Ernst & Young is one of the Big Four accounting firms that has been ordered… (Paul J. Richards, AFP/Getty…)
BEIJING — The Chinese government has ordered the world's Big Four accounting firms to appoint Chinese citizens to head their mainland operations within five years, an edict that could crimp the auditors' expansion in one of the world's most important markets.
The new regulations, announced Thursday by China'sMinistry of Finance, also require Deloitte Touche Tohmatsu, PricewaterhouseCoopers, Ernst & Young and KPMG to localize their management ranks starting this year.
Although the firms have hired thousands of Chinese accountants in recent years, many of their senior staffers have come from outside China. The firms were originally allowed to operate largely with foreign partners because qualified local staff were scarce.
The edict comes amid rising tensions between regulators in the U.S. and China over the sharing of audit information of mainland China-based companies whose shares are traded on U.S. exchanges.
On Wednesday, the U.S. Securities and Exchange Commission charged a Chinese unit of Deloitte with violating the Sarbanes-Oxley Act by refusing to hand over documents related to a Chinese firm that's under investigation for defrauding investors. Deloitte has said doing so would violate Chinese state secrecy laws.
Under the new rules, the Big Four will have to show by the end of this year that no more than 40% of their Chinese partners have gained their certified public accountant certification overseas. By 2017, that cap will drop to 20%, and a Chinese citizen must be picked to head each of the Big Four's operations in China.
At present, only about 30% of the Big Four's partners in China have been certified in China, according to Paul Gillis, a professor of accounting at Peking University's Guanghua School of Management and a former partner at PricewaterhouseCoopers.
"What China is really doing here is adopting the global norm," Gillis said. "If you look at the Big Four around the world, China is an anomaly where foreigners control their practices. In the rest of the world, the Big Four are a collection of practices owned by local partners."
Still, he said, finding so many seasoned Chinese partners could prove a challenge for the Big Four.
The changes take place at a time when the Chinese auditing industry has been hobbled by accounting scandals involving several U.S.-listed Chinese companies, some of which have seen their shares delisted or halted.
In the latest move, the SEC launched legal proceedings Wednesday against Deloitte's Shanghai-based unit.
American regulators are demanding that Deloitte turn over documents relating to their former client Longtop Financial Technologies, a Chinese software company whose shares were suspended last year on the New York Stock Exchange because of massive accounting irregularities.
Deloitte says Chinese law prohibits the firm from sharing that information.
"China regulators would be authorized to dissolve the firm entirely and to seek prison sentences up to life in prison," Deloitte wrote in response to a subpoena filed in U.S. District Court for the District of Columbia.
The impasse raises concerns about how the new local partnership rules could further diminish the ability for the Big Four firms to assist in U.S. investigations.
"If everybody running these firms is a Chinese citizen and the government puts pressure on them to protect a favored state-owned enterprise or industrial policy, they will have no power to resist," said James McGregor, a senior counselor for APCO Worldwide in Beijing.
The chairman of the U.S. auditing industry regulator said this week that Beijing may soon allow American inspectors into China as observers in the audits of U.S.-listed Chinese firms.
Unlike banking, where foreign firms still have only a small market share because of regulations, the Big Four command about one-third of the Chinese auditing sector with revenue of $1.3 billion in 2010, according to the Ministry of Finance.
China has been determined to develop its own firms and has encouraged Chinese auditors to expand or consolidate over the years to meet the demands of China's increasingly lucrative corporate sector.
"As more and more Chinese companies go public, the Chinese government wants to promote the development of local auditing firms," said Ye Kangtao, a professor of accounting at People's University in Beijing.
Gillis said the new rules were more than a decade in the making. China negotiated in its entry to the World Trade Organization that auditors eventually must become certified with a Chinese license.
That put foreign partners on notice. The Chinese certification exam is notoriously difficult and is only offered in Chinese. A push to translate the test into English was quickly quashed when China called for reciprocity and suggested the American equivalent be offered in Chinese, Gillis said.
"The big question now is what are the local partners going to do with their newfound power," Gillis said.