Views on the integrity of global capital markets
03 February 2016

From Stocks and Bonds to Crowdfunding, China’s Capital Markets Regulatory Scene

A fast-growing, high-risk, largely unregulated microfinance sector, and a report on private equity practices that found problems with the way companies are doing business are the two primary issues now on Chinese regulators’ radar.

How are they handling it?

The China Banking Regulatory Commission (CBRC) publicized a consultation paper request on “Temporary regulatory measures for Internet finance intermediaries’ activities” on 28 December 2015 to seek public opinions. The information did not specify an implementation date, but it’s clear from its tone that there is a growing concern for risk within the microfinance sector.

Here’s why.

In 2015, microfinancing for small companies and personal loans were the two biggest contributors to the rapid growth of peer-to-peer (P2P) platforms’ assets. The Wall Street Journal reported there were 2,612 Chinese P2P online platforms in operation as of the end of November 2015. Among them, about 30% were found to have “problems.”

Even China’s mammoth P2P online platform, Lufax (陆金所), has estimated a loss of US$415 million for FY2015 and will continue to be in the red with a loss of US$68 million in FY2016. Lufax estimated that profitability will start to arrive during 2017, according to figures released on 18 January 2016. To date, Lufax, together with CreditEase (宜信), are the two largest P2P platforms in China, both of which have claimed to surpass America’s online P2P market leader, Lending Club, in terms of loan-transaction amount. At present, Lufax remains unlisted, whereas the subsidiary of CreditEase, Yirendai, was listed on the New York Stock Exchange a month ago.

Given that even the giants are finding it a challenge to generate decent profits in the current volatile environment, it is not hard for us to envision how it must have been for the rest of the smaller online P2P platform players.

How P2P Platforms Should Operate

In its consultation paper request, CBRC highlighted the way in which online P2P platforms should operate. First, they should only serve as an information intermediary. Second, they should not absorb any form of credit risk and/or provide any form of implicit guarantee. Third, after having obtained their commercial operating license, online lending platforms must register with the local financial regulatory authority.

How P2P Investors Can Protect Themselves

The CBRC’s consultation paper request also listed these suggestions to enhance investor protection:

  1. Specific cap on the loan amount granted to an individual borrower and/or entity.
  2. Mandatory disclosures on loan amount, loan types, and bad-debt ratio.
  3. Sales of insurance and wealth management products are strictly outlawed.

Poor Private Equity Practices

The China Security Regulatory Commission (CSRC) announced findings of its “Private Equity Regulatory Enforcement Situation” report on 15 January 2015. They included that last year alone, CSRC had investigated some 140 private equity funds and uncovered the following five common categories of problems:

  1. Information filing
    1. Fraudulent information submitted during registration
    2. Incomplete information filed
    3. Material information not disclosed in a timely manner
  2. Illegal fundraising activities
    1. Sourcing for funds from unaccredited investors
    2. Mis-selling, especially through providing implicit guarantee on principal and interest
    3. Having an investor population beyond legal limit
  3. Operating beyond the boundary of laws
    1. Misappropriation of fund’s money for unauthorized investment and/or personal use
    2. Paying out management fees beyond what is stated on the terms of contract
  4. Insufficient corporate governance

As a result of the CSRC investigations, more than 27 top managers were prosecuted or put under administrative monitoring, subject to the severity of infringement in each case.

Our Take on the Regulatory Landscape in China’s Capital Markets

Clearly, regulators are optimizing the framework and enforcement structure to ensure the orderly functioning of Chinese capital markets. Their focus going forward should continue to be on investor protection. However, they will also need to perpetually strike a balance between optimizing investor protection while not hindering the creative impetus of the burgeoning microfinance innovation.

No Matter the Market, Investors Have Rights

Market participants (retail investors especially) should not solely rely on regulators to protect their investments. As long as regulators have maintained a fair-and-even playing field for all market participants, they’ve done their job.

Investing is risky, and ultimately every investor is responsible for his or her own money. Because it is not practical for everyone to be able to build his or her own suitable investment portfolio, getting the proper advice from an asset manager might be crucial. To aid individual investors seeking financial advice, CFA Institute offers a Statement of Investor Rights that highlights what investors should expect and have access to when interacting with their financial advisers.

Our Position on Crowdfunding: Ensure Investor Protection, Guard Against Fraud

We expressed our position on the regulatory policy regarding crowdfunding activities within the US and Europe in February 2014. We are generally concerned about the weakening of investor protections and the potential for fraud that the alternative finance’s environment may provide. We also developed an issue brief on investment-geared crowdfunding that defines crowdfunding’s scope, discusses its potential, and highlights a blueprint for the associated regulatory framework.

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Image credit: iStockphoto.com/Hong Li

About the Author(s)
Alan Lok, CFA

Alan Lok, CFA, is director of capital markets policy at CFA Institute. He is responsible for conducting research projects in the area of market instruments and market structures in the Asia-Pacific region. Mr. Lok works with regulators, institutional investors, academics, and various other stakeholders within the financial industry to uphold investor protection and market integrity.

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