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Internet Finance Regulation: Not Everything is Black and White

by Major Tian

July 20, 2015

Internet-finance-01
Illustration by Chao Fansen/CKGSB Knowledge

The government has finally issued guidelines to regulate China’s internet finance industry, but the devil may lie in the yet-to-come details.

China’s booming internet finance industry has hit a new milestone over the weekend, as Chinese regulators released preliminary guidelines on how to regulate the lucrative but also highly risky business.

The 6,000-word-long document, jointly written by 10 government agencies, tries to categorize different business models in the industry and establish basic regulatory principles for each of those models. It also stipulates eight general provisions on subjects such as information disclosure, internet security, crime prevention, industry self-discipline, etc. While the document has clarified many key issues for companies operating in this field, it hasn’t cleared up all the confusion for market participants, as more detailed regulations still need to be made in the future.

Nice Gesture

Given Beijing’s promotion of the “Internet Plus” strategy and “public entrepreneurship and innovation”, it doesn’t come as a surprise that the guidelines begin with six provisions stating how internet finance will inspire positive changes in China’s rigid financial system and how the government will facilitate growth in the industry.

“Financial regulators should actively support financial institutions to carry out internet finance businesses,” the document says. “The commercial administration should support internet companies to register [as financial service providers] legally…. And the telecommunication and internet information regulators should actively support internet finance businesses as well.”

This creates a friendly environment for the industry to grow, as the government will adopt a slew of supportive policies, such as encouraging investment into this field, giving tax breaks for internet finance start-ups and granting qualified institutions access to the central bank’s credit data base, according to the guidelines.

“The government wants to support internet finance because China’s financial system is still quite underdeveloped compared with western countries, especially in areas such as small-and-medium enterprise financing, personal credit system building and data mining,” says Cao Huining, Professor of Finance at Cheung Kong Graduate School of Business. “But on the other hand, internet finance, in essence, is still finance, and it has certain vulnerabilities that require vigorous regulations. So I think that’s the general mentality of the Chinese regulators now.”

Turfs Assigned

To tighten the government’s grip on internet finance, the first challenge for regulators is to understand various business models in the market and then classify them accordingly so that they fall under the jurisdictions of different government agencies.

In the guidelines released on Saturday, regulators summed up six categories of internet finance operations, namely internet payment, internet loans, equity crowdfunding, internet sale of funds, internet insurance, and internet trust and consumer finance. Different regulative bodies are assigned to each category: for example, the People’s Bank of China will be in charge of online payment; China Banking Regulatory Commission will supervise internet loans and internet trust and consumer finance; and China Securities Regulatory Commission will preside over online funds selling and equity crowdfunding.

“I was a bit surprised by how detailed the categorization is,” says Lu Yi, a partner at an online lending platform called Zhao Cai Bank. Lu, a well-known figure in the peer-to-peer lending industry (P2P) in China, said that he only expected a more vague framework as the document is the first of its kind. “Compared to rumors about the document before, this one is clearly written by experts and it shows how serious the government is about the development of the industry,” he adds.

Details to Come

Now that the responsibilities have been divided, the tough part is for each regulator to come up with detailed stipulations that are practical enough for companies to follow. Both Cao and Lu said that they expect more regulations to emerge soon, given that the current guidelines haven’t provided enough answers for market participants worrying about the legality of their businesses.

One example is in the P2P business, a relatively high-risk area where hundreds of platforms have collapsed or vanished as a result of poor risk management or financial fraud since 2014. To rein in the moral hazards of misusing lenders’ money, the 14th provision in the new guidelines stipulates that lenders’ funds should be parked separately from the platforms’ accounts in banks, which will be entrusted to manage and supervise the transactions of these accounts.

The key issue is not whether a third-party should be introduced, but which parties are qualified to act as trustees. Currently hundreds of P2P platforms are working with non-banking institutions to manage funds and payments, and if the 14th provision is enforced in the end, it means that all those firms would need to switch partners to banks.

“I think the door for non-banking institutions won’t be completely closed,” says Lu. “Perhaps they will be able to serve a relatively low level of platforms in the future.”

Lu says that he has been trying to work with banks for entrusting funds and that his company will also enhance information disclosure on its website. But before more details are announced, there’s not much he can do. “Sometimes you are eager to work with the bank, but the bank may not want to work with you,” he says.

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