The Red Iceberg

The Fall of the Communist Dynasty and The Looting of China touched on the widespread fraud that has become apparent, both in mainland and US listed Chinese companies. I also showed that an extraordinary number of the Communist Party and the military cadre  had massive unexplained wealth, with the Top 70 recording a net collective worth of over $80 billion. This week Bloomberg  was banned by the Chinese government for reporting the incoming presidents families assets at over $367M.

As Xi climbed the Communist Party ranks, his extended family expanded their business interests to include minerals, real estate and mobile-phone equipment, according to public documents compiled by Bloomberg.

Those interests include investments in companies with total assets of $376 million; an 18 percent indirect stake in a rare- earths company with $1.73 billion in assets; and a $20.2 million holding in a publicly traded technology company. The figures don’t account for liabilities and thus don’t reflect the family’s net worth.

I explained how this net worth had come about by the implementation of the Cadre capitalist system by Deng in the early 90s and how that evolved into a kleptorcacy.

To this we add the standoff between the China and the US over accounting standards. This issue has been going on for a few years and there looks to be no resolution in sight. Chinese firms could be cut off from US capital markets by the end of the year says Patrick Chovanec  a professor at Tsinghua University’s School of Economics and Management in Beijing, China. .

unless a compromise can be reached, there is a very real chance that U.S. securities regulators may end up employing the “nuclear option”:  forcibly delisting every Chinese company currently listed on a U.S. stock exchange — such as Sinopec, Sina.com, China Life, and China Unicom.   It’s a potential catastrophe-in-the-making that few investors or politicians have given any serious thought to.

There is a high probability  that the Chinese simply cannot comply with US requirements because Chinese politicians and princelings would be implicated in these massive frauds , with over 200 companies having listed in the US this would result in a massive dislocation of capital when these companies are forced to relist in Hong Kong. If as Paul Gillis , a Professor at Peking University’s Guanghua School of Management contends the

PCAOB and the SEC make no progress. The issue becomes political and widely known. Deregistration becomes the only option and it is the PCAOB that pulls the plug. That then forces the exchanges to decide how to enforce their rules that require companies to have auditors and audited financial statements in order to be listed. I expect in this scenario that the exchanges are forced to delist the companies, and the scramble to Hong Kong begins.

On the 20^th June, the SEC served formal requests on  the Chinese arms of all of the Big Four audit firms China Securities Regulatory Commission (CSRC) warned  the Big Four global accounting firms not to provide audit records to overseas regulators. Currently, Mainland Chinese affiliates of the international audit firms have 130 clients listed on US stock exchanges with Deloitte (48 clients), PwC and KPMG (28 clients each) topping the list.

The reality is that Hong Kong hasn’t the capacity to re-register this amount of capital, so the issue is likely to become a powder keg in a US election run up.  Will Obama or Mitt be willing to stare down China on accounting and audit standards?

The problem maybe that neither side has room to move, US regulators and the ‘get tough with China brigade’ must move to protect the viability of US capital markets , while western style audits may expose far to  many politically connected kleptocrats behind the Chinese audit curtain for them to give way. The Chinese reluctance to provide information may indicate that the frauds that have been uncovered to date are merely the tip of a big Red Iceberg of Chinese cadre fraud.

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