Over the past two decades, large technology firms (bigtechs) have disrupted the traditional financial markets in China, leveraging vast user bases and technological capabilities to offer more competitive and accessible financial services.
Though the development of digital finance platforms have the potential to enhance financial inclusion and promote innovation, they also pose significant risks, including threats to financial stability, competition, systemic integrity, and consumer protection, a new paper by Christine Meng Lu Wang of the Chinese University of Hong Kong (CUHK) and Douglas W. Arner of the University of Hong Kong says.
The paper, delves into the evolution of platform-based finance in China, examining the risks associated with the market dominance of these firms and looking at the regulatory measures that have been launched to mitigate these risks.
The rise of bigtechs in China
In China, bigtechs such as Ant Group and Tencent have expanded their activities in finance, starting with payment services and then broadening the scope of business to provide credit, insurance and investment products.
Since then, these platforms have evolved into establishing extensive financial ecosystems that integrate various financial services and intermediaries.
Ant Group, formerly Ant Financial, exemplifies this development. The company was originally launched to provide an online escrow transaction solution to address trust issues in e-commerce, before evolving into a comprehensive financial ecosystem comprising a payment system, investment services, credit, insurance products, and more.
These ecosystems offer integrated services, leveraging advanced data analytics for personalized experiences, and providing significant discounts and incentives to attract and retain users. This strategy has allowed bigtechs to acquire wide customer bases and leverage network effects.
For example, monthly active user accounts of WeChat, the main social media platform of Tencent, has reached more than 1.35 billion, while Alipay, Ant Group’s digital payment platform, boasts about 660 million monthly active users in the country, in addition to more than 80 million active merchants.
Bigtechs also use large data volumes to develop innovative algorithms and techniques, streamlining business processes, improving decision-making efficiency in the financial sector, and enabling them to offer better, customized services and products.
For instance, Ant Group’s subsidiary microcredit companies use data from Alipay and Alibaba’s e-commerce business to create customer profiles and design credit products for different consumption scenarios, thus significantly improving access to finance, especially for the unserved and underbanked segments.
Risks of digital finance platforms
Despite these benefits, the emergence of bigtechs in China’s financial services industry poses serious risks relating to their economies of scale, scope and data-driven network effects.
One major concern is financial stability. Bigtechs partner with numerous financial institutions, creating complex interdependencies. These interdependencies can destabilize financial markets as the operational failure in one bigtech could trigger systemic crises and cause widespread economic disruption, the paper says.
For example, Ant Group has collaborated with hundreds of banks, asset management companies and insurance institutions to develop innovative products and services for an enormous number of customers.
By early June 2020, the company’s credit, investment, and insurance businesses had reached RMB 2.1 trillion (US$310 billion), RMB 4.1 trillion (US$571 billion), and RMB 52 billion (US$7.2 billion), respectively, highlighting the potential scope of economic disruption.
Bigtechs also serve financially vulnerable individuals and businesses marginalized by traditional financial sectors. These customers may react irrationally during crises, exacerbating instability, as seen in China’s 2015 online lending turmoil.
During that crisis, some platforms engaged in unsupervised and illegal activities, causing investors to suffer great losses as well as serious liquidity problems when lenders withdrew funds prematurely.
Competition risks are another significant issue. Bigtechs’ data monopolies in financial services create barriers for smaller competitors. Furthermore, these firms hinder competition by acquiring nascent companies, preventing the rise of strong competitors.
For instance, Alibaba, Tencent, and Baidu have made significant venture capital investments, consolidating their market dominance and stifling innovation.
The paper says that these firm have collectively acquired several companies valued at least billions of RMB and invested in a large number of startups, some of which have extensive customer base.
Finally, consumer protection issues also arise with digital financial platforms. While these platforms streamline financial transactions using innovative technologies such as biometrics, they often infringe on customer rights. For example, Alipay has used pre-ticked boxes on customers’ annual account statements, granting default access to customer information and thus raising privacy concerns.
Evolution of China’s regulatory approach
To mitigate the negative impacts of bigtechs on the financial sector, China has implemented several regulatory measures.
These measures address these firms’ market dominance and disruptive business models, focusing on financial regulation, antitrust and competition regulation, data security, and customer protection.
In financial regulation, Chinese regulators have implemented a special licensing regime requiring companies to obtain authorization before providing certain financial services.
For example, third-party payment service providers must acquire a special license. For online microlending, companies must obtain approval from the relevant authority that they intend to use emerging technologies and platform-based customer spending and transaction information to provide small loans via the Internet.
In antitrust and competition regulation, Chinese regulators have stepped up its oversight of bigtechs with high-profile enforcement actions.
For example, in December 2020, the State Administration for Market Regulation (SAMR) launched an investigation into Alibaba after the e-commerce giant forced merchants to sell exclusively on its platform. The agency concluded several months later that the firm’s business practices restricted market competition, fining it a record RMB 18.228 billion (US$2.8 billion).
The fine, equivalent to 4% of Alibaba’s 2019 turnover in China, was the highest amount ever imposed for violating the Anti-Monopoly Law. Then in July 2021, the SAMR fined Tencent multiple times in one month for violations involving multiple mergers and acquisitions.
To address data-related risks, China has introduced laws to enhance data governance. The Data Security Law, for example, adopted in June 2021, sets out rules for data classification, grading protection and risk assessment.
The law governs the creation, use, storage, transfer, and exploitation of data within China. Finally, to address systemic risks, China has formulated regulatory policies for financial holding companies, requiring approval from the central banks for companies controlling multiple types of financial institutions.
Featured image credit: Alibaba and Tencent
