[author: Amin Amirkia]

Earlier this month, China’s Ministry of Finance, State Administration for Industry and Commerce, Ministry of Commerce, State Administration of Foreign Exchange, and China Securities Regulatory Commission issued the Notice on Issuing the Scheme on the Localized Restructuring of Sino-Foreign Cooperative Accounting Firms (“Notice”), requiring the Big Four to “localize” their operations in China. The Notice became effective on May 10, 2012.

As the Big Four are seeing their original 20-year joint ventures expire, the Notice provides the requirements for their joint venture contracts to be renewed. Some key features of the Notice:

• The percentage of foreign-qualified accountant partners at each of the Big Four are not to exceed 40% of the total number of partners by August, and shall not exceed 20% of the total number of partners by 2017.
• Each of the Big Four’s respective chief partners are to be Chinese nationals and Chinese-qualified accountants. The Notice provides for a transition period, however, such that current chief partners not meeting the aforementioned requirements may (subject to certain conditions) continue to complete their remaining tenures for up to three years.
• No less than three of each of the Big Four’s top five partners (in terms of partnership assets), shall be Chinese-qualified.

The effort to ensure that accounting firms are led by locally certified accountants is consistent with international practice. Further, it is consistent with China’s entry into the World Trade Organization, as China had negotiated that auditors must eventually become qualified in China. Further, commentators have stated that, despite any immediate challenges, the Notice serves as a necessary step in order to build local talent, improve audit quality, and to develop China’s accounting industry.

Some have expressed concern that there may not immediately exist the necessary local staff to seamlessly implement the Notice and continue to ensure high-quality audits. This could present a challenge to investor confidence given the recent highly publicized accounting irregularities of several U.S.-listed Chinese companies, particularly where there is a forced pace of promotions for Chinese-qualified partners and where senior foreign-qualified partners leave their Big Four China posts. Concern has also been expressed over the fact that nationality is included among the Notice’s stated qualifications, as opposed to simply professional qualifications and experience.

The Notice comes at a time of heightened dialogue between U.S. and Chinese audit regulators. The U.S. Public Company Accounting Oversight Board has been insisting on access to inspect accounting firms in China that audit the books of U.S.-listed companies amid allegations of accounting irregularities. Moreover, the U.S. Securities and Exchange Commission has been pushing the Chinese affiliates of U.S.-based auditing firms to provide access to their audit work, even where such access could result in the violation of Chinese law.

The Notice ends long-running uncertainty over the future of the Big Four in China. The Big Four have adjusted to similar newly introduced requirements when operating in other countries in the past.