China Banking Research
It has been an eventful seven months for Ant Group, with more downs than ups. Ever since the suspension of its anticipated blockbuster IPO in November 2020, the fintech giant has been trying to satisfy a long list of regulatory demands to restructure its operations. Regulators have been especially concerned with what they perceive as a highly risky (and previously, lucrative) consumer lending business. With that in mind, Ant gaining approval to operate its new consumer lending unit Chongqing Ant Consumer Finance within six months is an important step in the right direction.
Fintech firms face an uncertain future in China
Fintech crackdowns in China tend to snowball. That was the lesson learned when Beijing began culling crypto and P2P lending firms. At first, it seemed those industry segments might survive if they could assuage regulators. It later became clear that the only way to satisfy regulators was to shut down or move into another line of business, as erstwhile P2P juggernaut Lufax did. China's fintech giants, once seemingly unassailable, now face their own day of reckoning with regulators. Ant Group and its counterparts are probably too big to fail. But they are not too big to be cut down to size.
China's money-laundering travails are growing
China has a fast growing money-laundering problem. Beijing issued a record RMB 628 million (US$97 million) in fines for money laundering violations in 2020, up nearly 300% over a year earlier, according to a new report by PriceWaterHouseCoopers. Since payment firms accounted for 42% of all fines issued, it is no surprise that Chinese regulators are enhancing oversight of fintechs.
Lufax's pivot away from P2P lending pays off
Lufax is one of the few prominent Chinese fintechs that foresaw tighter regulation of online lenders, perhaps because the company began as a peer-to-peer lender. As Beijing in 2017 launched what would become a sustained campaign to eradicate the scandal-ridden P2P lending sector in China, Lufax moved to exit the industry. By 2019, Lufax had transformed from a P2P lender into an online provider of credit facilitation and wealth management services. It is thus no surprise that Lufax is weathering the current microlending crackdown well so far. The company's IPO went off without a hitch in New York, raising US$2.4 billion.
How will China's fintech crackdown affect Tencent?
China's fintech boom was great while it lasted. The abortive Ant Group IPO heralded the end of that era. That's not to say that digital finance will fade away in China. Rather, the state will exert greater control over fintechs. Tighter regulations, similar to what incumbent banks face, will cut into fintechs' bottom lines and constrain their growth prospects. That does not augur well for Tencent, which counts fintech - through its WeChat Pay wallet and WeBank digital bank - as one of its core business groups. Bloomberg estimates that Tencent's fintech business was worth RMB 200 billion to RMB 300 billion before the Ant IPO was suspended.
China Issues Draft Rules Clamping Down on Online Microlending
On November 2nd, the People’s Bank of China (PBoC), the China Banking and Insurance Regulatory Commission (CBIRC), the China Securities Regulatory Commission (CSRC) and the State Administration of Foreign Exchange held talks with Ant Group’s management executives, including its founder Jack Ma. The next day, regulators issued new draft rules to tighten China’s rapidly growing online microlending sector. Ant Group’s IPO in Shanghai and Hong Kong was subsequently suspended after Ant said there had been “material changes” in the regulatory stance on financial services, which could result in Ant failing to meet the conditions for listing and providing information disclosures.
China's P2P lending endgame
China's peer-to-peer lending crackdown has been a lesson in risk management with Chinese characteristics. While SOE juggernauts in China may be too big to fail, the P2P lending sector was too big to prevail. Massive scams on the largely unregulated platforms defrauded retail investors of their life savings, threatening social stability. The China Banking and Insurance Regulatory Commission reckons that P2P lenders still owe depositors about RMB 800 billion (US$115 billion). There are just 29 P2P lenders left in China today, compared to 6,000 when the crackdown began in 2015.
Some things just weren't meant to be, like peer-to-peer lending in China. What began as a legitimate way to support financial inclusion through internet finance morphed into a scam-ridden zombie industry. Beijing has moved to shut down the majority of P2P lenders that haven't imploded on their own. The industry is going the way of crypto, another member of the fintech family that ran afoul of China's regulators. In a recent Sina Finance commentary, former Chongqing mayor Huang Qifan gave a scathing criticism of P2P lending, likening it to a digital version of traditional pyramid schemes he says have long existed in rural China.
Financial reform in China starts to pick up
The pandemic-induced economic downturn could be a catalyst for needed financial reform in China, where foreign firms have struggled to gain market share. The Chinese economy contracted in the first quarter and will likely grow just 1.2% for the year, according to the IMF. A new UN report estimates that FDI could drop 40% this year, falling below US$1 trillion for the first time since 2005. At the same time, China's trade surplus is narrowing. Capital outflows are rising despite stringent controls, reaching US$50 billion in March and April, according to Nikkei Asian Review. Capital inflows from foreign investors in the financial sector could help stabilize the renminbi.
On May 17, the People’s Bank of China (PBOC) Shanghai branch announced the launch of the Shanghai Fintech Innovation Regulatory Trial, which follows the trial in Beijing last December. In addition, the Shanghai Fintech Industry Alliance (SFIA) was established to encourage innovative fintech programs in the Yangtze River Delta region.
Regulatory sandboxes provide fintech firms a controlled and supervised environment to test innovative products, services, or business models. Fintech innovation is an important driver of growth in the financial industry, especially in China. However, potential risks need to be addressed, notably customer security and data protection. At the same time, regulatory uncertainty could dissuade investors from investing in a company. For their part, meanwhile, regulators need to develop a deep understanding of innovative applications so that they are able to effectively regulate new business models and technologies. Thus, regulators use a regulatory sandbox to achieve a balance between technological innovation and risk prevention, so as to implement more universal policies.
Project qualification and regulator duties
In mid-January, the PBOC announced the first batch of trial applications, including the Internet of Things, APIs, smart tokens and trusted execution environment. Six projects have been approved to join in the trial scheme in Beijing, including API open banking (CITIC aiBank), supply chain finance based on IoT (Industrial and Commercial Bank of China), automatic loans for micro-credit products (Agricultural Bank of China), mobile POS (China UnionPay, Xiaomi and JD digits), Zhiling products managing smart token (CITIC Bank, UnionPay, Duxiaoman payment and Ctrip) and instant online loan (Bank of Ningbo).
In late April, the PBOC extended the second batch of sandbox experimental cities to Shanghai, Chongqing, Shenzhen, Hangzhou and Suzhou, as well as the Xiong’an New Area, a much-anticipated new economic zone. The Shanghai trial will guide licensed financial institutions and technology companies to join in the scheme, with the aim to protect consumers’ rights and assist SMEs with maintaining their operations during the COVID-19 crisis. The Shanghai financial regulator said that it would apply “soft regulatory methods” such as information disclosure, product notice, and social supervision. It will also support the local sandbox to connect with other sandboxes around the world.
Although there are similar products widely available on the market, such as instant internet loans issued by banks or internet loan providers, putting a project into the sandbox can allow it to grow freely without falling afoul of existing regulations, supporting the creation of new business models and helping familiarize regulators with them.. However, if a project does not progress fast enough in the sandbox, it may stand little chance of succeeding in the real market.
The Sandbox experience in the UK and ASEAN
The British government first developed the concept of the "regulatory sandbox." The UK Financial Conduct Authority (FCA) launched its innovation program in 2014 and has supported more than 700 firms to test their innovation with real customers in the live market under controlled conditions. The access to regulatory expertise through the sandbox has reduced the time-to-market for firms and potentially lowered related costs. According to the FCA, 90% of the firms in the first cohort have continued towards a wider market launch. And at least 40% of firms that completed testing in cohort 1 received investment during or following their sandbox test.
Across ASEAN, regulatory sandboxes are also playing their role in managing risk in fintech innovation. In Singapore, the Monetary Authority of Singapore (MAS) launched its fintech sandbox in 2016 to encourage more fintech experimentation and innovation. One company, Inzsure Pte Ltd, was forbidden to continue serving as an insurance broker after the sandbox test.
The Bank of Thailand launched a regulatory sandbox in early 2017 and encouraged innovative companies to develop services and products. In the Thai model, a startup’s innovations stay in the sandbox for a fixed period of 6 to 12 months. Successful businesses after this period can apply for operating licenses.
Sandboxes in Zhejiang and the Greater Bay Area
Hangzhou is to release its Fintech Sandbox rules this week. The detailed establishment plan will be set by Hangzhou Central Sub-branch of PBC, Zhejiang Bureau of CBIRC, Financial Bureau of Zhejiang Province, and Hangzhou Municipal Bureau of Finance.
Meanwhile, in order to accelerate financial and trade integration of the “Greater Bay Area”, the PBOC announced the release of the “Opinions Concerning Financial Support for the Establishment of the Guangdong-Hong Kong-Macau Greater Bay Area” on May 14. The PBOC produced the Opinions in collaboration with the China Banking and Insurance Regulatory Commission (CBIRC), the China Securities Regulatory Commission (CSRC) and the State Administration of Foreign Exchange (SAFE). The options include plans to promote a cross-border regulatory sandbox.
These trial projects form part of China’s Fintech Development Plan (2019-2021). According to internet bank XWBank (XinWang Bank), the fintech regulatory trials will test the best regulatory methods and provide corresponding space and system guarantees for fintech innovations based on the “regulatory sandbox” innovative regulation model.
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At first blush, UBS's bid for a digital bank license in China looks rather ambitious. Beijing doesn't give them out too often. In fact, no foreign lender in China has one. There are just four licensed digital banks in China: Ant Financial's MYBank, Tencent's WeBank, Baidu's AiBank and China Citic Bank. Retail banking has long been the holy grail just out of reach for foreign banks in China. Yet UBS sees a chance to develop a digital-first wealth management business in the country as Beijing prepares legislation that could open up the market to more foreign competition.
Finally after all the discussions about China's central bank digital currency, we're getting close to the actual launch as the platform goes into pilot.
China has demonstrated a willingness to innovate in the financial services technology sector. For example, the Chinese government has announced accelerated plans for a Central Bank Digital Currency (CBDC), the People's Bank of China (PBOC) has filed scores of CBDC patents and fintech initiatives like Baidu’s Xuperchain network have been introduced to great fanfare. What's more, the PBOC's Fintech Development Plan (2019 – 2021) expresses support for technological innovation, including the use of public cloud.
However, the Chinese government is also traditionally cautious in regard to security and control. Thus, financial services companies in China who are contemplating the migration of critical business applications to the cloud would be well-advised to plan carefully. To that end, Chinese regulators have reportedly engaged in private conversations with information security representatives from several foreign banks, advising them that critical hosting engagements in the cloud will need to be handled exclusively by specialised "Financial Community Cloud" providers who have been certified by the government.
Why is Tencent investing in European fintechs?
Tencent is stepping up its fintech investments outside of China, where it and Alibaba's fintech arm Ant Financial effectively have a market duopoly. One approach for Tencent is direct expansion - the launch of WeChat Pay in international markets. That's a good idea in any country frequented by Chinese tourists or business travelers.
But direct expansion only goes so far, especially in developed economies. Tencent doesn't expect consumers in Europe or the United States will opt for WeChat Pay instead of Apple Pay, Google Pay, or apps created by local banks and fintechs. Instead, the Shenzhen-based company is taking strategic stakes in ascendant startups, including French mobile payment app Lydia and challenger bank Qonto. These investments will give Tencent a chance to grow its fintech business in Europe through local rising stars.