policy papers

HONG KONG DEMOCRATIC FOUNDATION

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North Point, Hong Kong

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Consultation Paper on Proposals to - (a) Enhance the Oversight of the Public Interest Activities of Auditors and (b) Establish a Financial Reporting Review Panel

30 October 2003

Secretary for Financial Services and the Treasury
Financial Services and the Treasury Bureau
18^th Floor, Admiralty Centre, Tower I
18 Harcourt Road
Hong Kong

Dear Sir,

Consultation Paper on Proposals to - (a) Enhance the Oversight of the Public Interest Activities of Auditors and (b) Establish a Financial Reporting Review Panel

We are writing with our submission on the above consultation paper. We would like to record our appreciation of the paper, as it presents complex issues clearly and sets out useful options for reform.

Overall, our view is that there is a serious need for reform in the oversight of auditing and financial reporting. Confidence in these functions is vital to Hong Kong’s success as an international financial centre. Many jurisdictions overseas have been undertaking major reforms in these areas, as the paper describes, and for that reason alone Hong Kong should conduct a serious review. Moreover, Hong Kong has had its own share of accounting and auditing problems in recent years, to the point where the need for reform has become urgent.

Essentially, we believe that a practitioner body like the Hong Kong Society of Accountants (HKSA) is not a suitable body to supervise the audit profession. Quite apart from the obvious conflicts of interest, which no internal mechanism can adequately address, the HKSA is simply not powerful enough to take on one of the Big Four accounting firms in a disciplinary case. We therefore support the creation of a statutory body for this purpose. However, such statutory body should not merely be another committee of individuals – which would be little better than another practitioner body, with all the conflicts that that entails – but a properly resourced executive authority with its own full-time dedicated staff. We also support the creation of a statutory body to review published financial accounts - the Financial Reporting Review Panel (FRRP). In order to economise on resources and prevent a proliferation of public bodies, we prefer that these bodies be located in the relevant existing statutory regulator, namely the Securities and Futures Commission (SFC).

Our more detailed comments, following the issues raised by the consultation paper, are as below.

Page 8/9. It appears that the HKSA’s proposal (a) to (c) to enhance the Society’s self-regulatory function would not meet IOSCO’s requirement (fourth bullet) that the oversight body be “independent of the audit profession”.
Page 14. We tend to agree with the SCCLR that Hong Kong does not need independent standard setting bodies since its auditing and accounting standards are intended to converge with international standards.
Page 15, 49(a). As discussed above, there is definitely a need to establish a separate IIB to monitor and consider complaints of alleged accounting, auditing and ethics irregularities committed by professional accountants involving listed entities.
Page 15, 49(b). We recommend that the IIB’s jurisdiction be limited to listed companies only. We acknowledge that large firms (whom we consider the HKSA unable to discipline effectively) also audit non-listed companies. However, the priority is to address the listed company area.
Page 15, 49(c). The IIB will have to have members with accounting experience, as well as independent members, and so will lack independence as a whole. To address this concern, we urge that consideration be given to positioning the IIB as a policy-setting and appeal body, rather than as the originator of reviews and “court of first instance”. Thus we would prefer to set up the IIB within an executive authority with substantial resources, namely the SFC.
Page 16, 49(d). The IIB (i.e. its executive arm, as proposed above) should be empowered to request information and investigate. This again, would be more consonant with domicile within a fully-fledged and resourced authority such as the SFC.
Page 16, 49(e). The IIB’s functions should cover the entire disciplinary process. The case should definitely not be referred back to the HKSA again, since this would defeat the whole purpose of setting up the IIB.
Page 16, 49(f). Public interest cases, and in fact all cases, should be handled by the IIB, the IIB being completely independent and separate from the HKSA. We have no confidence in the ability of a committee of a practitioner body like the HKSA to deal with practitioner disciplinary cases, no matter how the committee is constituted.
Page 16, 50. As stated above, the IIB should be located within the SFC, or at least served by the SFC in a similar manner to the Takeovers Panel.
Page 16, 51. We see the merit of all parties mentioned bearing part of the funding cost. However, if the IIB is located within the SFC, we would prefer a general increase in the SFC’s budget to cover it rather than specific additional charges, thus saving considerable administration. However, since the SFC is currently in a deficit position, some additional revenue for it may be needed.
Page 18, 56, practice review. We believe that the priority is to address public interest concerns regarding listed company audit and accounting practice. To do this, we recommend that the SFC establish a public company audit practice, like the US Public Company Accounting Oversight Board, with which auditors of listed companies have to register and by which they are overseen. Practice concerning non-listed companies can continue to be overseen by the HKSA itself for the time being.
Page 20, 60. The FRRP’s jurisdiction should cover listed companies only.
Page 21, 62. We agree that the FRRP should cover the statutory annual financial statements of listed companies only.
Page 22, 66. The FRRP should be set up under the SFC.
Page 23, 70. We agree with the proposed powers of the FRRP.
Page 24, 75. As regards the composition of the FRRP, we are of the view that conflicts of interest in a close-knit community like Hong Kong are inevitable, and no possible structuring of the FRRP can remove such conflicts. Therefore we recommend that the function of monitoring financial statements be handled in the first place by the executive arm of the FRRP, i.e. the SFC’s staff, in our proposal, and the FRRP itself be positioned as a policy-setting and appeal body.
Page 25, 79. We prefer that the FRRP be proactive in its approach, as the incidence of complaints in the Hong Kong environment may be somewhat random or minimal. However, it should adopt a progressive approach, operating with a light touch initially, in order to give the community time to adapt.
Page 25, 80, governance. We generally see the merit of the procedures proposed, but consider that if the FRRP is housed within the SFC, the mechanisms of accountability and transparency should follow those applying to the rest of the SFC’s operations, to minimise the administrative burden.
Page 27, 84, resources. We do not support the idea of a UK-style volunteer body actually performing the work of review and investigation, etc. This work should be done, and a first finding issued, by full-time executive staff – under our proposal the staff of the SFC. The significant funding requirement is discussed in our point 10 above.
Page 27, 85. We agree that the overseas domicile of the majority of Hong Kong’s listed companies poses challenges which are not paralleled in other jurisdictions. However, this makes the work of the FRRP all the more important, deserving of a higher priority in policy consideration and also funding. Hong Kong has to credibly regulate its overseas-incorporated listed companies.