Banking & Payments
Where do China’s fintech giants now stand?
CLSA analyst Hans Fan argues China’s regulators have treated fintech reform with a light touch.
Hans Fan Haishuo, deputy head of China research at CLSA, says the market is overly bearish on the idea of a regulatory crackdown on its big internet companies.
The cancellation of Ant Group’s IPO in November 2020 drew attention to regulators’ unhappiness with Ant and, by extension, Tecent and other giant internet companies with huge fintech businesses.
Since then, the authorities have begun to regulate these tech companies more like banks. This raises several questions about the viability of fintech in China.
In an interview with DigFin, Fan says Chinese fintech companies’ business models will remain intact in the wake of this regulatory overhaul.
He believes the regulators have completed the broad outlines of their reforms. Detailed rules will continue to emerge, but he rejects the notion that the likes of Ant or Tencent will be punished or sidelined. “The phase of tightening fintech regulation has peaked,” he said.
What are the fears regarding Chinese internet companies and fintech?
First, the example of China’s crackdown on peer-to-peer lenders beginning in 2018 shows the regulators can almost entirely eliminate an industry they don’t like.
P2P lenders in China, which relied on individual investors, grew to outstanding loans of $218 billion across 6,000 platforms. These platforms operated with little oversight and authorities estimated some 40 percent of assets were trapped in Ponzi schemes.
A heavy regulatory campaign has led to only 29 P2P platforms left, as of August 2020. Major players such as Lufax exited the business. The China Banking and Insurance Regulatory Commission (CBIRC) reckons there is still $115 billion worth of loans that haven’t been returned to investors.
That is not an outcome that Ant or Tencent would welcome.
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Second, the CBIRC and the People’s Bank of China have said they want Ant to “return to its roots in payments”, while ensuring that mobile payments will remain an unprofitable business. The fear is that Ant and WeBank (Tencent’s virtual bank) would be shut out lucrative businesses such as lending, wealth management, and insurance. If they are to engage in lending, for example, they must add a substantial amount of their own capital rather than simply rely on banks’ balance sheets; while their biggest competitive advantages – their customer data – could have to be shared.
Third, the PBoC in January warned that companies found to be monopolies could be broken up. The threat of Ant and WeBank being nationalized and pulled apart would be the worst-case outcome, reminiscent of the P2P collapse.
Fourth, the pilot test of China’s eRMB could be interpreted as throwing down the gauntlet to the internet giants. The DCEP (digital currency-electronic payment), or digital yuan, would break open the closed-loop systems of the internet giants, by allowing people to use DCEP instead of having to use AliPay for Alibaba or WeChat Pay for Tencent apps.
Combined with the other new restrictions, and it seems like Ant and Tencent are being forced to accept being mere payments infrastructure
Fan says the key initiatives ended up coming down lightly on internet giants. (He declined to comment specifically on Ant or Tencent.)
First, PBoC issued guidelines on payments in January, most importantly rules on what constitutes a monopoly and therefore could be subjected to anti-trust action.
First, if one company has more than a third of a market, or two companies together have more than half, they will be subject to “interviews”. This clearly applies to Ant and Tencent in the realm of mobile payments, where the two giants account for over 90 percent of volumes.
Specific to payments, a breakup is required if a fintech company is deemed “dominant”, defined by the volume of total nationwide digital payments. This definition includes banks and the large transfers they facilitate for corporations and state-owned enterprises.
Fan says the two internet giants constitute a mere 7 percent of this figure. They don’t come close to qualifying for anti-trust action. But they will now be subjected to regular “interviews” by regulators, which will provide off-the-record guidance. This is something that banks already experience. Fan guesses this guidance will go to ensuring merchant discount rates are kept low so that digital payments continue to grow.
“The authorities regard digital payments as infrastructure,” he said. “They want transaction costs to stay low.”
One QR code to bind them
The authorities have also promulgated two other important measures for payments. First, they have announced they will introduce a unified QR code. Today merchants use QRs that are affiliated with a given payment provider. Customers often have to choose a payment method based on whatever QR code the merchant offers.
A unified QR code will allow customers to shop using their preferred app. Competition will migrate to apps providing the best consumer service rather than to capturing merchants with payment gates.
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On Sunday, February 7, China’s State Administration for Market Regulation passed additional rules prohibiting internet companies from forcing merchants to choose among them. It also bans price fixing, restricting technologies and manipulating the market.
The internet giants have poured resources into merchant acquisition, so these rules will bite into their business financials. But the restructuring won’t affect overall volumes.
The third initiative is the launch of China’s eRMB, its DCEP program (for digital currency-electronic payment).
Fan says the impact domestically will be mild, rather than undermining the big tech players. He estimates DCEP will end up replacing 20 percent to 30 percent of cash over time. Banks are the primary distributor of DCEP, and they will want to provide merchants an attractive MDR. Fan says the main impact on internet companies will be to prevent them from making profits out of payments and encourage them to compete on service and a great user experience.
Where Fan sees DCEP as potentially having impact is overseas. “The PBoC will ensure that DCEP can be used everywhere,” he said, adding he thinks one of its purposes is to internationalize the renminbi.
And this is where China will rely on the likes of Alibaba and Tencent, which together operate in over 50 countries. They have huge overseas networks for consumers and small businesses, much bigger than any bank’s. The banks are limited to wholesale connections, largely among Chinese SOEs and projects, but if China really wants the rest of the world to start using the digital renminbi, it will need its tech giants to lead the way.
Fan says the demands on internet companies to share their data is real but limited. The PBoC has set up three bureaus in an effort to establish a personal credit-scoring system, akin to FICO in the US.
First it set up one within the central bank for financial institutions. Second it set up Baihang Credit in 2018, a credit bureau for non-bank lenders. Now it has licensed a third, Pudao Credit, a joint venture backed by Beijing Financial Holdings Group, JD Digits, and Xiaomi, among others.
Fan says these credit businesses will gather information for credit reports but do not represent a comprehensive score like FICO, at least not yet.
As for the new demand by authorities for internet companies to share their credit data, Fan says the detailed rules have not yet been decided. “There are still debates about who should own the data and how to use it,” he said.
Finally, Fan says the rules around fintech lending have turned out to be benign to internet companies.
CBIRC’s rules now make a distinction between co-lending and pure loan facilitation. About 60 percent of fintech lending today is co-lending, that is, tech companies lending alongside banks. CBIRC has raised the capital requirement so that fintechs must now put up at least 30 percent of the capital when doing so.
This is a big change for tech companies that might rely on banks’ balance sheets for nearly the entire loan. On-lending comes with some advantages (including no cap on interest rates, as per recent court rulings) but fintech companies must now pay up in the form of their own capital if they wish to engage in this activity.
Fan expects the pure facilitation model to go from 40 percent to 60 percent of fintech lending over the next three years. In this model, banks provide all the capital and are simply paying the fintechs for access to their customers and their customer data, to plug into banks’ own risk models.
This may lower profitability for fintech companies but it doesn’t put them out of the game, Fan says. Indeed, at least for a few years, fintechs will not compete head-on with banks for lending business, because they are chasing different customer segments.
By way of example, he says the average AUM per person at China Merchants Bank is Rmb55,000 versus around Rmb7,000 for AliPay. One is targeting high-net-worth individuals, the other is serving the mass market.
Fan says these lines are now going to blur, as tech companies and banks begin to compete for the middle class. Banks are working to digitize their consumer and SME portfolios, while tech companies will want to break into credit cards and mortgages.