Financial Services Special Report: China s Fintech Market

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1 July 216 Financial Services Special Report: China s Fintech Market SUMMARY China s fintech market has surged on the back of a booming internet finance sector, with online payments, lending, and sales of investment products leading the way. China s tech giants (Baidu, Alibaba, Tencent) dominate the market, with start-ups so far most successful in online lending (P2P). A strong internet finance sector is vital to serving the needs of SMEs and households long ignored by the traditional sector. However, weak regulation has created consumer and stability risks. A new system instituted in 215 divides responsibility between the PBOC, CBRC, CSRC, and CIRC, though the central bank lead a recent crackdown on illicit activity. There is substantial room for growth in the wider China fintech sector including insurance, crowdfunding, data analytics and online banking. UK innovation and regulatory expertise is highly prized in China creating opportunities for further commercial and policy collaboration. China Economics Network For comments, suggestions, questions, please contact us: Ruby Zhang Economic Officer, British Consulate General Shanghai Jiaxin Zhang Economic Officer, British Consulate General Guangzhou Kunal Khatri First Secretary Financial and Trade Policy, British Embassy Beijing Market Overview Fintech has rapidly emerged as one of the most innovative and disruptive sectors in the global economy, and China is no exception. With almost 7m internet users, a growing consumer economy, and world leading technology companies, there is enormous scope for the fintech sector to fundamentally transform China s economy. The rapid rise in internet and mobile usage over recent years has driven internet finance growth, meeting demand where the traditional sector has failed to do so. This report looks in particular at China s payments & settlement market ( 2.3tn transaction value in 215, 57% growth y-o-y), the online lending market ( 87bn of which 98% is P2P; 23%), and sales of investment products ( 825bn; 26%). These three sectors account for the largest share of China s fintech market. China s three technology giants (Baidu, Alibaba, Tencent) have been principal drivers of China s fintech market. Alibaba has built on its hugely successful business to business (Alibaba.com) and consumer/business to consumer (Taobao, Tmall) goods trading platforms, and the parallel demand for e-commerce facilities, to establish Alipay (now part of Ant Financial) as one of China s leading online payments systems. In similar vein, Tencent, owner of the dominant instant messaging service Wechat has capitalised on the scale of the social network to establish a dominant presence through Tenpay (mobile payments) and a lead in the online banking market through Webank, China s first mobile online banking service. Baidu, China s leading Internet user(m) Mobile Internet user(m) Figure 1: China internet penetration rate (source: CNNIC)

2 Financial Services Special Report: China s Internet Finance Market July 216 leading online search engine, lacks a similar flagship product and unlike its competitors, is hindered by not having a transaction history database to build on (Baidu relies on Alibaba for the vast majority of its data). It has however invested heavily in other internet finance companies and through partnerships with traditional financial institutions. The traditional financial sector has also sought to capitalise on the growing fintech market, in particular through online lending and sales of investment products. Significant players in this market include Ping an Group (through Lufax), Sinolink Securities, China Merchants Bank, and Hongling Capital. Start-ups to date have had most success in the online lending sphere. Renrendai and Yirendai (through Creditease) have had most success in the P2P market, but are just two of 4 P2P lenders in China a testament to rapid growth, but also lax regulation. Company Alibaba (Ant Financial) Tencent (Webank, Tenpay) Payments and settlements Online and mobile payments systems have led the way for China s fintech sector, touching on almost every aspect of people s daily life in China. Around 9% of Chinese netizens (those actively involved with online activity) conduct mobile payments during their online activities. In offline activities, 63% and 53% of netizens use payment app to pay at restaurants and convenience stores respectively. Through Wechat for instance, consumers can deposit money and/or link a bank card and scan a QR code to pay for items in the vast majority of shops and restaurants. Wechat also allows consumers to top up mobile phone accounts, transfer money to friends, donate to charity, pay for utility bills, order and pay for taxis and rail tickets, and purchase cinema tickets. It is the largest and fastest growing segment of the internet finance market with an overall transaction value of 2.2tn in 215 ( 1.2tn for online payment and 1tn for mobile payment). The market is dominated by, Ant Financial and Tenpay who together account for 7% of the online payment market and 89% of mobile payment market according to iresearch. Whilst Apple has sought to enter the market through Apple Pay it has been a difficult market to crack. One reason is that of the 22 million scanners in China, only around a third can be used for Apple Pay. HQ Payments and settlements Business Line Online Lending Hangzhou x x x Shenzhen x x x Baidu Beijing x x x Jing Dong Beijing x x China Merchants Bank Shenzhen x x Sinolink Chengdu x Securities Creditease Beijing x x (Yirendai) Renrendai Beijing x Ping an Shenzhen x x (Lufax) (Shanghai) Hongling Capital Shenzhen x Investment Products Figure 2: Top 1 internet finance companies in China according to market share, user traffic, transaction value; Source: Sohu (214) Lakala, 2% Tenpay, 21% Others, 9% Alipay, 68% Yinshangpay, 11% Tenpay, 2% Alipay, 48% 99Bill, 7% ChinaPnR, 5% Yeepay, 3% JDPay, 2% Others, 4% Third Patry Online Payments( B) Mobile Payment Online Payment Figure 3: Third party payment market transaction value; Source: iresearch) Figure 4: Share of payment market; Source: iresearch) 2

3 Financial Services Special Report: China s Internet Finance Market July 216 At the same time, security of funds remains a concern. In July last year, the People s Bank of China limited the size of transactions through third-party online payment systems to RMB5, per day and RMB2, a year, so that online payment suppliers can better manage risks. Online P2P lending platforms Chinese online P2P lending platforms have seen explosive growth in recent years, with China s market rapidly emerging as the world s largest. Transaction volumes in 215 reached 12.4bn, 1 times larger than in 211. Around 36 new platforms have emerged in the past five years alone, with the number of individual investors increasing 17 fold in the past two years. Lufax (estimated worth of 3.4bn), Renrendai (est. 1.23bn), and Yirendai (listed in US, market cap 467m) are the most competitive Chinese P2P platforms as measured by Online Lending House on basis of user traffic, profitability, business reputation and other factors. Hongling Capital, had the largest transaction value in 215 ( 8.9bn) followed by Lufax ( 2.9bn). Households and SMEs have been the principal borrowers in this sector. Around 8% of P2P loans are less than 1,, with SMEs accounting between 2 to 4% of all loans, whereas P2P in developed markets is dominated by consumer lending. Explosive growth in this sector has been aided in part through weak regulation, leading to significant oversupply and financial risk. In particular, P2P companies are treated as information providers, with the purpose of connecting lenders to borrowers (with banks acting as custodian for funds), rather than acting as money lenders. By not assuming any financial liability themselves, P2P operators initially fell out of scope of the regulatory framework. At the same time, P2P firms have P2P LendingTransaction Volume 6% 5% 4% 3% 2% 1% % Growth Rate Figure 5: P2P Lending Transaction Volume ( bn) and Annual Growth Rate (%) ; Source: Online lending house, typically offered customers higher returns than the traditional banks in order to attract customers. In March 216, the average interest rate of P2P products was 13%, with average maturity at 7 months; in contrast the 6 month fixed deposit rate of banks was less than 2%. Other firms have pushed the regulatory boundaries by using their own offline investment activities to increase returns and offer interest and deposit guarantees on P2P loans to attract investors. The current number of P2P firms is unsustainable. Despite the soaring transaction volume, the industry s profitability has been decreasing for 6 consecutive months, from 13% in December 215 to just over 1% in June 216. Online lending house data suggested that problem platforms accounted for more than one third of all P2P lenders at the end of March. These platforms typically conducted illegal activities including fraud, cash pooling where P2P funds are delinked from specific loan products and pooled for other collective investment purposes, and self-trade in which P2P platforms use investor funds to finance their own projects without notifying investors Fraud remains a serious concern in the sector. The most high profile case involved Ezubao, once the country s largest platform, which went out of business last December resulting in losses of 5bn losses that affected 9, investors. The government subsequently arrested more than 2 people associated with the fraud and launched a website to call for those affected to contribute information towards the investigation. Some platforms have also been contributing to property bubbles in China. In particular some P2P lenders have granted unsecured loans to low-quality borrowers and speculators with little due diligence. Some regulators have identified this as a factor contributing to property price bubbles in the top cities, including Beijing, Shanghai, and Shenzhen. 3

4 Financial Services Special Report: China s Internet Finance Market July 216 Online sales of Investment Products With a savings ratio of 49%, RMB 14tn in savings, and a relatively closed capital account, there is enormous demand in China for investment products. The online investment market took off in 213 when the investment product Yu E Bao, a money market mutual fund, was launched by Alibaba through its online payment platform Alipay (now part of Ant Financial), and managed by Tian Hong Fund. Yu E Bao allowed Alipay users (over 4 billion users as of 215) to flexibly invest their money (typically small amounts) into short-term money products (central bank bills, negotiated deposits, certificates of deposit). Within half a year, Yu E Bao grew into the world s largest money market fund with AUM at RMB816bn. The success of Yu E Bao demonstrates the huge demand of Chinese retail investors for high quality financial products, as well as huge commercial opportunities to be further unlocked. Whilst competitors have emerged, Ant Financial continues to dominate the market. The traditional financial sector is also levering online platforms to promote their products. A number of traditional financial firms have set up their own online asset management subsidiaries and mobile applications (ZhiNengJin by Guangfa bank, HuoQiLe by 99fund, LiCaiTong by Tencent), whilst others have sought to use third party platforms (Rong 36, Fund123.cn, Eastmoney.com) to expand sales channels. To date over half of China s investment funds have both offline and online sales (via third party or self-established platforms) channels. At the same time, declining returns through a slowing economy may hinder rapid growth in the near term. Annualised returns on Alipay s Yu E Bao product have fallen from almost 6% in Q1214 to 2.5% in Q1216, whilst the size of fund has been more or less level in the last two years. Regulatory System With exponential growth and high profile instances of default and fraud in 215, the government has substantially increased regulatory attention on the internet finance sector. In July 215 the PBOC issued new guidance, for the first time clearly setting out division of labour between the regulators for internet finance (See Fig 6). Reflecting the growing concern over internet finance, in March this year the Financial Services Offices in Shenzhen and Shanghai led efforts to crack down on online mortgage loans, blamed by some for the rapid rise house prices in both cities. This was followed in April by the PBOC launching a one year clean up of the internet finance industry, with business registration bodies in some instances also suspending new applications for licences. PBOC CBRC CSRC CIRC Figure 6: Regulatory responsibility for internet finance Responsibility Online credit investigation; Online Payment Online P2P lending; Innovations in the traditional banking sector Online securities products; Crowdfunding Online insurance products More recently the PBOC also established the China Internet Finance Association (CIFA), headed by former PBOC Deputy Governor Li Dongrong, to act as the industry s self-regulation body. With more than 4 members from traditional banks and internet finance institutions, the CIFA has been promoting regulatory compliance and information disclosure whilst also assisting the PBOC with the industry clean-up Online sales of funds ( B) Figure 6: Online sales of funds, transaction value; Source: iresearch

5 Financial Services Special Report: China s Internet Finance Market July 216 Whilst the regulators have come a long way to establish a regulatory framework around the burgeoning internet finance sector, this is a fast growing industry and coordination remains a challenge. Whilst the division of regulatory responsibility allows for greater focus on individual sector risks, it is difficult to establish a single and complete assessment of risk across the whole market. With a number of firms entering multiple business lines, the division in responsibility also risks becoming increasingly artificial. Provincial authorities also carry formal regulatory responsibility where an internet finance company has been established in their area, bringing with it risks of overlapping jurisdiction with the central regulators. Future trends and opportunities China s internet finance market remains in an early stage, and there remains enormous potential for new innovations and opportunities for policy and commercial collaboration. On the regulatory side, there is strong appetite to learn from the FCA s model of regulation of fintech, in particular on P2P, the regulatory sandbox and consumer protection. On the commercial front: Crowdfunding is already an established market with Baidu, Alibaba (Taobao) and Jingdong leading the way. It remains a relatively small market with 1bn in funds raised in 215 amongst 283 platforms. Strong regulatory requirements (e.g. minimum individual investment of 5, and maximum of 2 investors) are one reason for relatively slow growth in the sector, but there remains strong demand for crowdfunding for intelligent devices (e.g. smart phones, wearables), and culture & entertainment. Online insurance is also a rapidly emerging sector. According to CIRC official data, premiums income from online insurance business grew by 196% and 143% in 214 and 215, with online life insurance premiums increasing threefold year on year to RMB 146.5bn in 215. The overall penetration of insurance industry remains low however at 1%, and there remains strong potential for market growth in sectors with standardised policies such as personal, automotive and property insurance. Licensing remains a challenge nonetheless with only five firms having being awarded internet insurance financial licences. Online banking has further to grow with MyBank (Ant Financial) the leader in the field, though WeBank (Tencent) has to date proved less successful in the market. Data analytics underpins many innovations in fintech, and there is clear demand for new products to support individual and firm credit analysis, and also ease ability of firms to meet know your customer regulatory requirements. Financial Infrastructure: A nascent part of China s fintech scene with view Chinese start-ups disrupting financial services infrastructure in the way blockchain (for instance) start-ups are seeking to do elsewhere China s Ministry of Science and Technology also recently announced nine new pilot zones for fintech. Zhengzhou, Xiamen, Ningbo, Jinan, Nanchang, Guiyang, Yinchuan, Baotou and Shenyang will lead this round of pilots, following on from a first round launched in 211. These pilots present a new opportunity for collaboration and through the FCO prosperity fund the Consulate in Chongqing is working with Guiyang authorities to scope the potential to use crowdfunding to finance public infrastructure. Increasing inward investment in China tech (not just fintech) and outward investment in UK tech is also a key priority for the China market. Investment in Chinese fintech has grown rapidly in the last two years, rising from 134m in 213 to 1.8bn last year according to KPMG. In the opposite direction, in January this year Cocoon Networks launched a 5m tech fund in London, and the likes of Alibaba and Tenpay remain eager to increase international exposure. The Shenzhen Stock Exchange has also established a Tech 2. platform bringing together over 3 investors and 1 firms and has recently co-hosted such a platform with Korea. There is also rising demand for outward mergers and acquisitions activity by Chinese tech firms, with the Shenzhen Stock Exchange noting a doubling of M&A activity in the last three years. 5