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The Price of Innovation?

Alongside tightened oversight of internet finance in China, authorities are turning their attention to third-party mobile payment services, and are not afraid to impose financial penalties for malfeasance

By NewsChina Updated Oct.1

On August 6, the Shanghai branch of the People’s Bank of China (PBoC) slapped a penalty of 4.12 million yuan (US$598,000) on Alipay, a leading mobile payment service operated by tech giant Alibaba Group, for violating payment regulations. 

Insiders from the third-party payment industry speculated that Alipay may have violated money laundering regulations, and to date Alipay is yet to give an official reply. Alongside the Chinese central bank’s strengthened financial oversight, the third-party payment industry, particularly mobile payments, is expected to come under more intense scrutiny. 

Poor Consumer Protection
This is at least the third time the PBoC has fined Alipay. On April 23, 2017, the same branch – Alipay is headquartered in Shanghai, while its parent, Ant Financial, remains in Hangzhou, Zhejiang Province – fined Alipay 30,000 yuan (US$4,350) for breaches of payment regulations. On March 22, 2018, Alipay was fined 180,000 yuan (US$28,000) for violating three specific regulations by the PBoC’s Hangzhou branch.  

To begin with, consumers had their rights to information and choice poorly protected, because Alipay was found not to have provided them with sufficient information to understand and choose their products wisely.  

Second, the company was found to have conducted misleading marketing in video and social media campaigns. In addition, the proportion of processed complaints was not calculated properly, leading to inaccurately published data. Third, the collection of personal financial information also failed to comply with the “minimum and necessary” principle. Meanwhile, Alipay also misused customers’ financial data. 

According to the Administrative Measures for Payment Services of Non-financial Institutions and China’s Law on the Protection of the Rights and Interests of Consumers, the PBoC’s Hangzhou branch issued penalties of 30,000 yuan (US$4,360), 100,000 yuan (US$14,533), and 50,000 yuan (US$7,267) to the three breaches. 

In an ironic foreshadowing of what was to come, during the 2016 China Central Television 3.15 Show – an annual high-profile consumer rights show which exposes company malpractice – Ant Financial launched an initiative in conjunction with 59 other financial and online enterprises to promote the protection of consumer rights, including the security of their assets, rights to knowledge and rights to fair trade. What’s more, information transparency, protection of consumer privacy and improvement of consumer complaint mechanisms were included in the initiative. 

According to a report released by the central bank on August 13, the total number of online transactions processed by non-banking payment institutions in China hit 286.73 billion in 2017, with a value of 143 trillion yuan (US$20.8t), an increase of 74.95 percent and 44.32 percent year-on-year. The mobile payment market in China had reached 81 trillion yuan (US$12.77t) as of October 2017 – Alipay and its major rival, Tencent’s WeChat Pay account for 90 percent of the industry’s market share, according to the Ministry of Industry and Information Technology. 

Launched in 2004, Alipay was the first mobile payment platform to obtain a license from the PBoC in May 2011. Amid China’s cashless revolution, Alipay has an active user base of 520 million. Apart from the burgeoning online payment market, Alipay is an active player in the offline payment market at public places including restaurants, supermarkets, taxis and hospitals.  

But controversies have dogged third-party payment platforms, such as forms of money laundering on the platform conducted between vendors and customers on its online marketplace Taobao. For example, refunds are processed for goods not sent, or refunds for products are paid for with credit cards sent to the Taobao account, rather than back to the credit card. Practices such as these do not conform to the regulations. For its part, Alipay has pledged to tighten supervision and launched a string of measures which aim to ensure security, including the identification and authentication of users.  

With its expanding business, Alipay has extended its reach into the financial sector. In June 2013, Ant Financial and Alipay introduced the Yu’e Bao (Leftover Treasure) money market fund – which has become the largest such fund in the world. It allows investors to put money into the fund and withdraw it any time. The moment it launched, it generated a vast number of users, but also garnered a great deal of attention from supervisory departments.  

On June 21, 2013, the China Securities Regulatory Commission announced that some of the gains and losses of Yu’e Bao’s fund sales had not been reported to regulators and the company also did not provide sufficient information about how banks were monitoring fund transactions, 
demanding the company to make additional filings.  

In the PBoC’s annual report in 2017, Yu’e Bao was jumped on by regulators again. It stated that fund products, including Yu’e Bao, have blurred the boundaries between providing payment services and fund products. To make matters worse, these services have “profited from the interest rate differential, pushed up interest rates and the cost of social capital and aggravated the difficulty of raising capital and financial costs,” the central bank report said.  

In 2014, Alipay further extended its global reach by launching a service for transnational payments and tax refunds. On July 24, the State Administration of Foreign Exchange announced that five third-party payment enterprises, including Alipay, had violated China’s foreign exchange regulations. The agency warned that from January 2014 to May 2016, Alipay illegally conducted transnational payments of foreign exchange beyond its authorized scope and declared less money on international payment balances, although no detailed figures were reported. The company was given a penalty of 600,000 yuan (US$87,200). 

QR codes for payment displayed at a market stall, Nantong City, Jiangsu Province, September 10, 2018

Loose Regulatory Environment
In recent years, regulators have kept a keen eye on third-party payment enterprises. On August 6, the PBoC gave out four penalties of a combined 100 million yuan (US$14.7m), including the fine on Alipay. The other companies fined were Union Mobile Financial Technology, Gopay and Yinsheng E-pay.  

“Such penalties are not unique to China, and regulations on non-banking payment institutions are quite strict worldwide,” Yang Tao, a researcher with the financial institute of the Chinese Academy of Social Sciences, told NewsChina. He argued that third-party payment enterprises must grow rapidly in the beginning, but when they reach a certain scale, problems arise and regulation of the industry, particularly retail payments, will intensify. On the other hand, he added, financial regulations have been strengthened in recent years, including for internet finance. 

China’s third-party payment business started at the end of the 1990s, and by the early 2000s, when there were several payment institutions, most were operating under inadequate regulation. In 2010, the Administrative Measures for Payment Services of Non-financial Institutions was released by the PBoC, ushering in the explosive growth of payment enterprises. Regulations, however, remained relatively loose until 2016, when new rules were issued. 

“In fact, there were violations of laws and regulations for a long time. The market  
demand is huge, which brings substantial profits. In addition, the fines for violations are too low,” Yang said, adding that the solution lies in increasing the fines, which will aid the sound development of the sector.  

Meanwhile, regulators have stepped up measures to improve the institutional construction of company systems and regulations. On July 1, 2016, the Administrative Measures for Payment Services of Non-banking Institutions came into effect. It means that the PBoC will be able to keep an eye on payment institutions in real time. In April 2017, the PBoC required third-party payment service providers to keep 20 percent of customer deposits in reserve. Some third-party payment enterprises had embezzled funds and had even used customer funds for risky investments. 

Following the increasingly stringent domestic supervision, the doors are open for overseas payment institutions. On March 31, the PBoC released a directive that would allow overseas enterprises to operate in China. On July 27, WorldFirst, a UK-based company, became the first foreign player to apply for entry to China’s huge payment market. 

Some insiders argue that Chinese regulators are mulling a reshuffle of the country’s third-party payment industry. In Yang Tao’s opinion, however, stringent penalties were made to boost the healthy development of the industry. 

“The likely outcome is that small and medium payment enterprises will withdraw from the market. Despite the challenges, leading players like Alipay are unlikely to be surpassed in the short term,” he said. 

As for overseas players, Yang argued that even though they have comparative advantages in transnational payments and internationalization, they will face challenges in adapting to China’s payment competition and pricing strategy and domestic players will not be motivated by the introduction of competitors. 

In July, the PBoC released a new round of license extensions for third-party payment enterprises, and four of the 25 applicants were denied, mainly for irregularities related to payment services. In the two rounds of public notifications in January and June 2018, the licenses of four and nine enterprises were revoked as part of a clean-up campaign by the central bank. 

In the medium to long term, regulators are pushing forward real-time supervision mechanism to control the total number of platforms, optimize the structure, improve quality and maintain orderly development, Yang said. Bad actors in the sector will be forced to exit the market entirely.  

“It’s common to see ups and downs in the market. Some companies are merged and some collapse because of repeated violations of the regulations. In the payment industry, there’s been a withdrawal mechanism for a long time,” he said