China's reform needs foundation

Since Hank Paulson became US Treasury Secretary last year, he has taken an admirably constructive approach to the economic relationship between the US and China.

In a speech earlier this year, Mr Paulson eloquently made the case for China to accelerate the reform of its capital and financial markets.

But he overlooked a fundamental issue which, if not addressed, threatens to undermine every recommendation in his presentation.

Although he pointed out the importance of "sound accounting standards" and "independent financial information" as significant attributes of successful financial and capital markets, Mr Paulson made mention of these matters only in passing, as opposed to setting them as the cornerstone of his formal recommendations.

Without appropriate accounting and auditing standards, the ability of corporations to consistently apply them (and without an independent auditing profession to examine their application), further reform of China's financial and capital markets may stall or indeed never get started.

Chinese government officials must be credited with having worked diligently on the development of new accounting standards. According to Sir David Tweedie, chairman of the International Accounting Standards Board, the issuance in January 2007 of China's new "Accounting Standards for Business Enterprises" achieved "substantial convergence" with International Financial Reporting Standards.

But my point goes well beyond the appropriateness of the accounting standards. What use are progressive standards without sufficient qualified and experienced accountants to apply them and trained auditors to examine their application?

From 1949 until the late 1990s China's accounting profession was effectively disbanded. Chinese accounting firms in the 1990s had professional staff who were either in their 70s or in their early 20s.

The shortage of qualified accountants in China is acute and has been estimated at 300,000, a figure almost certain to be conservative. Credit must be given to The Chinese Institute of CPAs in striving to develop and implement training and to encourage the recruitment of talented students into the profession.

The talent and resource gap, however, is enormous and threatens to undermine many of the strides that China has made in the development of its capital markets.

For China to implement many of Mr Paulson's recommendations, it must rapidly accelerate the development of its accounting profession. Mr Paulson would be well advised to encourage the decision makers in Beijing to direct additional focus and resources to this fundamental challenge and to accelerate their reform of certain restrictive regulations surrounding the development of the practice.

Specifically, Mr Paulson should have an agenda item on the next US-China Strategic Economic summit that is focused on the accounting profession in China. Within this agenda item, attention should be given to how the US profession should help and how the Chinese profession should be more receptive to help in the following areas:

As one who believes the accounting profession serves as the cornerstone of the financial and capital markets - by virtue of confidence provided to investors - I encourage Mr Paulson to dedicate time and resources to this key issue at future sessions. 

stephen.chipman@gthk.com.hk

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