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SEC Staff Roundtable on Emerging Markets

Securities and Exchange Commission

Staff Roundtable on Emerging Markets

Thursday, July 9, 2020

Opening Statements

Chairman Jay Clayton

In his opening remarks, Clayton summarized the objective of this roundtable, stating that it is the latest in a series of efforts to highlight and discuss the various risks to investors in emerging markets. He specifically highlighted the Securities and Exchange Commission’s (SEC) ongoing work with the Public Company Accounting Oversight Board (PCAOB) and the issuance of several joint statements on certain investor risks related to emerging markets, most notably China. Clayton also outlined the SEC’s work with U.S. auditing firms to discuss audit quality and certain challenges inherent in auditing public company operations in emerging markets, stressing the need for effective and consistent oversight. He called on the roundtable participants to work with the SEC in continuing to raise investor awareness as well as promote continued investor choice and appropriate investor protection.

Commissioner Hester M. Peirce

Peirce emphasized the need for investors to have access to accurate financial data, not misinformation. She added that the SEC wants to understand the problems facing investors and work to implement measures to better advance the core SEC mission of investor protection.

Commissioner Elad L. Roisman

In his opening statement, Roisman said that while the increasingly interconnected global economy continues to expand investor access to potentially lucrative investments, investor protection efforts need to also intensify in lockstep. He highlighted the challenges posed as different jurisdictions implement different regulatory regimes in their markets, leading to a shifting landscape with uneven investor protections. He specifically noted his interest in hearing panelists’ perspectives on how the SEC, in conjunction with the PCAOB, can best ensure compliance with both financial reporting and audit requirements. Roisman also called upon the panelists to think about what further efforts the listing markets can take to better provide investors with a consistent experience when transacting in listed securities, irrespective of the issuer’s home country.

Commissioner Allison Herren Lee

Lee focused her opening remarks on calling for increased oversight of U.S. issuers with significant operations in China who make use of Chinese audit firms as it relates to their China-based operations.

Panel I: Investment in Emerging Markets by U.S. Retail Investors

Panelists:

  • Carson Block, Founder and Chief Investment Office, Muddy Waters Capital LLC
  • Ryan LaFond, Deputy Chief Investment Officer, Algert Global
  • Roger Robinson, President & CEO, RWR Advisory Group Moderators

Moderators:

  • S.P. Kothari, Chief Economic and Director, Division of Economic and Risk Analysis, SEC (Moderator)
  • Peter Driscoll, Director, Office of Compliance Inspections and Examinations, SEC (Moderator)

Kothari began the discussion by asking the various panelists to define the key characteristics of emerging markets. Block noted that a critically important feature of emerging markets is the lack of what he defined as “rule of law” in the financial sector. He continued that this can be observed in practice as the ability to enforce a U.S. court judgement in an emerging market jurisdiction is usually extremely limited and added that there is frequently the presence of corruption in said jurisdictions. LaFond noted that despite these issues, emerging markets are an important source of portfolio diversification as well as the fact that many U.S. companies and firms derive a significant amount of revenue and sales from countries with emerging markets.

Robinson focused most of his remarks throughout the panel on discussing the distinct challenges posed by China in comparison to other emerging markets. He stated that China represents an existential threat to U.S. security with Block opining that China has been waging an “undeclared economic war” on the U.S. for some time. Robinson said that corporate enterprise in China is often leveraged by the state to serve as a power projection vehicle. He continued on to criticize the lack of sufficient insight into the financials of Chinese companies as well as the fact that many U.S. investors, including state public employment pension systems and U.S. university endowments, are invested in companies that may be involved in human rights and national security abuses. Block took the opportunity to highlight Muddy Waters’ comment letter to the SEC containing two proposals to improve the quality of audits of China-based issuers.

Both Robinson and Block agreed that there is a complete dearth of diligence and regulatory oversight as it relates to China-based issuers. Robinson criticized the SEC and PCAOB, specifically the May 2013 PCAOB-China Securities Regulatory Commission (CRSC)-Ministry of Finance (MOF) memorandum of understanding. Both stated that there is a significant amount of work to be done on this front and Robinson added that he is in favor of independent diligence activities spearheaded by the SEC. Block concluded that while it is difficult for U.S. law to reach bad actors based in China, it does have the capability to focus on the enablers of these bad actors based in the United States.

Panel II: Limitations on Inspection and Enforcement in Emerging Markets: Auditors’ Global Oversight of Member Firms in Emerging Markets

Panelists:

  • William D. Duhnke III, Chairman, Public Company Accounting Oversight Board
  • Julie Bell Lindsay, Executive Director, Center for Audit Quality
  • Cheryl J. Scarboro, Partner, Simpson Thacher & Bartlett LLP
  • Robert Zink, Chief of the Fraud Section, U.S. Department of Justice

Moderators:

  • Stephanie Avakian, Co-Director, Division of Enforcement
  • Sagar Teotia, Chief Accountant

Teotia opened the panel by inquiring about the inspection process globally, particularly in emerging markets and China. Duhnke explained there is no difference in the PCAOB’s mandate for firms that operate in emerging markets, and the obligations do not change based on the location of a firm or the public company being audited. Duhnke noted that international cooperation strengthens audit quality but said the PCAOB is currently unable to conduct inspections in France, Belgium, China and Hong Kong. He said that while agreements with France and Belgium are expected to be completed soon, Chinese authorities refuse to allow the PCAOB to conduct oversight consistent with the rest of the world, saying it is imperative for investors to understand these access challenges. He added that they are in constant discussions with the Chinese authorities, but it is unlikely they will be productive unless China agrees to overarching principles regarding access to information necessary to conduct inspections.

Lindsay explained that global auditing entities comprised of locally owned and operated firms are responsible for facilitating consistent quality services across the firms in their network around the world, as well as coordinating strategy, quality controls and risk management across firms. She said she therefore does not see differences in what firms do across jurisdictions, as the global entity enforces those quality control standards which are then bolstered by firms’ internal inspections processes.

Asked the unique challenges to enforcement in emerging markets, Zink said gathering evidence is the biggest difficulty. He noted that counterparties can provide documents through formal nation-to-nation channels, and the Department of Justice (DOJ) utilizes Patriot Act subpoenas when there is a corresponding financial institution located in the U.S., though he noted that process takes much time. He added that while many cases end in settlements, the DOJ can obtain forfeiture orders that allow them to seize assets, though when fines or restitution are ordered there is less the DOJ can do. Scarboro explained, from the perspective of a defense attorney, that gathering relevant documents and conducting interviews in China is challenging, noting there are laws in China protecting state secrets, which has a broad definition, and restrictions on the export of electronic data. She explained that they often utilize local law firms to review data on site and determine if they risk violating local law, which she said adds much time to the process. Scarboro also noted that it is a challenge to verify information like bank balances and other financial information.

Panel III: Disclosure and Reporting Considerations with Respect to Investments in Emerging Markets

Panelists:

  • Paul Gillis, Ph.D., Professor of Practice, Peking University’s Guanghua School of Management
  • John May, Partner, SEC Services Leader, PwC US
  • Amy McGarrity, Chief Investment Officer, Public Employees’ Retirement Association of Colorado
  • Sarah Payne, Partner, Sullivan & Cromwell LLP
  • Jill Walker, Senior Vice President, Corporate Financial Services, and Chief Accounting Officer, Starbucks Corporation

Moderators:

  • Raquel Fox, Director, Office of International Affairs
  • William Hinman, Director, Division of Corporation Finance

The third panel began with a discussion about disclosure issues within emerging markets, specifically taking a look at the environment of markets in China. McGarrity emphasized the importance of clear, reliable, and relevant disclosures that are substantive. She pointed out that requiring such disclosures is great; however, she also voiced concerns over the possibility of delisting and restricting public market investors from being able to access international companies. Gillis further expanded upon global disclosure policies, specifically citing the possibility of banning firms from being listed in U.S. markets if their auditors are not inspected by the PCAOB. He questioned the relevance of these PCAOB inspections and whether they should be required across the board for all emerging markets. May stated that these PCAOB disclosures provide investors with a good view of the present issues and state of the industry. He suggested that the PCAOB disclosures should be less embedded in the risk factor section of the overall disclosure to ensure greater accessibility by investors.

The panel then examined the differences in practices within emerging markets. May indicated that corporate governance consistently varies and stated that there is a wide range of approaches in dealing with issues of corporate governance. He emphasized that focusing on the implications of these differences better illustrates what the differences truly are. Gillis narrowed in on overseas vehicles and the way in which U.S. law generally defers to foreign governments when deciding matters of corporate governance in locations such as the Cayman Islands. McGarrity expanded upon this sentiment and discussed the structure of companies settled in either the Cayman or British Virgin Islands. She stated that a company’s presence in this market is certainly a factor in analyzing their business structure and provided ways to handicap an analysis to account for this factor.

The panel concluded with a more in-depth discussion of how a U.S. based issuer should interact with operations in China. Walker provided several examples such as analyzing the strength of working relationships within China operations, the frequency or openness of such communications, the location of where operations are performed, and how these operations are incorporated into both internal and external audits. May highlighted the key two areas of risk assessment and communication. He emphasized the importance of understanding the statutory reporting scheme and the difference between what is reported to corporate and what is reported locally. He also mentioned the importance of providing detailed written instructions to ensure no ambiguity throughout communications.

Panel IV: Improving Emerging Market Investing for US Retail Investors and Markets

Panelists:

  • Noriko Honda Chen, Equity Portfolio Manager, Capital Group
  • Rodney Comegys, Principal Global Head of Vanguard Equity Index Group, Vanguard Equity Investment Group
  • Sebastian Lieblich, Managing Director and Global Head of Index Solutions, MSCI
  • John Tuttle, Vice Chairman and Chief Commercial Officer, NYSE Group Inc.
  • John Zecca, Executive Vice President and Global Chief Legal and Regulatory Officer, Nasdaq

Moderators:

  • Dalia Blass, Director, Division of Investment Management
  • Christian Sabella, Deputy Director, Division of Trading and Markets

The fourth panel centered around listing standards and the factors considered when making decisions in regard to these standards. Tuttle began the conversation by offering a perspective from the New York Stock Exchange. He stated the exchange looks more at the “spirit” of a listing rather than following a checklist of specific items. He emphasized NYSE’s mission to find ways to step up and raise awareness in these capacities, and one example of doing so would be providing emerging market specific disclosures on a listing, such as by flagging a ticker. Zecca followed up by providing Nasdaq’s point of view. He provided three areas that Nasdaq has focused on to help address issues in listing standards specific to companies in emerging markets: setting a minimal liquidity standard, ensuring a level of sophistication in knowledge regarding the U.S. market structure prior to being listed, and focusing more on the audits themselves.

The conversation then shifted to a discussion on the potential benefits and risks of imposing more rigorous listing standards for emerging market issuers being traded in a U.S. market system. Zecca provided a word of caution against competing on regulation, as it may tempt U.S. investors to invest in foreign jurisdictions as opposed to staying within the U.S. Tuttle pointed out that having non-U.S. companies listed on U.S. markets is good for investors because there would be more transparency and accessibility than in a foreign market. Comegys echoed this sentiment stating that more disclosure is better because companies should be as transparent as possible. He stated that many established international companies are most likely dual listing. Comegys also pointed out that emerging markets should only constitute a portion of a portfolio to reap the benefits of diversification.

The panelists continued to discuss diversification, and whether a certain threshold of return can justify the increased overall market risk. Lieblich stated the traditional risk vs. return characteristics do not account for the construction of a broad base market capitalization index. Chen advocated for having more portfolio managers and a small concentration of emerging market securities in individual portfolios. She stated investing in multinationals would mitigate risk of investing in emerging market funds as it would be through companies based in the U.S. or Europe. Comegys described a weighted index offered by Vanguard that offers access to 8,000 different companies, including emerging market securities. He stated it would have hard to speculate what would happen if one of these companies left the NYSE and changed their listing.

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