China announced a series of draft provisional rules to regulate the country's problematic online lending sector three weeks after the Ezubo case. Photo: SCMP Pictures
Three weeks after the Ezubo case, the China Banking Regulatory Commission, together with some other government agencies, announced a series of draft provisional rules to regulate the country's online lending sector. The rules authorize the local financial regulators to take the lead in the overhaul aimed at promoting a healthy development of the problematic industry and meeting the demand of small and medium-sized enterprises eager for safe financing channels. The draft is circulated for public comments.
According to the draft, which imposes 12 restrictions on online lenders, P2P platforms are categorized as the intermediary agencies that can only provide services ranging from information collection and exchange to credit assessment and matching lenders with borrowers. They are not allowed to set up capital pool, in order to prevent illegal fundraising. The rules also ban P2P platforms from working with other financial institutions, agencies and brokerage firms to conduct offline sales activities. In addition, P2P platforms are stipulated to sign fund trusteeship agreements with eligible banking institutions through which the capital accounts of lenders and borrowers are managed and monitored in case of possible risks.
Following the release of the draft, many local financial regulators called a halt in registration of Internet finance firms. Thepaper.cn, a leading digital news outlet in China, reported earlier this month that Shanghai's industrial and commercial bureau had suspended the registration of Internet finance firms starting from January 4, 2016. Registrations involved with finance and business outsourcing will not be approved, said thepaper.cn. Big cities including Beijing, Shenzhen and Chongqing also followed suit, media reports said.
Statistics from wdzj.com, an Internet finance data provider in China, showed that there were 106 newly added problematic P2P platforms in December 2015, 52 percent of which have run away with investors' money. As of the end of December last year, the total number of China's P2P platforms amounted to 3,858, but the number of problematic ones was as high as 1,263, according to statistics from wdzj.com.
Thepaper.cn quoted an analyst as saying that the registration suspension is the first step taken by local financial regulators, which will be followed by a series of dyed-in-the-wool audit and rectification. The registration will resume after local financial regulators work out formal regulatory rules, thepaper.cn cited the analyst as saying.
"The registration ban will not be lifted in the short run, but it will have little impact on the already registered Internet finance platforms," said Tang Seng, project director at daicash.com, a Chinese online lending platform.
Tang said that the draft regulation, which specifies 12 "red lines" P2P platforms cannot cross, dashed previous expectations that the rules will focus on the registration capital management, by paying more attention to the P2P platforms' obligation for sharing information with investors and the establishment of fund trusteeship cooperation with banks.
"The registration suspension will leave some leeway for local financial regulators to assess possible risk exposures in the sector," said Li Zichuan, chief information officer at wd315.cn, a Chinese P2P platform, adding that the implementation of the formal regulation will plunge the online lending industry into a "cold winter".
But Huang Shiqiao, chief executive officer of touzhijia.com, another P2P platform in China, said that the online lending industry is still at "a nascent stage with large growth potential", despite the fact that the lack of supervision has meant that an increasing number of online lenders have been involved in fake investment projects and illegal fundraising.
Competence of local financial regulators
The provisional regulation assigns the China Banking Regulatory Commission, the Ministry of Public Security, the China National Internet Information Office and local financial regulators to supervise the P2P platforms, which are ordered to complete a rectification within 18 months. According to the provisional regulation, the China Banking Regulatory Commission, the banking regulator under the State Council, China's cabinet, will be responsible for formulating unified industry and supervision rules and offer guidance to the local financial regulators which are responsible for dealing with the financial risks and monitoring the P2P platforms, in order to prevent illicit activities such as illegal fundraising.
Police urge depositors from Ezubo to follow the procedure as they line-up outside the State Bureau for Petition in Beijing to file complaints in December 2015. Photo: AP
"After the 18-month deadline, the local financial regulators will face the dilemma of whether they close most of the ineligible P2P platforms or turn a blind eye to them till judicial intervention," said Huang Yiping, deputy dean at the National School of Development of Peking University and member of the Monetary Policy Committee of the People's Bank of China.
Huang is concerned about the local financial regulators' competence in managing and supervising the P2P platforms because their businesses are cross-regional and the money they raise is basically from retail investors nationwide who are not fully capable of assessing and bearing financial risks, which will lead to the proliferation of the risks.
"Most of the P2P platforms will find it difficult to accomplish the transformation (mandated by the interim regulation) within 18 months…And in fact, some local financial regulators are incompetent of supervising the online lending sector," said the central bank advisor.
The provisional regulation stipulates that the lenders should have experience in investing in non principal-protected wealth management products, and are familiar with the Internet. But in real life, many P2P platforms have attracted through offline sales a large number of retail investors who are above 50 and have little knowledge about Internet finance.
According to data from huirendai.com, a Chinese Internet-based wealth management platform, 19.2 percent of its retail investors in 2015 were people above 50 years old.
Can banks play the role as fund trustee?
The provisional regulation also stipulates that P2P platforms should trustee the lenders and borrowers' fund to the qualified banking financial institutions which are responsible for capital account opening, fund trusteeship, payment and accounting, and regularly reporting data information to the superiors. But the banking financial institutions have no need to evaluate the credibility of the P2P platforms' fundraising projects and the information related to lending transactions, says the provisional regulation.
Xu Xianliang, chief executive officer of lanmao.com, a Chinese online fund trusteeship platform, said that the 18-month period will also leave enough time for the banks to improve their fund trusteeship and payment systems but not at the cost of the stability and quality of the two systems. Xu pointed out that the regulators' dependence on the banks in their effort to regulate the online lending sector will give rise to the growth of a batch of third-party banking system service providers, especially those with innovative Internet ideas.
"Fund trusteeship can effectively separate investors' money from the P2P platforms so as to reduce the risk of fund embezzlement," said Zheng Haiyang, vice general manager of shengcaijinrong.com, a Chinese P2P platform, revealing that his company has been in talks with some state-owned banks over fund trusteeship cooperation ahead of the release of the provisional regulation.
But a survey conducted by wdzj.com shows that there are only 70 P2P platforms nationwide that have fund trusteeship cooperation with the banking financial institutions.
Zheng attributed it to two factors: high cost and distrust from the banks. On the one hand, P2P platforms are reluctant to entrust banks as fund trustees because the service will have high fees, while many P2P platforms are currently seeing a profit decline; on the other hand, banks are fearful of being used as a tool to enhance some P2P platforms' credibility.
A report released by the Payment and Clearing Association of China shows that most of the P2P platforms prefer to use third-party payment institutions, instead of banks, as their fund trustees due to the high threshold of the banks' fund trusteeship service and the complicated approval process.
At present, the banks which have established fund trusteeship cooperation with P2P platforms are almost all stock-holding banks, with the number of big state-owned banks limited, said an International Finance News report.
What's more, the P2P platforms backed by the state-owned banks tend to be favored by investors because of the good brand image and government endorsement. But some analysts pointed out that entrusting unassociated banks as the P2P platforms' fund trustee is the future development direction of the online lending industry, and that only by innovation can the P2P platforms make themselves standout among competitors, no matter who acts as the trustee.