The Evergrande crisis puts PwC in the spotlight
If Evergrande were listed in London, rather than Hong Kong, politicians and regulators would already be scrambling to review the work of its auditors.
The Chinese real estate developer has grown aggressively since its inception in 1996. It has grown into one of the largest corporations in China, with more than 1,000 real estate projects in 234 cities and total liabilities of $ 300 billion, or about 2% of China’s crude. domestic product. Today he is in the midst of a crisis, on the verge of non-payment of some of his loan repayments.
In its accounts for the first half of this year, its board expressed concerns about the company’s ability to continue operating – one of the first times Evergrande has publicly acknowledged its serious financial problems.
Yet just six months earlier, its longtime auditors, PwC, had signed its financial statements without such warning.
If the company defaults and a complex financial restructuring – or bankruptcy – ensues, it will sound like a familiar story to UK audit observers, who have seen the damaging fallout on the audit profession from there. collapse of businesses from Carillion to Thomas Cook.
As in these examples, Evergrande listeners – who have earned 271 million Rmb ($ 42 million) since 2009 – have approved the numbers presented to them by management for years. And just like its peers who have audited these UK companies, PwC may well face criticism of the level of challenge being applied to management over accounting policies that may have shown warning signs of the company’s financial health. .
PwC declined to comment on its Evergrande audits because it is a live customer engagement.
The liabilities of Evergrande’s balance sheet have long seemed fragile. Indeed, even as some large investors crammed into its bonds, believing that the Chinese government would never let a company of its size and importance go bankrupt, many others witnessed looming disaster.
Of its $ 300 billion in liabilities, Evergrande had $ 89 billion in outstanding debt at the end of June, 42% of which was due within a year, according to the S&P rating agency, which downgraded the company’s rating in August. JPMorgan analysts have estimated that Evergrande’s “net gearing” – its debt as a percentage of its equity – is well above the 100% reported in its accounts due to billions of dollars in off-balance sheet debt.
The quality of Evergrande’s assets is also probably one of the main issues raised if the lid is lifted by its creditors.
In 2016, Hong Kong-based accounting firm GMT Research visited 40 Evergrande development sites and concluded that Rmb150 billion in asset write-downs was needed – three times equity. He claimed that for years Evergrande had allowed failed projects such as abandoned hotels to pile up on its balance sheet without depreciation.
GMT also took issue with the way Evergrande classified in its accounts the parking spaces and commercial properties of its residential developments. He said the company had “persuaded” PwC to accept the classification of these as investment property, rather than an inventory of assets for sale.
“Are his listeners asleep?” GMT wrote. “The company is insolvent in our opinion and its equity is worthless. “
In Europe, the United States, Australia and South Africa, auditors are increasingly criticized and scrutinized when companies have collapsed. Cases of auditor negligence have also become commonplace in insolvency proceedings in recent years.
In Asia, audit firms have avoided much of this public flogging, but reputation risks in this part of the world are increasing. Already, the Big Four are caught up in geopolitical tensions between the United States and China over access to audit documents of Chinese companies listed in New York. And an accounting scandal at Luckin Coffee in China over fake sales has raised questions about the quality of the audit work EY does.
Auditors are also likely to be in the crosshairs of Beijing regulators. China’s finance ministry said it would try to improve the quality of company audits in 2021, applying “strict law enforcement and strict supervision.”
This means that PwC could find itself facing not only the combined wrath of investors and Evergrande customers if the company’s problems worsen, but Beijing’s might as well.
For Big Four auditors in general, this is a reminder that public, political and regulatory risks are increasingly becoming an international issue.