In this episode of Looking Back Looking Forward: Digital Finance in China, Professor Douglas Arner revisits the culmination of China's digital financial transformation experiment and events that rein in big tech platforms in favor of competition, financial stability and the broader social stability.
“Looking Back, Looking Forward” is a video series with HKU Kerry Holdings Professor in Law Douglas Arner discussing issues in financial law, technology (FinTech) and regulations.
Transcription of Prof Arner's Ep. 6 of LBLF Digital Finance in China originally published on 30 July 2021:
"As we record this video, stock markets, Chinese stocks, tech companies all across the world are experiencing unprecedented volatility. And I think I want to talk a little bit this month about what is happening. Of course, if we think about China - China over the past three, four decades had re-emerged as one of the world's largest economies. At the same time, it has particularly, over the past decade, experienced an unprecedented digital financial transformation as well as seeing the evolution of an increasing range of large tech companies, big tech companies. And we think about China's digital financial transformation, this is something that we've talked about in previous episodes.
"It began about 10 years ago as an experiment and it was looking for a solution to constraints in the traditional financial system, particularly for small and medium-sized enterprises and non-state enterprises for which China's traditional financial system, both its banking system as well as its stock markets, had not historically been very good at providing finance for.
"And, MSMEs and the non-state sector, over the past 30 years, have been the biggest driver of growth in China's economy and in employment as well as in innovation. And so, a real policy challenge - a big problem - how can you get finance to small and medium-sized enterprises and the non-state sector when your traditional financial system isn't doing very well?
"This is a common problem all across the world, and the Chinese experiment, began about a decade ago, was to allow the development of digital financial services. And we really see this in two parallel trends: One, the evolution of peer-to-peer (P2P) lending platforms so that by about five years ago China had more P2P lending platforms than the rest of the world combined. The second aspect was in the evolution first of digital payment systems via tech companies - Alipay via Alibaba and Ant, Tencent Pay, Wechat Pay via Tencent, and their expansion eventually to over a billion people In China and more beyond. And on the back of that payments model, big techs developed even bigger data pools, which they used as a platform for all sorts of other businesses, including lending as well as reservations, social media, all sorts of interactions.
"And if we think about the peer-to-peer platforms, in 2015, China experienced major stock market turmoil. In fact, more severe than the turmoil that we are seeing this summer, in 2015, and coming out of that, China realized that there were significant amounts of lending going from unregulated P2P lenders into individuals investing money in the stock market, creating potentially a dangerous feedback loop as stock prices began to drop, peer to peer lenders calling in their loans to individuals, triggering more stock sellers and eventually the links to the actual funders of the peer to peer platforms, individuals, companies and banks facing losses on their lending as well as stock portfolios.
"And that experience of 2015 began a process in China of building a regulatory system for digital finance, in particular, closing down the P2P lending experiment. But largely for the first few years, leaving the big digital platforms alone. But from about 2019 we see the move of the Chinese government to increasingly regulate the giant digital financial platforms, and on Tencent in particular, because they had become so large and so important to the country's financial system, its economy, and its society, that they had become too big to fail – systemically important financial institutions. And we see a process across 2019 and 2020 of China essentially reining in the giant platform finance companies and bringing them into the financial regulatory scheme.
"Why? Two big objectives: supporting growth and development through enabling competition, which was being stifled by large platform dominance, our topic in last month's discussion, and second, protecting against financial stability but also wider social stability issues.
"Over the past month, we've seen a new turn. We've seen increasing activities, first involving DiDi, a ride-hailing company with 500-600 million customers across China, and a move to require the lead regulation of any sort of company in China seeking to raise funds outside of China to undergo as a first step a national security review in the context of its data and information systems by the new national cyber security agency (National Cybersecurity Center), a new prioritization of national security issues alongside financial stability, social stability and innovation and growth objectives.
"And I think that this is a change in trend to what we've seen before. It is an indication that when we look at the role of big tech companies in China, at the role of digital finance companies in China, that our regulatory approach and the regulatory objectives which we're seeing are evolving in a quite different direction than we would have seen going two years ago. And if we look at the outlook for the coming years, what this suggests is an increasing focus on bringing down the oversized role of large tech companies in China - to reduce dependencies to reduce the negative impacts from the standpoint of inequality of social development, to reduce the potential that such dominance constrains development and to reduce risks to exposures to foreign technologies."
Related paper: Regulation of Digital Financial Services in China: Last Mover Advantage by Weihuan Zhou (University of New South Wales), Douglas W. Arner (The University of Hong Kong) and Ross P. Buckley (University of New South Wales) :: SSRN