Global standards essential for financial control

Regulators across the globe have enacted a continuing succession of new rules and regulations to help financial firms manage and reduce risk in all sections of the financial markets. Starting with the technology bubble of the late 1990s, an excessive enthusiasm about market opportunities and fraud has resulted in major shocks not only to the financial system, but to the global economy as well.

Market globalization means that all significant economies must reach a high level of trust and compliance for the global economy to remain viable and stable. China is now the world's second-largest economy, and so it must learn from the recent financial crisis and resulting recession in the West.

However, financial crimes, such as fraud, money laundering and terrorist financing, are not just Western issues. Risks increase as economies grow more rapidly, as illustrated by the downfall of a number of Chinese companies. The investment world has welcomed many Chinese companies to their global markets, but some fail quickly as accounting fraud and market manipulation comes to light.

According to an analysis by McKinsey, the aggregate market capitalization of Chinese companies listed in the United States fell in 2011/12 by 72 percent with around one-in-five delisted. As a result of some of the major Western frauds of the past, markets are increasingly distrustful of new entrants and the losses they have suffered from companies, such as Longtop and Rino International. Accounting fraud, lax regulation and the use of variable interest entities, a corporate structure previously used by the Alibaba group, are behind many of the losses.

In many cases, the fraud was obvious with inflated inventories and revenues being used to achieve high listing valuations and to attract investor funds. A major issue, though, is the lack of international trust in the quality of information provided during the listing processes. Chinese laws forbid international audit firms from releasing information on any audits performed in China. In some cases, listing exchanges based in New York and Hong Kong have taken action against the audit firms. However, they cannot send their own teams to China to perform independent reviews because of infringement of sovereignty concerns.

Such impositions would not be necessary if China adopts international accounting standards, such as International Financial Reporting Standards and relevant elements of the Sarbanes-Oxley. It also should rigorously investigate and prosecute both auditors and business management responsible for committing fraud. While nothing has changed yet, there are growing signs of future cooperation with the authorities in the US and the Hong Kong Special Administrative Region, as well as the likely introduction of IFRS accounting standards.