Risks loom as China orders Big 4 auditors to go local

* Transition to local control mandated by 2017
* PWC, KPMG, E&Y, Deloitte dominate China market
* Questions posed about audit credibility-analysts

By Kevin Drawbaugh
WASHINGTON, May 10 (Reuters) - China and the world's largest
audit firms face credibility risks under an order Beijing issued
saying the firms must hire more Chinese citizens to manage
operations there, analysts said.
Thursday's order follows a string of accounting scandals at
Chinese companies listed on U.S. stock markets and amid broader
questions about China's willingness and ability to conform with
international business standards and rules.
As the world's second largest economy, China has enterprises
with global ambitions, but markets often question the
accountability and transparency of these businesses. The new
government order will do little to alleviate that skepticism.
China's Ministry of Finance announced the audit industry's
so-called Big Four - PricewaterhouseCoopers, Ernst & Young, KPMG
and Deloitte - must begin to hand over the reins of their
Chinese practices to its citizens and accountants.
PricewaterhouseCoopers said it supports the programs and has
been "localizing its China practice." Ernst & Young said the new
order is "in line with E&Y's existing strategy." KPMG and
Deloitte could not immediately be reached for comment.
The China operations of the four firms are now led largely
by expatriates. The Chinese order caps at 40 percent the number
of foreign-qualified partners a Chinese Big 4 affiliate may have
as of August, and at 20 percent by 2017. The rules also say each
of the Big Four's senior partners eventually must be Chinese
citizens. All now are foreigners.
For the firms, finding enough qualified Chinese accountants
to do the work will be a challenge in the short term, but not an
insurmountable one over time, auditing industry analysts said.
In the long term, depending on the smoothness of the
transition and the behavior of Chinese partners who take over,
Chinese audits could be further called into question, they said.
"If the changes lead to greater turnover among partners, or
a wholesale replacement of leadership by the local partners,
there is risk that audit quality would be affected," said Paul
Gillis, professor of accounting at Peking University.

LOCAL CONTROL NORMAL
The Big Four firms have their main offices in the United
States. Like most multinational businesses, the firms over the
years have transferred control of overseas affiliates to local
citizens, which is cheaper and, in some ways more efficient than
maintaining a staff of costly expatriates in a foreign country.
That transition has been on track to occur in China, as
well, but the government order is an attempt to make that happen
faster, perhaps too fast, said Tom Selling, publisher of The
Accounting Onion, a website on accounting issues.
"They're basically asking to accelerate a natural process in
a sub-optimal way," he said.
Investors in U.S.-listed Chinese companies have been burned
by a recent string of accounting scandals.
On Wednesday, U.S. securities regulators charged Deloitte's
China practice for refusing to provide audit work papers related
to a U.S-listed Chinese company under investigation for
accounting fraud.
The Big Four dominate China's accounting industry. In 2010,
their audit practices, excluding their consultancy businesses,
had combined revenue of more than 9.5 billion yuan ($1.5
billion), according to the Chinese Institute of CPAs (CICPA).
Including consulting, the four firms say they each employ
around 10,000 people in mainland China, Hong Kong and Taiwan.
Singapore's accounting industry went through similar changes
in the 1980s, as did Hong Kong's in the late 1990s. In those
cases, the local partners used their enhanced voting power to
force out many foreign partners.
"There doesn't seem to be any good news here for investor
protection," Selling said.
"There are real political overtones here," he added. "The
Chinese ... see this as a way of protecting information and
their companies, but there's a big risk for them. The U.S.
capital markets and the Big Four are still the gold standard.
There's a chance the Chinese are overplaying their hand."

(Additional reporting by Rachel Armstrong in Beijing and Dena
Aubin in New York; Editing by Howard Goller)