At the eleventh hour, Chinese regulators on November 2 halted what was to be Ant Group’s record-setting $37 billion IPO – two days before it was to list on the Shanghai Stock Exchange. The offering was hugely oversubscribed, reflecting the intense investor interest. The IPO is still expected to go forward, but with a significantly lower market valuation due to the changes in Ant’s business model necessary to comply with hastily rolled out regulatory requirements.
The episode shines a light on the formation of Chinese regulatory policy and holds important lessons for the future development of China’s financial system. It also reflects the challenges facing policymakers worldwide in deciding how to regulate innovative payments initiatives and fintech lending platforms. Ant branded itself first and foremost as a tech company but functioned in many ways as a bank. Its algorithms underwrote loans which its partnering banks funded. The status of Jack Ma’s fintech empire as a national champion further complicated the matter for Chinese regulators.
Champion status also created difficulties for Germany’s bank regulator earlier this year. Wirecard’s emergence as the long sought-after candidate as national tech champion led to highly improper supervisory practices by the German authorities. BaFin, the bank supervisor, was willfully ignorant of the company’s accounting fraud, blinded by the prospect of a company that – at last – rivaled the size and heft of a successful Silicon Valley fintech firm. At bottom, Wirecard’s wrongdoing was garden variety accounting fraud. In contrast, Ant has not engaged in any evident wrongdoing.
The attractiveness of the innovative fintech space has bedazzled some US financial regulators and troubled others, with mixed results. The Office of the Comptroller of the Currency had planned to issue special purpose bank charters to fintech companies that don’t provide full banking services. Litigation in 2018 quickly stopped these efforts dead in their tracks. The OCC was sued by New York’s financial regulator and by the Conference of Bank Supervisors. A court later ruled that the OCC had no authority to issue a bank charter to an institution that doesn’t take deposits. Yet, the OCC is at it again. In September it signaled a revamped licensing initiative. Over the last year and a half, Facebook’s Libra, a payment system based on digital currency, received a cold reception in the US Congress and central banks worldwide.
But the regulatory action taken against Ant had a unique twist. At a conference in October, Ma had criticized both the traditional banking sector and its regulators as outmoded and timid in launching and approving innovative business practices. Ma said banks had an old-fashioned “pawnshop mentality” – insisting on tried-and-true collateral for small business loans rather than algorithmically analyzing large data sets that more effectively priced default risk. Ma’s tirade would have been unwise for an issuer even in a mature financial regulatory system such as the US’s.
On orders from President Xi Jinping, four Chinese regulators promptly took action, meeting with Ma to take him and his company to task, and later stopped the IPO. The commandment from the top reflected the need for President Xi and the Communist Party to maintain control over an increasingly independent and dominant force in the financial markets. In addition to reigning in Ma’s ambitious business model, the regulatory action reflected concern over the systemic risk posed by the online giant.
The regulators quickly drafted a rule that was even tougher than was being contemplated and aimed it directly at Ant. Henceforth, micro-loan firms will need to fund 30% of each loan co-originated with a bank – many multiples of the 2% Ant currently provisions. Further, Ant must cap loans at the lower of (i) Rmb300,000 (about $44,000) and (ii) one-third of a borrower’s annual pay. The capital requirement and loan cap significantly reduce the profit potential of micro-lending in China.
This hasty and unscheduled regulatory chain of events stands in stark contrast with the rules- and process-based route for new regulations in the US. An IPO’s registration with the SEC typically take months of SEC review and comment before the agency declares a registration statement “effective”. Pending, material regulation that would impact the issuer would be part of the comment process, ensuring few surprises as the issuer and underwriter prepare for eventual launch. Lead underwriters – which for Ant included Citigroup, JPMorgan Chase, and Morgan Stanley in its Hong Kong arm of the IPO – assist an issuer in marshaling an IPO through the regulatory process. Without doubt, both they and their Chinese co-lead mangers were caught completely off guard by the IPO’s stoppage. As for issuing a new rule, US regulators must follow a long-drawn-out, transparent notice-and-comment process that enables firms to provide industry’s perspective on the rule’s costs and benefits for their business. The process often results in the softening of a rule’s impact.
Nonetheless, in taking the action against the Ant Group, the Chinese authorities had a deep understanding of the financial risks that the fintech behemoth and its business model posed. They were haunted by the severe disruptions in the domestic stock market in 2015-16 and the role debt played in fueling a stock bubble. The Shanghai stock market suffered a severe downturn beginning in June 2015. Volatility continued into 2016.
Throughout this episode supervisory actions were chaotic and haphazard. Regulators before the crash had tried to reign in stock margin lending then, following the crash in June 2015, frantically sought to pump up the market through massive injections of cash by the central bank, commandeering companies to buy up stock, and even offering investors cash to purchase stock. The agencies’ panic stemmed from the high amount of leverage incurred by unsophisticated retail investors to buy stock on margin and the potential for a backlash against the government and social unrest. Such a backlash would certainly have occurred in the Ant case if the rule had been issued after investors purchased Ant’s stock.
As in 2015, the Ant episode involved systemic risk to the financial system, this time due to the twofold risk of Ant’s market dominance and its role in contributing to a growing pile of consumer debt. Ant engaged directly in lending through its online payments platform, gaining over half a billion domestic customers. It was acting as a bank by underwriting loans while banks took the default risk, giving Ant a skewed incentive to write risky loans. Compounding this problem, the loans were unsecured, putting at risk not only Ant but its customers as well since they were not constrained by a loan-to-value ratio that is the staple of mortgage lending. Ant’s business model thus posed high risk to the lender, the borrower, and the financial system as a whole.
By waiting so long to put guard rails on Ant and the micro-lending sector, the Chinese authorities risk slowing the country’s quest to join the league of countries that boast efficiently regulated and trusted financial markets. That said, fintech has tripped up even the most developed of the world’s regulatory systems.