Inside China: New rules for fintechs by SBR’s Jeremy Stevens

LAGOS (Capital Markets in Africa) – Policymakers in China are bringing technology firms into alignment with national priorities to ensure that policy intent is met, fostering innovation that serves the real economy and improves wellbeing, whilst preventing financial risks though prudent regulation. The implication is that central government has made a value judgement: only innovation that serves the real economy, and doesn’t compromise financial stability, will be provided pathways to flourish. However, given a choice between encouraging innovation and preventing risk, China’s regulators prefer the latter option.

Beijing seems unconvinced of a simple trade-off between state intervention and innovation. Instead, the “healthy development” of fintech requires the state and big tech to move in lockstep, cooperating to “forge a national competitive edge.” At the minimum, state guidance represents the cornerstone of industrial policy which is tuned for creating the incentive structures to liberate the positive forces of innovation. At a maximum, state control of the entire business ecosystem is a critical input for innovation.

A series of rules unveiled in the past few months has zeroed in on fintech – home to some of China’s most successful businesses, entrepreneurs, and national champions. This is utterly consistent with the path taken in other sectors of the economy, such as insurance, banking, real estate and others. Previously, regulations facing fintech players had a lighter touch, divergent from traditional financial institutions. In other words, in fintech, “tech” was given greater emphasis than “fin”.

Those days are now over. The official view – communicated by a host of senior policymakers in recent months – is that fintech has not necessarily changed the essence of finance. Therefore, businesses and entities operating in the space must be treated equally. Emerging is a broad-based campaign to rein in the financial services operations of fintech firms. Furthermore, even though most of the emphasis has come from the financial regulator, other agencies have started on some auxiliary fronts, and numerous agencies have included fintech in their priority lists for 2021.

The rationale for the focus on fintech is a rather lengthy list of issues ranging from anti-competitive practices and the failure of innovation to serve the public, to excessive online micro-lending, banks raising deposits using technology platforms, and non-banks collecting deposits. For fintech companies specifically, this translates into far greater scrutiny and supervision; hot topics are curbing monopolies, organizing and managing the expansion of capital, and better protection for consumers.

We believe that this clampdown is merely the beginning of the regulatory adjustments many firms will have to make. What emerges reading the 14^th Fiver Year Plan (14 FYP) is that (i) Beijing remains as committed as ever to ensuring financial stability, and (ii) the financial de-risking campaign is the important lens through which to view the crackdown on fintech. Indeed, in the orbit of de-risking, a full chapter was dedicated to dealing with fintechs.

One related issue for the authorities is that the fintechs are becoming “too big to fail”. In fact, Chinese tech giants may well be broken up. According to the new regulations, for example, a non-bank payment company with half of the market in online transactions or two entities with a combined two-thirds share may be subject to antitrust probes. Currently, Alipay and WeChat Pay account for 55.6% and 38.8% respectively of China’s mobile payments market.

China’s anti-monopoly drive will intensify. Again in the 14 FYP, antitrust issues were confronted from a few telling angles, artfully linking the clampdown to some pressing national priorities. First, clamping down on anti-competitive practices were required to preserve an “orderly” market. Second, the accumulation of wealth to fintech exacerbated income inequality. Third, big tech’s may hamper data resources from circulating fluidly throughout the digital economy. Fourth, job creation is central and cannot simply be made subservient to the quest for greater efficiency.

Related, regulators have warned fintech about anticompetitive behavior too. According to CBIRC Chairman Guo Shuqing “big tech firms tend to hinder fair competition and seek excess profits”. In fact, Chinese President Xi Jinping mentioned “abuses of dominant market positions” by internet industry players back in 2016. Just this week, Chinese regulators published antitrust rules for the internet industry targeting behaviour such as unfairly forcing users to choose between platforms. Previously, selling below-cost to strangle the competition, and improper use of data and algorithms, has also been highlighted as concerns.

The message regulators are sending goes well beyond anti-monopoly issues. Rather, they want online business practices to reflect sound and legal business practices. The country’s industrial regulator, the Ministry of Industry and Information Technology (MIIT), for example, has taken umbridge for data privacy breaches. Meanwhile, the China Consumer Association (CCA) published a statement, naming and shaming some for both violating consumers’ rights and manipulating their behavior.

Regarding the disorderly expansion of capital, the CBIRC has launched a broad campaign to rein in tech companies’ involvement in finance, particularly their collaborations with banks. Many banks had teamed up with internet companies to expand consumer lending. These partnerships provided banks allowed them to reach a broader range of customers than otherwise. Banks can no longer acquire customers beyond their geographic remit. Also, tech firms involved in online lending ventures with banks to contribute at least 30% of the funds involved. The CBIRC has also told banks that they must cease outsourcing core functions – such as loan origination and borrower risk assessment – to technology companies.

The PBoC has also adjusted in regulations of the client reserves held by non-bank payment institutions. Previously, for an e-commerce transaction, a customer typically authorizes payment to a third-party in advance of making a purchase. This allowed payment providers to pool customer reserves and invest them in revenue generating avenues. The requirement now is that fintech firms must hand over that cash to designated banks, benefiting the formal banking system.

Microlending too faces determined regulation. The path of peer-to-peer (P2P) online lending industry offers a cautionary tale. By late 2020 all P2P platforms had closed – from a peak of about 5,000. Among other stipulations facing microlenders, the draft rules require that firms that do business across provincial lines must maintain a minimum of CNY5 bn in capital. Currently less than a handful out of China’s over 200 inter-provincial microlenders meet this requirement.

In conclusion, China aims to strike a balance between encouraging fintech development and preventing financial risks via prudent regulation and greater scrutiny. Put plainly, even national tech champions should be compliant with national policy objectives – be that financial derisking or data privacy protection or creating jobs. For fintechs, this translates into curbing monopolies, preventing the disorderly expansion of capital, and with better protecting consumer data privacy.