a definitive move.

Let’s go back to the 2001 Enron scandal. Arthur Andersen, formerly one of the “Big Five” accounting firms, was found guilty of criminal charges relating to its audit of the energy company’s finances.

Enron’s market cap slumped to US$200 million from a peak of US$80 billion, before it filed for bankruptcy.

The scandal revealed the loophole that nobody was overseeing the auditors. 

As a result, various institutions including the International Forum of Independent Audit Regulations (IFIAR) and the European Commission (EC) drafted rules requiring independent accountancy regulation.

Currently, up to 45 economies have met both the IFIAR and EC standards. They include developed economies such as the United States, United Kingdom, Germany, France, Australia, Japan, and Singapore. Eight nations have met only the EC standards, while eight other economies only have IFIAR recognition.

Unfortunately, Hong Kong does not meet the standards set by either IFIAR or EC. The IMF has singled out Hong Kong in this regard in 2014. Interestingly, mainland China is one of the eight economies adhering to the EC standards.

An amendment bill giving the FRC full responsibility for the auditors has been submitted to the Legislative Council. That would make the FRC the independent oversight body for the auditors of the 2,200 listed companies in Hong Kong.

The bill, if it becomes a law, would allow the FRC to inspect at least 5 percent of the auditing reports from the big four accounting firms. The bill is widely expected to be passed.

However, the move means the annual expenditure of FRC will spike from just HK$30 million at present to HK$99 million. And the costs will be shared by investors (50 percent), listed firms (25 percent) and auditors (25 percent).

Some argue that the government should pay for some of the expenses. And there are concerns that the FRC may face mounting legal suits for lack of sufficient financial capability.

Legislator Kenneth Leung Kai-cheong suggested that the government should provide a seed fund of HK$600 million for the new FRC.

The overhaul of the watchdog, to provide stable and sufficient funding for FRC to execute its responsibilities, would make FRC eligible for IFIAR membership.

Under the bill, the FRC’s composition will include industry practitioners. This proposal may not meet EC standards, which require all regulators to be industry non-practitioners.

This means the auditing community is still divided over where it should go.

This article appeared in the Hong Kong Economic Journal on March 22

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal columnist

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