Since its birth in 1949 until the late 1970s, The People's Republic of China (PRC) operated under a strict planned economy system. During the more than 30-year planned economy period, the Communist Party of China (CPC), under the leadership of Chairman Mao Zedong, was the sole ruler and creator of all policies and regulations. The country experienced remarkable economic development in the early stages but eventually witnessed a drastic downturn due to the political turmoil that culminated in the Cultural Revolution. As a result, in 1976 when the Cultural Revolution ended, the national economy was in a deep predicament.

When the new generation of government under the leadership of Deng Xiaoping assumed power, a market economy was introduced as a complement to the existing planned economy. During the 1980s, domestic economic reform officially took off nationwide. The entire 1980s represented an initial experimentation period for the market economy concept.

The first real and effective changes came in the early 1990s. In 1991, China established its very first stock exchange in Shanghai, and then in Shenzhen (1992). In 1992, Mr. Deng toured the major southeast coastal cities and reemphasized the government's commitment to the development of a market economy and the establishment of market-based systems in China. Mr. Deng's "Communist market economy theory" was further carried forward by his successor Jiang Zemin and Zhu Rongji in the 1990s. By end of the last century, the China market had become a market economy phenomenon.

Under the leadership of the CPC, the Chinese government acted simultaneously as policy maker, implementer, enforcer, and evaluator. Unlike in other market economies, one of the Chinese government's roles was to approve or endorse any business activity. With government being the sole owner of most businesses, it also served as the strategic decision maker whose representatives managed and ran the SOEs.

The late 1980s marked the beginning of a concerted effort to separate governmental functions from business functions within the SOEs based on the notion that government officials should not hold any executive position in any commercial entities. However, given the existing government structure, the top executives of the large strategic SOEs are all appointed by the Organization Department of the CPC Central Committee. These executives, inevitably, have strong ties to top government officials; thus, government is still the key influential force within these large SOEs. The management of the small and midsize enterprises (SMEs), theoretically, is appointed by their board, and thus should have operational autonomy and decision-making power. However, given the complex cross-shareholding situation that is common among the SOEs, government influence still plays a key role in impacting the SMEs' decision-making processes.

The largest owner of PRC businesses is the government. From the early 1950s to the late 1970s, the SOEs constituted the sole corporate structure that was allowed to exist. The government owned every asset in the country, from farmland to large enterprises. The entire nation during this period was educated to work for the interests of the country and the Party only. Under this type of propaganda, different interests were not allowed to exist, and thus, no effective governance system was considered necessary.

The establishment of China's first stock exchanges in the early 1990s marked the beginning of a true ownership diversification process. Upon approval from the relevant ministries, SOEs can float a portion of their shares in the public markets. Listed companies' capital structure can consist of state-owned shares, legal person shares, A shares, B shares, H shares, and other foreign investment shares. In 2003, authorized foreign mutual funds with joint venture local partners (foreign stakes must stay below 33% in 2003, and below 49% in 2005) were allowed to invest in domestic securities. SOEs ownership will be further diversified by foreign shareholdings.

China is one of the few markets that have maintained a strong growth trend during the recent global downturns. According to the National Bureau of Statistics, in 2002, China enjoyed an 8% GDP growth rate to reach RMB10.24 trillion (approximately US$1.2 trillion) and became the world's second-largest economy after the U.S. Imports and exports remain strong. There is a US$30.4 billion surplus in exports. Foreign direct investment in 2002 reached US$52.7 billion. As of the end of 2002, national foreign reserves reached US$286.4 billion, a 35% year-on-year growth from 2001. The national currency, the renminbi, is still not fully convertible. The official rate is fixed at US$1 to RMB8.3 range.

China has a savings rate equivalent to about 40% of total GDP, one of the highest in the world. In 2002, total savings reached US$1 trillion. Most of the savings are in bank deposits, with a small percentage in equity investments. Bank financing is the primary funding source for companies in China. Corporations, especially SOEs, rely largely on bank loans and policy lending for their Cap-ex needs.

The "big four" state-owned commercial banks and two state policy banks have dominated both the lending and bank deposit markets. From the 1970s to the 1990s, while the PRC strived to transition from a planned economy to a market economy, most of the banks' lending was still policy lending. Coupled with the fact that all of these banks had poor internal risk control mechanisms and the SOEs faced financial difficulties, mounting nonperforming loan (NPL) problems inevitably became very serious. Official statistics estimate that NPLs comprise about 24% of total lending. However, Standard & Poor's Ratings Services estimates that this figure could be as high as 45%.

The second group of banks forms the newer joint-stock banks. Since these banks are owned jointly by government and by private entities, they have more operational autonomy compared to the state-owned banks. In addition, since these banks had fewer policy-lending responsibilities and a shorter history, their NPL problems are far less serious than the state-owned banks. On the other hand, because of their smaller scale and fewer government linkages, their market shares and relative influence are also significantly smaller than that of the state-owned banks.

Aside from bank financing, the equity market represents the other main funding source for corporations in China. The PRC equity market has developed into a size with market capitalization of RMB4,253.05 billion (more than US$500 billion), 1,229 domestic listed companies, and 592.55 billion outstanding shares (as of end-January 2003). A total of 32.5% of the total capital is floating and tradable. There are two stock exchanges located in Shanghai and in Shenzhen trading four types of equity stocks: Shanghai A shares, Shenzhen A shares, Shanghai B shares, and Shenzhen B shares. All stock issuance is subject to the approval of the CSRC.

Social and industrial associations in China also play important roles in providing guidelines, policies, and most importantly, business connections. These associations are categorized into three classes. The first-class institutions are directly under the leadership of the State Council and/or the Ministries. The district and provincial associations normally are also members of these first-class associations. These associations normally act as quasi government bodies in regulating and monitoring their members. They may also act as a positive enforcer in improving the corporate governance standards of their members. However, in certain situations, when the enforcement adversely affects the associations' own interests, they may also act as obstacles to achieving good governance.

The current mainland China legal system has a history of only about half a century. Compared to the developed European and the U.S. legal systems, the Chinese system is only at a stage of infancy. PRC Constitutions were drawn out in 1949. The National People's Congress (NPC) has the highest authorization to legislate and to amend the constitutions and laws. The Standing Committee of the NPC has the power to interpret laws and draw up decrees. Only the chairman of the PRC has the power to issue these laws and decrees.

The existing PRC legal system basically follows the Continental legal system, which in turn is based on fiduciary duty, governmental regulations, and legislation. However, the system is still heavily impacted by China's more than 2000-year feudalistic history. Therefore, the true "system" consists of not only laws and rules, but also a large element of the Chinese culture, which in turn, allows the implementation and enforcement processes to be more discretionary. Under some circumstances, relationships can totally undermine a legal decision. Selective enforcement is often seen as a result of either the law enforcer's personal interests, or (better, but equally dangerous) the special interests of certain market groups.

Criminal laws were traditionally given more emphasis than commercial laws. The existing PRC legislation also inherited some of these traditions. Therefore, Criminal Law, Civil Procedures Law, Administration Law, People's Court Administration Law, and so on, were among the earliest ones to be issued (in 1978). The promulgation on July 1, 1979 of the Law on Joint Ventures Using Chinese and Foreign Investment marked a new era in China's legislation on foreign investment and corporate laws. It was not until the late 1980s and early 1990s that the bulk of rules and regulations dealing with civil and commercial law issues were promulgated.

The PRC Company Law was first passed at the Eighth National People's Congress in December 1993, (effective July 1, 1994) and amended in December 1999. The Company Law is intended to regulate corporate structures and activities, and to protect commercial interests of the companies, their shareholders, and creditors. Two types of companies are stipulated under the Company Law: limited liability companies and joint stock companies. The law also articulates the responsibilities, rights, and liabilities of shareholders, the board of directors, managers, and the board of supervisors. Among the unique aspects of PRC Company Law are the requirements for minimum registered capital, fixed office space, and certain legal representatives.

The other major commercial laws that guide the PRC commercial world include:

• Contract Law (1999), which assigns rights and securities to all parties of the contracts;
• Bankruptcy Law (1988), which addresses only bankruptcies of state-owned entities;
• PRC Trust Law (2001), which deals with issues relating to the establishment and operation of trustees;
• PRC Security Law (1995), which stipulates the creation of security interests such as guarantees, mortgages, pledges, liens and deposits; and
• The Law of Commercial Instruments, which deals with issues such as types of commercial instruments, and issue, transfer, endorsement, acceptance, recourse, and so on, of commercial instruments.

The PRC's capital market is highly and centrally regulated. The State Council Securities Commission (SCSC) is the highest authority body for the capital markets. The CSRC is the executive arm of the SCSC responsible for conducting supervision and regulation duties.

There are four types of shares that list and trade in the domestic equity markets. Shanghai A and Shenzhen A shares are for domestic investors, while Shanghai B and Shenzhen B shares are for foreign investors. All listings must comply with PRC Company Law, the Memorandum by the State Council Regarding Standardizing Limited Company and Joint-Stock Company According to Company Law (1995), and the Circular by the State Economic and Trading Commission Regarding and Implementation of Standardizing Limited Company and Joint-Stock Company According to Company Law (1997).

The Company Law requires listed companies to adopt a two-tier board structure. The Board of Directors consists of two-thirds top executives and one-third independent directors. The Board of Directors is accountable directly to shareholders. The second board, the Board of Supervisors, consists of independent shareholders and employees (employees cannot be less than one-third). According to the listing rules, directors and top management cannot be appointed as supervisors.

Under the existing share registration system, all listed shares are secured and fully transferable. Shareholders should have equal rights in terms of profit sharing, participation in shareholder meetings in person or via proxy, voting, and monitoring/ questioning/making recommendations to the management. However, given that the most common shareholding structures have one major shareholder, it is difficult for the minority shareholders to form a large enough pool to reach the minimum thresholds needed to enjoy some of their rights, such as nominating directors, calling special meetings, and raising a resolution to the board and/or at the shareholder meetings.

From a legal standpoint, a company's Articles of Association have binding force on all shareholders, directors, supervisors and managers. The articles should be approved at shareholder meetings. The law also allows shareholders to amend the content of the articles.

The Code of Corporate Governance requires listed companies to set up incentive and control systems. Listed companies are now required to establish a review system for directors, supervisors, and management, and set up a performance-linked remuneration mechanism. Although Nomination and Remuneration Committees are not compulsory under the listing rules, executive directors generally are not involved directly in the decision-making processes that determine their own compensation packages.

It is required that all domestic listed companies have at least two independent directors on or before June 30, 2002, and one-third of the board members must be independent directors on or before June 30 2003. Though independent directors only comprise a minority percentage on the board, it is important to have some independent voices heard. For major transactions and connected party transactions, the guidelines require independent directors' approval before the proposal can be submitted to the entire Board of Directors. Independent directors can also provide independent views on issues such as important investment, opportunities, directors' appointment and removal, and directors and executives remuneration. However, the true effectiveness of the independent directors remains to be seen in practical terms. In particular it needs to be demonstrated that independent directors are provided a meaningful role on company boards, and are not just window dressing for compliance requirements. Active participation of the independent directors is more crucial than simple compliance with the regulatory requirements.

Differences between the existing PRC standards and IAS have narrowed considerably. However, there are still some major differences in key areas such as consolidation basis, provisions, and off-balance sheet treatment. The bulleted list below contains a detailed list of discrepancies between the PRC accounting standards and IAS as noted by the major global accounting firms. On the other hand, since the new national accounting standards became effective over the past two years, key areas where PRC standards and IAS have started to converge include business combinations, lease accounting, impairment of assets, pre-operating expenses, foreign currency translation, the calculation of earning per share, and segment reporting.

As noted in GAAP 2001 – A Survey of National Accounting Rules Section 3 – Country Summaries, by Andersen, BDO, Deloitte Touche Tohmatsu, Ernst & Young, Grant Thornton, KPMG, PricewaterhouseCoopers, Chinese accounting may differ from that required by IAS because of the absence of specific Chinese rules on recognition and measurement in the following areas:

• Uniting of interests (IAS 22.8);
• Provisions in the context of acquisitions (IAS22.31);
• Employee benefit obligations (IAS 19);
• Discounting of liabilities (IAS 37.45);
• The treatment of an issuer's financial instruments (IAS 32.18/23);
• The derecognition of financial assets (IAS 39.69);
• Hedge accounting for derivatives (IAS39.142); and
• The treatment of the cumulative amount of deferred exchange difference on disposal of a foreign entity (IAS21.37).

There are no specific rules requiring disclosures of:

• A primary statement of changes in equity, exceptions for joint stock limited enterprises (IAS 1.7);
• The fair value of financial instruments (except for listed investments) (IAS 32.77);
• The fair value of investment properties (IAS 40.69);
• Discontinuing operations (IAS 35);
• Diluted earnings per share (IAS 33.47); and
• The current or FIFO cost of inventory when LIFO is used (IAS2.36).

There are also inconsistencies between the PRC standards and IAS. Under the PRC standards:

• Certain subsidiaries with dissimilar activities can be excluded from consolidation (IAS 27.14);
• Subsidiaries are excluded from consolidation if intended for sale, even if previously consolidated (IAS 27.13);
• For most business combinations accounted for using purchase accounting, the identifiable assets and liabilities of subsidiaries acquired are consolidated based on their book values (IAS 22.40);
• Either provisions for major overhaul costs or deferral of incurred major overhaul costs are allowed (SIC 23);
• Trading and derivative financial assets and liabilities are generally not held at fair value (IAS 39.69/93);
• Proposed dividends are accrued (IAS10.11);
• Deferred tax accounting is uncommon and, when done, is calculated on the basis of timing differences, with the deferral method or the liability method allowed (IAS12);
• Definition of extraordinary items is wider (IAS 8.6/12);
• Certain disclosures relating to primary segments (for example, acquisitions and depreciation of assets) are not required (IAS 14.57/58); and
• There are no rules addressing the consolidation of special-purpose entities (SIC 12).

In certain enterprises, there other issues could lead to differences from IAS:

• Under some circumstances, finance leases can be recognized at the undiscounted amount of minimum lease payments (IAS 17.12); and
• There is no specific requirement for segment reporting to be prepared (IAS 14.44).

The national accounting professional organization: the Chinese Institute of Certified Public Accountants, operated through the MoF, has administered and issued the professional designation "Certified Public Accountant" (CPA) to qualified candidates since 1988. The national examination for Chinese CPAs was introduced in 1994. The CPA firms are also licensed and required to comply with the rules and standards.