China has built an impressive new accounting industry to support its burgeoning commercial power – but the Big Four firms are not beaten yet.
Foreign firms in China have followed a pattern, notes Peking University’s Professor Jeffrey Towson. They sweep in and do well for a few years. Then the local companies learn, take market share and eventually marginalise the foreigners in the Chinese market. This story has played out in industries from smartphones to real estate.
In accounting, however, that hasn’t yet proved the case. More than three decades into the modern era of the Chinese accounting industry, the big western accounting firms still dominate. PricewaterhouseCoopers Zhong Tian, Deloitte Huayong, BDO China Shu Lun Pan, Ernst & Young Hua Ming and KPMG Huazhen are the five largest Chinese accounting firms by revenue – and some of the fastest-growing.
Will it last? For most of the past decade, the indigenous Chinese firms looked poised to take over. But in the past few months, the timing of their ascendancy has become far less clear.
Growth of the Big Four
The stakes are high – revenues of the leading 10 Chinese accounting firms together topped US$4 billion in 2017. Professor Paul Gillis, a colleague of Towson’s, estimates that PwC, the top firm in China, has around 13,000 staff in the country. He sees it quickly becoming the second largest PwC branch, with more staff than the firm’s UK arm.
Gillis, a former head of PwC in China turned academic at Peking University’s Guanghua School of Management, is now the pre-eminent foreign analyst of the Chinese accounting industry. His 2014 book The Big Four and the Development of the Accounting Profession in China is recognised as the definitive account of the industry’s re-emergence in that country. He tells the story of the modern Chinese accounting industry after 1978, as the country began opening to the world.
As Gillis explains, the then Big Eight western accounting firms saw the opportunity clearly in the 1980s. They began building up representative offices to advise foreign firms entering China, at first often working out of hotels. By 1992 they had won the right to audit, working with Chinese partners, and were helping to develop Chinese accounting standards. They pulled in all manner of outside experts to help them understand the country; former Australian diplomat and future prime minister Kevin Rudd worked as a KPMG China consultant before entering politics.
But the real boom began after China joined the World Trade Organization in 2001, when the Big Four were allowed to operate in their own right. They worked with multinationals setting up in China, and then signed up most of China’s largest state-owned businesses as audit clients.
As Chinese commerce expanded, Chinese firms sprang up to perform audits. Soon smaller firms joined forces and the first large indigenous Chinese accounting firms emerged. Gary Biddle, professor of financial accounting at the University of Melbourne and a veteran of Hong Kong accounting, says the Chinese government rapidly committed itself to modern accounting and adopted global and US standards. Chinese universities began pumping out high-quality accountants; the number one university for Big Four recruits globally, according to Gillis, is now the Shanghai University of Finance and Economics, which supplies the Big Four with hundreds of recruits a year. More students go overseas to universities in countries such as Australia, New Zealand, Canada and the US. Chinese accounting standards were high from the start, Gillis says, and accounting quickly gained great prestige in China – more, perhaps, than in the US.
All through its modernisation, China remained a highly nationalistic entity that Gary Biddle describes as “like a giant conglomerate”. The domination of Chinese accounting by the Big Four soon began to rankle. Gillis writes that by 2006 Ding Pingzhun, director-general of the government-aligned Chinese Institute of CPAs (CICPA), spoke of the Big Four as firms that “lord themselves arrogantly across China”. The Big Four had done in 10 years, Ding said, what might have taken them “more than 100 years if in other countries”.
In his 2014 book, Gillis suggests that the Big Four have met their match in China. Ian Gow and Stuart Kells, in their 2018 book The Big Four: The Curious Past and Perilous Future of the Global Accounting Monopoly (see Acuity Aug/Sep 2018), similarly argued that China might be “the first place where the Big Four fall from their pedestal”. The main threat they cited was an organised push against the Big Four by large parts of the Chinese state.
Gow and Kells’ book also documents a long campaign by the CICPA to promote indigenous Chinese accounting firms. That included an effort to create a national accounting champion outside the Big Four – a “fist”, as Ding Pingzhun put it. When that failed, Gow and Kells reported, CICPA in 2007 adopted “a strategy to create 10 internationalised accounting firms capable of serving Chinese companies globally”.
This multi-firm strategy won official government backing. In 2010, China introduced mandatory rotation of auditors of financial institutions and state-owned enterprises. This was depicted as a move to improve audit governance in an emerging accounting profession. It might also have been expected to reduce the Big Four’s grip and give indigenous Chinese firms a shot at the big time.
Yet when the first rotation arrived in 2012, the target firms mostly simply swapped one Big Four member for another. The main effect was to cut the fees; Gillis estimates they fell 25%. The Chinese firms felt they lacked the skills to audit a large bank and aimed to win audit roles at second-tier banks instead, Gillis believes. One Chinese firm told him it had passed up an opportunity to audit the huge state-owned Industrial and Commercial Bank of China (ICBC), now the largest bank in the world by total assets.
Indigenous Chinese firms
Nevertheless, by the mid-2010s the new multi-firm vision seemed to be forming into reality. Yang Jiantao founded Ruihua in the 1990s and built it to the point where by 2013 it was the Chinese firm for not one but two second-tier accounting networks, RSM and Crowe Horwath. CICPA estimated in 2016 that the indigenous Ruihua had reached the number three spot in China by revenue.
Ruihua was a product of the Chinese state’s sympathy for local accounting firms. Yang told Accounting and Business magazine in February 2016 that Ruihua served the largest number of state-owned firms. Yang was reported as crediting government departments for creating a favourable environment for Chinese accountancy firms to grow. Paul Gillis predicted in 2016 that Ruihua would soon overtake PwC as the largest Chinese accounting firm.
As Yang was first building Ruihua in the late 1990s, Zhang Ke was running Coopers & Lybrand’s Chinese affiliate. After Coopers merged with Price Waterhouse to form PwC, he was widely seen as the heir apparent to the job of PwC managing partner in China. Instead, fed up with tutoring western staff about China as they swung through for three-year stints, Zhang left with a number of other Coopers partners and set up ShineWing. He designed it from the start as a Chinese multinational professional services business. It took over Australia’s Moore Stephens in 2015, has offices in South-East Asia, Japan, Europe and Egypt and by 2016 was China’s tenth-ranked firm. Gillis calls Zhang “probably the best accountant in China” and ShineWing “probably the highest-quality local firm” in the country.
But the latest CICPA figures, released in mid-2018, show that the fall of the Big Four and the predicted triumph of indigenous firms will have to wait at least a year or two yet. In the past two years, three of the top 10 Chinese firms have grown by more than 20%: Deloitte Huayong; KPMG Huazhen; and at the top, ranked number one by revenue, PricewaterhouseCoopers Zhong Tian. The Big Four plus BDO China Shu Lun Pan together make up China’s top five accounting firms. And if the official figures are right, the Chinese versions of the Big Four have been collectively growing faster than the fast-growing Chinese economy itself.
In contrast, the two best-known home-grown Chinese firms – Ruihua and ShineWing – have both shrunk significantly in the past two years.
This failure of the indigenous Chinese firms to take market share was a major surprise to almost everyone. Just when it happened is a little unclear, because the CICPA seems to have mysteriously failed to produce any figures for 2016. But if CICPA was hoping that the big Chinese firms would recover quickly, the 2017 figures removed that hope.
Gillis speculates that both Ruihua and ShineWing fell foul of China’s tough accounting regulations in their work with some of the smaller audit clients, businesses too small to attract the Big Four. The Four’s target market is cautious multinationals and globally ambitious Chinese firms such as Alibaba, Xioami and PetroChina.
But they have some other advantages.
“The Big Four had a one-hundred-and-fifty-year head start,” says Gillis. They are centrally managed and have integrated their long-established Hong Kong arms into their Chinese operations; some have even brought in their operations in Taiwan or Singapore. They invest more in high-quality managers, standardised practices and risk management. “It’s unrealistic to think you could create a global network today running up against the established firms,” Gillis says. The smarter Chinese firms, he says, have joined existing global networks like RSM or Grant Thornton.
Chinese firms face an additional hurdle, he notes – many of the larger firms have grown through mergers and remain to some extent “a collection of sole practitioners who share some of the overhead”. That makes the firms weaker than their revenues would indicate; they don’t operate with the cohesion of the Big Four.
“The Big Four have an amazingly valuable franchise and access to clients,” says Gillis.
Accounting in Xi’s China
Gillis expects the indigenous Chinese firms to poach staff from the Big Four over the next two years and make their move on Big Four clients in 2020, when the next audit rotation arrives for large firms.
Gary Biddle, however, looks at Chinese accounting’s future through a different lens: the increasing centralisation of Chinese President Xi Jinping. He sees a possibility that Xi could rein in the competition between the Chinese firms, or even nationalise them. The Chinese state wants a strong accounting sector, he says – but it might be willing to get it through central control.
As Biddle reminds people, China’s economy remains very different from those of western developed nations. Success still often relies less on the firm than on the opinion of the Chinese Communist Party. For that reason, Biddle expects the Chinese firms to struggle if they try to expand into foreign markets. China remains “a completely different system”, he notes – in accounting as in much else.
The Chinese accounting industry could conceivably face disruption from an unexpected direction: the current US administration. Under President Donald Trump, the US is pursuing trade restrictions against China; China has begun retaliating. That retaliation could drag in the Big Four.
The Big Four have many of their roots in the UK and Germany (and KPMG was for a while technically Swiss), but Paul Gillis says they are widely seen in China as US institutions and could face restrictions. On the other side of the ledger, Gillis points out that the US could have Chinese firms deregistered with the Public Company Accounting Oversight Board (PCAOB), leading to their delisting in US capital markets.
Involving accounting in a trade war might damage the US more than China. US exports of accounting services, including exports to China, more than doubled between 2006 and 2016. And the US consultancy TradePartnership worldwide estimated in a June report that just the Trump administration’s steel and aluminium tariffs could affect more than 26,000 US business and professional services jobs.
David Walker is the former editor of Acuity.
This article was originally published in the October 2018issue of Acuity.