Blindspots in the financial regulation of China's tech 'platform companies'

Recently, financial regulators like the People's Bank of China (PBOC) have conducted meetings with colossal technology "platform companies", including Ant Group, to formulate "rectification" and restructuring plans. The regulators aim to lower systemic financial risks by imposing fines on companies while emphasising the need to promote stable and healthy development of the platform economy, strengthen anti-monopoly measures and prevent the "disorderly expansion of capital".

In the past decade or so, China's economy and lifestyle have made great strides towards full digitalisation. Propelled by big data and AI, changes in business models and the financial sector have profoundly affected people's habits, application scenarios in payments, and risk management. At the same time, these industries are undergoing changes that are not entirely guided by government planning.

As technology platform companies constantly emerge, companies such as Tencent Holdings and Alibaba Group have become influential globally. Among the top ten domestic mobile apps in China, four are developed by Tencent and three by Alibaba. Alibaba enjoys nearly 60% market share of China's e-commerce while WeChat Pay and Alipay account for more than 90% of China's mobile payment. It is increasingly evident that the winner takes all.

The men behind Alibaba declared several years ago that the company is already as big as an "economic entity". This implies that Alibaba is deeply embedded within China's economy and, to a certain extent, its hold on the country's information security.

With the deep integration of data, technology and finance, and in the name of technology and business model innovation, companies such as Alibaba and Tencent utilise their platform advantage to obtain data on hundreds of millions of users at extremely low cost. In so doing, they skirt regulations to gain from arbitrage, shut out competitors using their market advantage, and infringe upon legitimate consumer rights and interests. If this increasingly evident trend of harmful development is not curtailed, systemic financial risks will be hard to avoid.

Rapacity explains the recent disorderly expansion and financial risk issues involving platform companies. Another is the issue of a mismatch and imbalance between demand for financial services and regulation, which has remained unresolved for years. In this imperfect financial supply system, the irrational exuberance of platform companies is often the result of various channels for arbitrage.

With the emergence of fintech, market players have new hopes and high expectations of technology to change the financial sector. However, fintech itself is a double-edged sword. With fintech, the volume and rate of capital flow will significantly increase, and poor management will result in instantaneous and huge losses. Hence, the mistakes of unchecked growth of internet finance should be avoided in fintech development.

Based on the typical trajectory of financial development in major economies, China's financial services development is at a delicate stage of growing impetus for a breakthrough. This is also a critical stage at which systematic financial risks have built up but the capabilities to mitigate risks are constrained. In financial innovation and the opening up of its financial sector, China has yet to build the corresponding capabilities to manage the complex financial systems and cutting-edge fintech.

Therefore, there are blind spots and shortcomings in financial business development and the regulation of platform companies, involving the scope of regulation, management and control of core data and information, coordination of monitoring systems, and timeliness in responding to sudden financial events.

First, the financial offshoots of platform companies far exceeds the imagination of the regulatory authorities. Financial business expansion has long been beyond the Chinese authorities' scope of regulation, resulting in extremely high tangible and intangible risks.

For example, Ant Group's Alipay mobile application was initially only a basic payment platform but has expanded to provide other services for more than a billion users after rounds of expansion. It is common knowledge that one of the most popular Alipay functions is micro-loan services, which provides short-term loans to millions of individuals and small businesses, and that Ant Group charges significant fees for providing trading platforms. According to Ant Group's disclosure, this service accounted for nearly 40% of its total sales in the first half of 2020.

Therefore, Ant Group is essentially a financial institution that uses the internet and technology to provide loans. Relative to traditional commercial banks, it is more adept at calculating customers' financial risk and solvency using technology, with higher profitability. With an annualised interest rate of between 10% and 20% for micro loans, it is convenient and does not require collateral.

This type of unsecured credit loans, with a leverage ratio of more than 100 times, is akin to a huge financial bomb that may detonate at any time. If this happens after the public listing of the borrowing companies, it will have an unprecedented impact on China's stock market and very likely trigger a systemic financial crisis.

Regrettably, the financial business expansion of financial platform companies like Ant Group has long been outside the scope of China's regulators and warrants their attention.

Second, while the regulators have estimated the latent financial risks of platform companies, they do not have the essential financial information, leading to a lack of knowledge of the magnitude of the risks and when the risks may be triggered.

Established under the State Council of China in 2017, the Financial Stability and Development Committee attaches great importance to the regulation of internet financial companies. Since its inception, it has listed shadow banking, internet finance, asset management industry and financial holding companies as the four major areas for regulation.

The central bank and the relevant regulatory agencies have repeatedly warned some technology companies about providing financial products and services. Several companies have obtained the necessary licenses but others continue to provide credit and payment services and sell insurance products without the necessary licenses, possibly causing issues of competition and bringing about financial stability risks. The chaos of internet finance took about three years to be fundamentally rectified.

However, huge platform companies, such as Ant Group, have long been regarded as internet technology companies. They have long refused to provide essential data and related financial information to the central bank and regulatory agencies in the name of protecting user privacy.

Under normal circumstances, Ant Group is only required to submit simplified monthly transaction records, comprising mainly consolidated data, to the PBOC's Credit Reference Center. However, despite talks with the regulators, it has expressed willingness to share only a small amount of data and information, making it impossible for the regulators to effectively evaluate risks given the insufficient information and incomplete data. Consequently, as the ultimate lender, the PBOC is not fully aware of the magnitude of Ant Group's financial risks and the latent risks involved.

Third, platform companies are in possession of massive data and technological advantages, and are adept at "regulatory capture" or getting the upper hand over the regulators. The regulators suffer from inadequate regulatory capabilities and hence do not know how and what to regulate.

Companies like Ant Group have huge amounts of data, which underlines its advantage over traditional financial institutions. In 2019, it handled 110 trillion RMB of payment, nearly 25 times that of PayPal, the largest online payment platform outside of China.

To overseas analysts, Ant Group is already the world's leading and the most integrated technological financial platform that comprises the functions of Apple Pay, PayPal, Venmo, MasterCard, JPMorgan Chase, iShares and insurance companies, with even better risk evaluation capabilities.

In China, Ant Group has the most advanced fintech that can import over 3,000 variables into its credit risk model which facilitates loan approvals in three minutes. As credit rating downgrades is a concern, borrowers rarely default on Ant Group's loans.

With the data and technology, companies like Ant Group can better understand the work and lives of users than commercial banks. Based on users' purchases, the platform companies can easily assess users' income levels, habits, preferences and lifestyles.

In addition, these companies have formed a powerful lobby by leveraging upon countless interests and relationships, which directly or indirectly serve the companies' business expansion and financing as well as their PR and crisis management mechanism.

Fourth, the regulators remain focused on the prevention and mitigation of financial risks in the traditional financial domain and lack pre-emptive early warning of financial risks as well as adaptive regulation of huge data and technology platforms.

This is evident from certain key reports. The China Financial Stability Report 2020, for instance, has highlighted the challenges in the prevention of financial risks due to the Covid-19 pandemic and counter-cyclical macroeconomic regulatory policies. It has also included new issues such as major economies' management of fiscal and financial policies to deal with the pandemic; monitoring the risks of large enterprises; trust; development and regulation of fintech; financial holding companies; and digital currency among its special topics. However, the focus of these reports in recent years has continued to be on traditional finance, especially on default risks of large enterprises. .

China should lead the way in ensuring positive, rule-based development of internet technology companies. It should adapt to industrial changes brought about by big data and AI revolution so that the industries and technological innovation will ultimately serve to improve the lives of the masses . However, not even the top Turing Award-winning AI engineers have prescient knowledge of AI's impact on society. Therefore, it is not technology that holds back progress. Rather it is the difficulty in managing judiciously the boundaries of technological applications.

In the absence of government regulation, platform companies have expanded in a disorderly manner and are naturally prone to systemic financial risks. While allowing internet technology companies the room to operate with pre-emptive regulatory measures, the regulators must lead in the healthy and orderly development of platform companies with clarity on the limits of these companies' conduct.

Related: Alibaba probe: China's challenges in dealing with monopolies start with the state-owned enterprises | Is Alibaba doomed? [Part I] | What the Chinese government wants to tell Alibaba and China's tech giants [Part II] | Lesson for Jack Ma's Ant: Finance is finance and technology is technology | China's tightening fintech regulations may benefit Ma Yun's Ant in the long term