• The New Chinese Corporate Internal Control Rules
  • October 24, 2008
  • Law Firm: Sheppard, Mullin, Richter & Hampton LLP - Los Angeles Office
  • On June 28, 2008, the Basic Rules for Corporate Internal Control (“Rules”) were jointly issued by the Ministry of Finance, the National Audit Office, the China Securities Regulatory Commission, the China Banking Regulatory Commission and the China Insurance Regulatory Commission. The Rules will take full effect on July 1, 2009 and initially affect only listed companies.

    The Rules contain seven chapters and fifty articles, covering the issues of information and communication, internal supervision, etc.. Within these provisions, some points worth focusing on are as follows:

    • Enterprises are required to apply a self-evaluation system and consider the operation of internal control by their personnel into their performance assessment mechanism. Further, an annual report shall be published.
    • Corresponding administrative agencies under the State Council are empowered to carry out supervision and inspection of the internal control of the enterprises.
    • Enterprises may entrust an accounting firm to audit the effectiveness of its internal control and publish an auditing report.

    We agree with the Regulation office of the China Banking Regulatory Commission which states that the Rules provide a generic platform for the business operation of Chinese companies in all sectors and industries. As a uniform regulation on the internal control issue, the Ruler allows the Chinese government to make the financial situations of companies more transparent, to strengthen the sense of fiduciary duty of the leaders of Chinese companies.

    This is a signal that shows the inspiration of China to utilize management and competitiveness of its companies, which would help to bring about stability to the Chinese capital market. However, there are some differences in the real situation.

    A survey of Deloitte (China) in 2007 revealed most of the public companies in China did not have effective internal control systems, even though, by then, there had been two Guidelines for Internal Control of Listed Companies issued respectively by the Shanghai Stock Exchange and Shenzhen Stock Exchange. What is worse, in a second survey commenced in May 2008, 72% of all the enterprises interviewed agreed that they had  achieved no improvement in their consistent supervision operation.

    Similarly, the effectiveness of the Ruler is not so apparent. It will take a long time to improve the companies’ internal controls. Until then, no significant changes will be likely.