The dispute centers on Beijing's refusal to give U.S. regulators access to audit records for nine U.S.-listed Chinese companies, a standoff that has so far focused minds only on the implications for the future of U.S.-traded Chinese stocks.
However, accounting experts say the issue has the potential to not only force Chinese firms to de-list from U.S. markets, it could also put U.S.-based firms with big Chinese businesses in a position where they have difficulty producing audited accounts.
"The potential consequences of failure to find common ground are almost too frightening to contemplate," said Thomas Shoesmith, a partner at Pillsbury law firm in a note to clients.
This week, the U.S. Securities and Exchange Commission (SEC) charged the Chinese affiliates of five of the world's biggest audit firms with violating U.S. securities law, raising fears that it could go on to apply its ultimate penalty - banning the affiliates from working on audits of U.S.-listed companies.
"If these five accounting firms are barred from practicing before the SEC, it seems certain that companies with major Chinese operations will find it difficult or impossible to find accountants," Shoesmith said.
U.S. firms with major Chinese businesses include fast food group Yum Brands Inc, tech firm Qualcomm and construction equipment maker Caterpillar. Some have begun to show concern about the possible impact of the dispute.
"It would impact us and any other U.S. company with significant operations in China," said Yum spokesman Jonathan Blum.
"Essentially, there would be no auditors in China that the U.S. government would recognize. It will require a diplomatic resolution, I believe, and we are monitoring the situation."
Caterpillar also appeared anxious for a settlement.
"As this issue revolves around differences between U.S. and Chinese regulators, Caterpillar hopes each side can work to resolve this issue while demonstrating mutual respect and understanding for the laws and regulations of each country," the company said in an emailed response to questions.
Multinationals operating in China commonly use Chinese affiliates of the so-called Big Four audit firms - Deloitte, KPMG, PricewaterhouseCoopers (PwC) and Ernst & Young - to audit their Chinese business divisions.
These four dominate world auditing to an extent that U.S. firms would have trouble finding alternative auditors for their Chinese businesses if the affiliates of all four were barred.
In China, the affiliates say they are prevented by state secrecy laws from releasing audit papers to U.S. regulators.
Washington's reach is also hampered by the structure of the auditing groups themselves, which are set up as global networks of legally separate, national affiliates aimed at insulating the groups from difficulties felt in specific jurisdictions.
The standoff is seen as a test of China's ability and willingness to comply with international capital-market norms as it takes on the role of global economic superpower. At the same time, U.S. regulators are in largely uncharted waters, with little experience in dealing with foreign defiance.
The SEC began proceedings on Monday against the Chinese affiliates of the Big Four as well as second-tier audit firm BDO. The charges centre on the affiliates' refusal to turn over to U.S. authorities the paperwork from audits of nine U.S.-listed Chinese companies suspected of possible wrong-doing.
Months of talks between the Chinese Securities Regulatory Commission (CSRC) and U.S. regulators have failed to reach a solution, and lawyers struggle to see a way forward.
"The CSRC won't back down on the State Secrecy Law," said James Zimmerman, a lawyer in Beijing at Sheppard Mullin Richter & Hampton.
"If the SEC and CSRC are unable to find common ground and reach a consensus, China can expect that the U.S. will stall or refuse to cooperate in other ways in the future. Then it becomes tit for tat," he added.
The SEC and CSRC both signed a 2002 memorandum of understanding to exchange information to help each other enforce their laws, but the agreement is not legally binding.
Under rules set by the Public Company Accounting Oversight Board (PCAOB), the U.S. audit industry watchdog, an audit firm needs to be registered with the watchdog if it looks over more than 20 percent of a company's consolidated assets or revenue.
Yum, Qualcomm and chip-maker Advanced Micro Devices are among U.S. firms that draw more than a fifth of their revenues from China.
If diplomacy fails, accounting experts say the SEC may have no choice but to stop the Chinese affiliates from auditing U.S.-listed firms. Then, the PCAOB could move to de-register them.
If that happens, multinational companies (MNC) might struggle to file their financial accounts.
"That could lead to the inability of the U.S. (auditing) firm to sign off on the audit of the MNC, since it has no way to audit the China operations," wrote Paul Gillis, a professor at Peking University on his China Accounting Blog.
One way around the problem would be to split the audit among several firms, so that no one auditor is playing "a substantial role", Gillis added, noting that only auditors playing a substantial role would need to be registered with the PCAOB.
But he said that solution would be expensive and likely to reduce audit quality.
A WAY FORWARD?
Most analysts remain optimistic a solution will be reached before the SEC deploys these sanctions, but papers filed this week by the SEC in a court case against Deloitte Touche Tohmatstu CPA Ltd suggest a solution is still some way off.
The SEC wants documents related to Deloitte's audit of Chinese software firm Longtop Technologies, which delisted in the United States after an accounting scandal.
"In short, the CSRC remains unwilling or unable to provide the SEC with meaningful assistance in its enforcement investigations," the papers said.
The CSRC has not commented on the issue since the SEC charged the Chinese auditing affiliates, but it indicated recently that both sides were trying to reach a solution.
"Audit papers are very important to maintain market integrity and the CSRC is ready to cooperate with other jurisdictions on this issue," CSRC director general of international affairs Tong Daochi said at a Thomson Reuters regulation conference last week.
"We have engaged with the SEC, SFC (Hong Kong's regulator) and PCAOB on audit working papers and we are making progress and I think we should be able to work out a way to get them out."
(Reporting by Rachel Armstrong and Dena Aubin; Additional reporting by Ernest Scheyder in NEW YORK, Vikram Subheadar in HONG KONG, Kevin Drawbaugh and Andy Quinn in WASHINGTON, and the Beijing newsroom; Editing by Mark Bendeich)
By Rachel Armstrong and Dena Aubin