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The revised Company Law of 2023 formally introduced the audit committee system. Articles 69 and 121 explicitly provide that limited liability companies and joint-stock companies may, in accordance with their articles of association, establish an audit committee under the board of directors in lieu of a board of supervisors or a supervisor. This article examines the origins and advantages of the audit committee system through relevant regulations and practices, and offers several recommendations concerning the selection and composition of audit committee members.

Q: What has been the process of development of the audit committee system in China?

A: The audit committee system originated in the US in the 1930s, in response to the frequent financial scandals following the economic crisis, and it has since become an important component of modern corporate governance.

In 1993, Tsingtao Brewery established an audit committee in accordance with the Hong Kong Stock Exchange regulations when it listed in Hong Kong, marking the first introduction of the system by a Chinese company. In 2002, the China Securities Regulatory Commission (CSRC) issued the Corporate Governance Code for Listed Companies, formally requiring listed companies to establish audit committees.

In 2023, the revised Company Law formally introduced the audit committee system. In December 2024, the CSRC issued the Transitional Arrangements for the Implementation of Supporting Rules for the Revised Company Law, stipulating that companies listed from 1 January 2026 must abolish their boards of supervisors and establish audit committees.

Existing listed companies are required to gradually abolish their boards of supervisors and introduce audit committees. To date, several listed companies have already abolished their boards of supervisors, established audit committees under their boards of directors and released announcements detailing the specific implementation rules for these committees.

Q: How does the introduction of the audit committee system further improve corporate governance structures, and what are its specific advantages?

A: Strengthened financial oversight with greater focus and effectiveness. In recent years, financial fraud scandals led by directors, supervisors and officers have been frequent, posing significant risks to companies beyond regular operational disruption. The introduction of the audit committee system enables more targeted and robust financial supervision.

According to article 2.2.10 of the Self-Regulatory Guidelines for Listed Companies on the Shanghai Stock Exchange (SSE) No.1 ¨C Standardised Operation, an audit committee can monitor the preparation of financial reports, review these reports and regularly communicate with internal and external audit institutions, thereby promptly identifying and correcting issues and enhancing the transparency of financial information.

Led by professionals, the system is more specialised and independent. Although the current Company Law does not explicitly define the composition of audit committee members, related regulations such as the Listed Companies¡¯ Articles of Association Guidelines (2025 Revision), the above-mentioned SSE Guidelines and the Shenzhen Stock Exchange Listing Rules have made initial attempts to address this issue.

These rules mandate that more than half of the audit committee members in listed companies be independent directors, with an accounting professional serving as the convener, and allow for the independent hiring of external audit institutions when necessary. This arrangement, which combines specialisation and independence, enables the audit committee to more keenly identify financial risks and potential issues, thereby improving supervisory effectiveness ¨C a model from which non-listed companies could benefit.

Q: Are there recommendations for improving the audit committee system?

A: The audit committee system has become an important tool for enhancing modern corporate governance by enabling comprehensive, professional and self-monitoring of a company¡¯s financial condition. However, the current Company Law only requires that companies ¡°establish an audit committee composed of directors within the board¡±, and does not specify whether the board or the general (shareholders¡¯) meeting should appoint the committee members.

Article 2.2.7 of the SSE Guidelines requires the board to appoint at least three directors to the audit committee, and article 133 of the Listed Companies¡¯ Articles of Association Guidelines (2025 Revision) mandates that the board establish the audit committee. For listed companies, the typical representative of joint-stock companies, regulatory authorities have clearly stipulated that the board should set up and appoint the audit committee. For companies outside of the listed sector, where corporate governance structures differ, the following recommendations are proposed.

(1) The general meeting of shareholders should appoint the audit committee members. If the board was responsible, it might favour candidates whose interests align with its own, thereby compromising the committee¡¯s independence or tending to protect the board¡¯s or management¡¯s interests over those of the shareholders, or the company as a whole. Given that the general meeting is the company¡¯s ultimate decision-making body, its role in appointing committee members would better safeguard independence and impartiality.

(2) Independent directors should serve on the audit committee. Having internal directors on the committee risks undermining the separation between the supervisors and those being supervised. Independent directors, being separate from the management and major shareholders and often having expertise in finance, accounting or law, can offer an objective, professional, external perspective on company decisions. This arrangement helps to prevent tunnelling, reduce the risk of financial fraud, and protect the interests of the company and minority shareholders.

The introduction and refinement of the audit committee system mark a significant step towards modernising Chinese corporate governance to international standards and professional practices. However, as a relatively new system, it still has areas for improvement. It is hoped that future legislative initiatives will provide clearer provisions to promote its widespread, effective application in China.

Jiang Lu is a senior partner and He Linhua is a paralegal at Ronly & Tenwen Partners