AUDITING GIANT: KPMG receives visitors at an exhibition on November 13, 2007. Localization efforts are taking effect at the auditor and its three accounting counterparts in China (CFP)

Localization is the word on every accountant's mind in China as the country sets out on efforts to put more Chinese into positions of authority at the big four accounting firms of KPMG, Deloitte Touche Tohmatsu, Ernst & Young and PricewaterhouseCoopers (PwC). The new measures took effect in May.

"What China is really doing here is adopting the global norm," said Paul Gillis, a professor of the international MBA program at Peking University's Guanghua School of Management. "If you look at the big four around the world, China is an anomaly where foreigners control their practices. Throughout the rest of the world, the big four are a collection of practices owned by local partners."

Now, the accounting firms face challenges as they make cuts to their foreign staffs to promote Chinese partners to decision-making positions while facing internal and external challenges to their market presence.

Cooperation to partnership

On May 2, the Chinese Ministry of Finance (MOF) and related political bodies issued the Plan for Localizing Conversion of Sino-Foreign Cooperative Accounting Firms, effective May 10. The plan applies to the big four accounting firms in China.

Under the plan, the big four, upon expiration of their current business licenses, are required to convert their organizational structure from Sino-foreign cooperation to special general partnership. Under the new rules, each firm should have at least 25 Chinese citizens as partners, employ more than 100 Chinese Certified Public Accountants (CPAs), and have registered investment of more than 10 million yuan ($1.59 million).

Regulators have granted the accounting firms a five-year transition period. Generally, qualified partners of the reorganized accounting firms must hold either a Certified Public Accountant, Certified Public Valuer, Certified Tax Agents or Certified Cost Engineer license issued in China. During the transition period (until December 31, 2017), Hong Kong, Macao and Taiwan residents or foreigners who do not have the required licenses but are otherwise qualified may assume the title of partner, but their numbers are not allowed to exceed 40 percent of the staff and must be lower than 20 percent by the end of the transition period.

The plan also stipulates that only Chinese citizens are qualified to hold the position of chief partner of the reorganized accounting firms. Current foreign chief partners of the big four may continue their term for another three years.

Requiring a local CPA license before a person can own an interest in a local CPA firm has raised questions about whether the rules are meant to oust foreign partners.

The new regulation is in line with international practice and will not lower the accounting quality, said Yang Min, Director of the Accounting Department of MOF.

"China has properly arranged a transition program for the big four accounting companies and taken into account the views of Chinese and overseas partners when we came up with the plan," Yang told Xinhua.

Top executives from China and overseas all signed and accepted the localization program, she noted.

According to Liu Guangzhong, Deputy Director of the Accounting Department of MOF, despite the fact that the big four in other countries are controlled and managed by local partners, the new rule does not require an immediate staff change.

"It is an international norm for accounting partnerships to hire mostly holders of local certificates. China is still the only market where foreign partners control the practice, whereas local partners head the operations in other regions," said Ma Jinghao, an independent tax expert.

According to MOF data, nearly half of overseas partners in the big four accounting companies hold accounting certificates acquired in other countries. Most of those partners are residents of Hong Kong.

Yang also said that the localization program would pay close attention to the quality control of such auditors after they are localized.

"The new localized accounting offices will not only come under the supervision of the Chinese Government and industrial association, but also under the guidance of parent companies of the big four," Yang said.

Liu noted that auditing quality would be retained despite the changes. He indicated that core management structure changes will be gradual and will not affect the firms' management pattern.

David Wu, lead partner at PwC China, said the new business model would usher in a disciplined audit market.

"This is a conversion to a new legal format and the big four firms will now be treated on par with local accounting firms. So all the companies more or less operate under the same legal structure," Wu said. "Under the new dispensation it will mean more pressure on those who are signing off the accounts and carrying out due diligence to fulfill their audit responsibilities."

"If the changes are done in a responsible and measured manner, I do not believe that there will be an adverse impact on audit quality," said Paul Gillis from Peking University.

Gillis expected auditing quality in China to improve over time since the accounting firms have such a large talent pool to draw from.