Beijing has spent years sitting back and encouraging its powerful fintech firms to create and innovate. But it is starting to crack down on parts of an industry that it feels may have grown too far too fast, starting with peer-to-peer lenders.
It is no secret that China’s fintech sector has seen spectacular growth. Alibaba and Tencent, while still mostly domestic in focus, are already global names in their own right: Hong Kong-listed Tencent had a market cap of $495 billion by the middle of May, while New York-listed Alibaba was only $2 billion behind. Only five companies – Alphabet, Amazon, Microsoft, Facebook and Apple – all US-based, are more valuable. These two Chinese firms are the respective owners of Alipay and WeChat Pay, the country’s most profitable digital payments services, and are just the tip of the spear.
Of the world’s 27 fintech ‘unicorns’, or firms with valuations above $1 billion, nine are Chinese, according to TechCrunch. Barely a week seems to pass without a fintech outfit from the mainland announcing its intention to go public. In March, three such companies filed listing documents with the Hong Kong securities regulator. In April, Weidai, a micro-lender based like Alibaba in Hangzhou, said it planned to raise $400 million in an IPO in the second quarter, also in Hong Kong.
The allure of investing in one of these bright young things is easy to explain. Beijing has spent the last several years tacitly encouraging entrepreneurs to find new ways to disrupt its financial sector, simply by sitting back and doing nothing. “The whole of China is a regulatory sandbox, a safe zone for startups to test new applications and ideas,” says Dexter Hsu, an analyst at Macquarie who covers Greater China banks and fintech. “If they don’t explicitly say you cannot do it, you can do it.”
So startups have. A blend of factors including laissez-faire government policy, an exceptionally large online public (China had 772 million internet users at the end of 2017, more than the combined populations of the EU, Russia and Japan) and an underdeveloped banking sector have conspired to give the domestic industry less of a leg-up than a jet pack. From a standing start, China has quickly become the global leader in online lending. It accounts for three quarters of the global market, mostly by connecting less creditworthy borrowers to private lenders keen to generate outsized returns on their capital.
In 2017, China’s peer-to-peer (P2P) lending institutions completed transactions worth $445 billion, according to San Francisco-based LendingClub, which connects borrowers and investors in the US. But anyone keen to put their money to work in the sector, or to see this as a golden age of financial innovation, would be wise to remember who guards the sandbox. It was the Wild West here for decades. The government likes to let experiments get started, then step in when industries are big enough to withstand a crackdown – David Li, Shenzhen Open Innovation Lab Beijing has always been acutely aware of any threats to its supremacy, or to any peril that could erode social stability and thus the Communist Party’s grip on power. The government of Xi Jinping, China’s most authoritarian president in decades, views fintech and digital disruption in general as a “double-edged sword”, says a consultant who has advised, among others, the banking and state asset regulators.
“They are proud of the digital giants who make China look big and strong on the world stage,” says this consultant. “But they fear the downside – micro lenders who rip people off, payment flows they cannot see or control.” So it has come as little surprise to see the authorities put their foot down. In May, the ministry of industry and information technology said it would start to produce ratings for blockchain products, in an attempt to regulate the technology that underpins virtual currencies such as bitcoin and ethereum. Beijing banned initial coin offerings last year, blocking websites that offered cryptocurrency trading services.
That, says one analyst, was a sign that the authorities will “crack down completely on technologies that it believes create too much uncertainty and danger”. It has also followed through on a threat, first made in October 2017, to place curbs on the thriving but lightly regulated online micro-lending market, whose reputation has been hammered by a spate of failures, frauds and scandals.
The most notorious of these was Ezubao, a P2P lending platform that collapsed in 2016 after collecting Rmb59.8 billion ($9.44 billion) from 900,000 investors, Rmb38 billion of which it failed to repay. In court, the firm’s own executives described it as a “complete Ponzi scheme” that they used to bilk customers and fund their lavish lifestyles.
Indeed, barely a month goes by without another eye-watering swindle making the news. In April, authorities in Shanghai arrested eight executives at Shanlin Finance, an unlicensed financial institution that disguised itself as a peer-to-peer lending platform, which raised Rmb60 billion from customers before running out of cash. “Some of the practices have really got out of hand in recent years,” says an executive at a Shanghai fintech investment fund. “You see people borrowing money on P2P platforms to fund the down-payment on their mortgage – it’s the same mentality that convinces others to buy bitcoin on their credit cards.”
That helps explain the more nuanced aspects of new P2P rules, including demands that providers cannot promise stable returns. “The point is to show lenders and borrowers that these are riskier investment practices,” says one analyst. Contagion Beijing’s crackdown on the sector has been systematic rather than aggressive, with the aim of ring-fencing smaller or shakier firms in order to limit any future contagion. From the middle of 2017, agencies reporting to the central bank started to close down unlicensed or fraudulent P2P platforms. Many reputable outfits opted to shut up shop rather than face heightened scrutiny. One, Hongling Capital, said it would close down its online lending unit by 2020, after its founder and chairman, Zhou Shiping, admitted P2P lending was “neither what we are good at, or something we see potential in”.
But closing down errant operators and waiting for others to fail was clearly too passive an approach for many in power. This April, regulators announced the introduction of a record-filing system that will limit the size of any loans made through P2P platforms to Rmb1 million for individual borrowers and Rmb5 billion for firms, force providers to use custodian banks, cap nominal annual rates at 36%, and bar lenders from guaranteeing principal or interest on loans. The rules surrounding the system remain sketchy, despite demands that operators comply with them by the end of June. The new system is at heart exactly and simply what it says: a process that requires P2P platforms and online lenders to tell the authorities who they are, where they are, and to whom they lend. But that will be enough, reckons an executive at a leading peer-to-peer lender, to “force most smaller players out of the industry for good. A lot of them operate at the edges of the law, if not beyond the margins. They don’t want the authorities to know who they are.”
So what happens now? Is Beijing’s aim to clip the wings of P2P firms and to formalize and consolidate an industry that had grown too far, too fast? If so, what does that mean for those heavily invested in the sector? Or does the Party desire something more: to bring to heel every digital disruptor, from micro-lenders to payments firms, reminding them who is in charge and of their wider responsibilities to state and country? That Beijing is determined to crack down on errant or marginal or just overly boisterous online lenders is clear to see. From an estimated 6,000 in early 2016, the number of P2P lenders in China has dropped sharply, to fewer than 1,500 by the end of April 2018, analysts say. And the number will continue to fall.
“Many will be wiped out,” says Macquarie’s Hsu. “You’ll end up with P2P down to 400, micro-lenders down to 100. Don’t be too optimistic about this corner of the fintech industry. Before, no one cared who was lending to whom, what the level of interest rate was, who owned your debts, and who oversaw or ensured repayment. Any small outfit that isn’t cost-efficient will get wiped out.”
Logic There is logic to Beijing’s crackdown. Until 2014, the P2P sector was limited to a few relatively large and well-known players. At that point, several provinces in southern and eastern China took advantage of malleable or non-existent rules by handing out new lending licences. Startups and newly minted units of financial institutions, from trust companies to wealth managers, were allowed to lend to small firms and retail customers not just at home, but in any one of the country’s 32 provinces and regions.
These firms rushed to set up new offices, some building thriving national networks. The trouble, says Hsu, was that once they were outside their home province, “many of them weren’t regulated by anyone at all. Local regulators had no oversight across a provincial border. And the central banking and securities regulators didn’t know who they were, and often had no jurisdiction.”
This is “just part of China’s process of completing its financial regulation,” says David Li, who founded Shenzhen Open Innovation Lab, a promoter and accelerator of fintech startups based in the tech-driven southern city. “It was the Wild West here for decades. The government likes to let experiments get started, then step in when industries are big enough to withstand a crackdown.” Several people interviewed for this story drew a direct line between the clampdown on wayward lenders and the appointment in March of Guo Shuqing as chairman of the powerful new China Banking and Insurance Regulatory Commission.
A former chairman of China Construction Bank, Guo is considered one of president Xi’s allies – and vital to Party efforts to avert a future financial crisis that could stem from rising debt, inflated asset prices, or unregulated new technology.
“China has been very lucky not to have suffered some kind of systemic crisis already, given its speed of growth,” says Zennon Kapron, founder of Shanghai-based financial research and advisory outfit Kapronasia. “But history tells us that some kind of crisis will happen – it’s a matter of when, not if.”
In recent months, authorities have introduced stricter rules overseeing the onshore money market fund industry, which has transformed the way millions of Chinese save, and which has grown exponentially in recent years. Assets under management hit $1.1 trillion at the end of 2017, up from $680 billion the previous year, according to the Asset Management Association of China. In February, Beijing capped how much investors can redeem in a single day, limiting the total to Rmb10,000 in an attempt to allay any threat of systemic financial risk. “Party leaders worry when they look at the size of these numbers,” says a Shanghai-based technology investor.
“When it comes to online payments, they are in effect letting private companies dominate the flow of money around the country. And there are other issues at work too, including corruption and money laundering. Banks are regulated – it’s right that fintech companies are, too.” Then there is Beijing’s push to co-opt the country’s digital and fintech firms into realizing president Xi’s broader nation-building goals, from knitting society more closely together, to policing it more effectively and transforming the economy into a leader in everything from AI to quantum computing. Tencent’s WeChat messaging system is used to monitor crowds at public events, while on its website it has claimed that its cloud services help to “standardize and streamline Party-building work”.
Another online giant, e-commerce firm JD.com, is working with the People’s Liberation Army to upgrade the army’s logistics and procurement systems. Flourish That’s not to say that financial technology in China has reached its high-water mark, or that the nation’s digital companies are done disrupting – far from it. Mainland-based technology firms raised $58.8 billion in fresh capital from investors in 2017, up from $56.1 billion in 2016 and $45.1 billion in 2015, according to media-and-data firm Tech in Asia. DiDi, a leader in AI and autonomous technology, secured $5.5 billion, the largest single investment for 2017.
As Asiamoney went to press, Ant Financial, the fintech firm controlled by Alibaba founder Jack Ma, was reported to be close to raising fresh funding of at least $10 billion from investors including Carlyle Group and the Canada Pension Plan Investment Board. Meanwhile, digital banks and payments services continue to flourish, even as new competition enters the fray. One of the newest online lenders, AiBank, a joint venture between search company Baidu and China Citic Bank, that uses big data to target individuals and small firms, was launched in December 2017. And investors are eagerly anticipating a brace of big-ticket Hong Kong IPOs. Xiaomi, which makes smartphones, and Meituan Dianping, a delivery firm backed by Tencent, are expected to raise up to $10 billion from their respective IPOs before the year is out.
“We are not looking at the end of innovation boom but just a course correction on certain booming sectors,” says Open Innovation Lab’s Li. Nor has P2P run out of steam. True, a year of closures and new regulation has battered valuations. New York-listed Yirendai has seen the value of its stock fall 40% since hitting a high of $50.53 in October last year, just as Beijing set out plans to clamp down on the sector. Another leading player, Qudian, has seen the value of its shares slump 70% since completing a $900 million New York IPO in October. Macquarie initiated coverage on Yirendai and Qudian in November 2017, setting its target price for the stocks at $60 and $36 respectively.
It remains committed to its forecasts, praising Yirendai’s lower regulatory risk and funding costs and Qudian’s decision to anticipate new rules by peremptorily capping interest on loans at 36%. The Guangzhou-based firm boasts Ant Financial as an investor, guaranteeing it “easier customer retention, superior asset quality” and higher customer flows, Macquarie added. Moreover, this is a sector that’s generating profits.
A report by Macquarie Research last November shows that fintech lending companies had a collective profitability of about Rmb2.8 trillion in the first half of 2017, against Rmb2.1 trillion for the whole of 2016 and following small losses in both 2015 and 2014. Yirendai reported net income of Rmb1.37 billion in 2017, up 23% from the previous year, while net revenues jumped 71% to Rmb5.54 billion. Total new loans in 2017 more than doubled to Rmb20.5 billion. Still, some have cautioned investors to pause before buying back into P2P stocks.
“I’d take a wait-and-see approach, as the other shoe has yet to drop in terms of regulation,” says Kapronasia’s Kapron. “We will certainly see consolidation in the market in the long term, which will benefit the bigger and better players, but the risk surrounding these stocks will remain in place for at least another six months.” Yet for all the uncertainty surrounding the sector, it is hard to see traditional P2P lenders or new fintech lending platforms (whatever they may look like in the future) going away.
Macquarie says fintech lenders are a “formidable threat to banks”, and that they are “poised to dominate consumer finance” in China for years to come. It tipped total outstanding lending by P2P institutions to hit Rmb2.9 trillion by 2022, up from Rmb1.2 trillion in 2017. “The crackdown won’t be good for smaller or shakier firms,” says its analyst Hsu. “But it will be good for the sector in the long term, as legitimate players are able to consolidate and emerge as real powers.”
Besides, Beijing needs their ability to match cash-rich lenders with smaller or poorer borrowers, particularly at a time when many state banks face a funding crunch. “These platforms provide substantial benefit to the financial industry and to the economy,” says Kapron. “They are a vital source of liquidity for small and medium-sized enterprises, which are the lifeblood of China’s economy, and they have helped raise levels of financial inclusion and empowered women. At their best, they are tremendous economic and financial levellers.”