China issues comprehensive regulations on internet finance

This article was first published in E-Finance & Payments Law & Policy in September 2015.

In recent years, China has witnessed an unprecedented boom in Internet banking and finance covering a wide range of financial services provided over the Internet, such as online money transfer, peer-to-peer (P2P) lending, equity crowd funding and online wealth management.

However, laws and regulations have not kept with these developments. Even though there has been a huge increase in the number of emerging service providers of Internet financial services and new customers subscribing to Internet financial services on a daily basis, there has been a legal vacuum until recently, when the Chinese authorities issued a series of regulations to tighten their grip on Internet finance.

The new regulations aim to address potential risks while providing more support for the Internet finance sector overall. As the first comprehensive regulation for Internet finance businesses, the new rules will have extensive and far-reaching implications for Internet finance and related sectors in China. Whilst new opportunities have opened up for domestic and foreign banks and Internet enterprises, it is anticipated that the regulatory environment will become more sophisticated and industry players will have to quickly familiarise and ensure they are compliant with the increasing regulations governing this sector.

On July 28, 2015, ten Chinese central regulatory agencies and industry regulators, including the People’s Bank of China (PBOC), the China Banking Regulatory Commission (CBRC), the China Insurance Regulatory Commission (CIRC) and the China Internet Information Technology Office (CIITO) jointly released the Guiding Opinions on Promoting the Healthy Development of Internet Finance (Guiding Opinions). This is the first comprehensive regulation issued by the Chinese government in relation to Internet finance.

In the Guiding Opinions, the government sets out general rules (including governmental policy commitments), basic rules and specific preferential measures relating to Internet finance covering Internet payment, online lending, equity crowd funding, Internet fund sales, online insurance services and Internet consumer finance. The Guiding Opinions’ positive attitude towards Internet finance is demonstrated by a variety of supportive policies and rules.

First, according to the Guiding Opinions, innovation in relation to Internet finance platforms, products and services will be encouraged to stimulate market vitality. The government will support financial institutions in building innovative Internet platforms for online banking, online securities, online insurance, online fund sales, online consumer finance and other services; support Internet enterprises to set up Internet payment institutions, online lending platforms, equity crowd funding platforms and online platforms for selling financial products; encourage e-commerce enterprises to build and improve their own online financial services systems and effectively expand the supply chain operations of e-commerce enterprises; and encourage financial institutions and Internet enterprises (collectively, Industry Players) to actively carry out product, service, technology and management innovation to enhance their core competitiveness.

Second, the Guiding Opinions require that the financing channels available to Industry Players be broadened and that the financing environment be improved. Measures will be taken to support private investors who want to establish Internet financial industry investment funds; encourage high-quality Industry Players that satisfy relevant conditions to raise funds by becoming publicly traded on the domestic capital markets; and encourage banking institutions to support Industry Players in the embryonic stage pursuant to various financial policies which support the development of small and micro-sized enterprises. In addition, the Guiding Opinions also support for those Industry Players contemplating a listing on a stock exchange in China.

Third, the Guiding Opinions require all supervising bodies to simplify their administrative procedures and fully support the development of Internet finance while performing their supervisory functions, in order to create an environment that is beneficial to the development of Internet finance.

Further, the Guiding Opinions clarify the division of responsibilities among the relevant regulatory agencies. Under the Guiding Opinions, PBOC, as the central bank in China, will supervise online payments and CBRC will oversee P2P online lending and provision of online trust services, while CSRC will be responsible for supervising crowd funding and online sale of funds and CIRC will oversee the provision of online insurance services. SAIC as the authority which regulates the incorporation of corporates will be responsible for registering the establishment and incorporation of the Industry Players and CIITO will oversee the provision of financial information services and provision of Internet content services.

Fourth, the Guiding Opinions include certain specific preferential measures to promote the development of Internet finance, including preferential taxation policies. Industry Players in the embryonic stage may enjoy preferential taxation policies if certain conditions are satisfied. Additional pre-tax deduction of research and development expenses incurred by Industry Players in relation to new technologies and products will be possible. Given current Chinese taxation laws do not provide special rules for Internet enterprises, these preferential taxation policies will probably only benefit small or innovative enterprises which will also enjoy preferential taxation treatment in relation to income tax and stamp duty, etc.

Lastly, according to the Guiding Opinions, the government will push forward the construction of a credit infrastructure as well as nurture the Internet financial supporting service system. The Guiding Opinions require support to be given to the construction of infrastructure in big data storage, network and information security maintenance and other technical fields; encourage Industry Players to establish credit information sharing platforms; promote the process of relevant qualified Industry Players accessing basic financial credit information databases; allow Industry Players who meet particular conditions to apply to be licensed to conduct credit investigation business; support qualified credit intermediaries to carry out credit ratings of Internet enterprises to enhance transparency; and encourage accounting, audit, legal, consulting and other service intermediaries to provide relevant professional services to Internet enterprises. Under such provisions, the Industry Players will be able to conduct credit investigations on its customers more easily and effectively. This will be of great significance to the online lending companies, because the profitability of many Internet finance products, especially the P2P products, relies mainly on the credit of the individuals.

The Guiding Opinions set out certain basic rules that must be complied with when conducting business in relation to Internet payments, online lending, equity crowd funding, online sales of funds, provision of online trust and financial services.

According to the Guiding Opinions, direct lending on P2P online platforms will be governed by current relevant Chinese laws, regulations and judicial interpretations of the Supreme Court in China. This means that online lending will need to be carried out within the current legal framework and comply with relevant requirements. For example, the Provisions of the Supreme People’s Court on Certain Issues concerning Application of Law in Trial of Cases involving Private Lending (Private Lending Provisions) issued by the Supreme People’s Court on August 6, 2015 will influence online lending businesses. According to the Private Lending Provisions, an annual interest rate not exceeding 24% will be held legally binding and enforceable by a court; an annual interest rate exceeding 36% will be considered to be illegal, and any interest paid by the borrower and exceeding the annual interest rate of 36% shall be refunded to the borrower; while an agreement on an annual interest rate between 24% and 36% will constitute a “natural obligation” under Chinese law, which means both (i) the lender’s request of the payment of the interest exceeding the interest rate of 24%, and (ii) the borrower’s request of the refund of any already paid interest exceeding the interest rate of 24%, will not be upheld by a court. Such interest rate requirements are more flexible than the former requirement prescribed by the Supreme People’s Court that the maximum interest rate may not be higher than four times the interest rate charged on similar types of bank loans and thus is considered to be advantageous to online lending businesses. Another good message conveyed by the Private Lending Provisions is that the loans between companies, which were prohibited before, becomes now legal and will be enforceable before a court.

In relation to equity crowdfunding, the Guiding Opinions aim to help small and micro-sized enterprises to boost innovation and start-up ventures. Equity crowd funding is defined as “financing (a project) by raising monetary contributions from the public”, while in the consultation paper for the Guiding Opinions, crowdfunding was defined to limit to fund raising from specific investors. The language in the final version of the Guiding Opinions seems to reflect the nature of equity crowdfunding more accurately. Under the Guiding Opinions, raising money publicly through crowd funding is permitted, so it will be possible for a crowd funding platform to freely advertise and disclose financing information to the general public, rather than being restricted, as previously, to only advertising and making disclosures to “specific recipients”. However, the number of participants in equity crowdfunding is currently limited to 200 shareholders.

Online sale of funds is also regulated by the Guiding Opinions. Fund sales agencies that cooperate with other agencies to sell funds and other wealth management products via the Internet will need to comply with certain risk disclosure obligations, and they cannot solicit clients by promising investment returns in violation of particular provisions. In addition, fund sales agencies and their partner agencies, when providing investors with returns through activities other than fund products, must state and present the composition of such returns, the prerequisites for such returns, applicable circumstances, etc. in a comprehensive, truthful and accurate manner. A clear line is being drawn between the returns on fund products and the returns though other activities. In practice, there are currently many third party payment platforms engaging in Internet fund sales in breach of the fund sales regulations since such platforms do not hold the necessary fund sales qualification issued by the CSRC. The distinction between third party payment platforms and fund sales institutions in this regard remains unclear and needs to be further clarified by the CSRC.

The Guiding Opinions also repeat obligations on trust companies to comply with certain supervising requirements in relation to qualified investors. Under the Guiding Opinions, trust companies that sell products and carry out other trust business via the Internet must comply with regulatory provisions such as prudently screening their clients’ identities and assessing their risk tolerance, and they must not sell products to clients whose risk tolerance does not match the risk profiles of such products.

In the last part of the Guiding Opinions, several requirements are imposed on Industry Players to address existing problems in the current Internet finance business area and to ensure market order.

Under the Guiding Opinions, any organization or individual that intends to set up a website to provide Internet financial services must, in addition to complying with relevant financial regulatory procedures as required, put in place website record-filing procedures with the telecommunications authorities. The nature of such website record-filing procedures is not completely clear. If the Guiding Opinions refer to the current ICP (Internet Content Provider) filing procedure, then the process will be relatively easy, but if they refer to a special additional permit required from a government department or agency, the threshold required to be met to enter into Internet finance business may be raised significantly.

Furthermore, an Industry Player is required to select qualified banking institutions as fund depository institutions to manage and oversee client funds and to manage those client funds and its proprietary funds under separate accounts. Currently certain Chinese financial institutions provide fund depository services. However, high service charges, high operational costs and a lack of nationally standardised procedures and risk control mechanisms will be issues for future fund depositary services.

An Industry Player is required by the Guiding Opinions to disclose adequate information to clients and make relevant information about its business operations and financial condition available to clients promptly, so as to enable investors to understand its operating conditions. The Guiding Opinions have introduced the “consumer” concept in consumer protection law into the field of Internet finance and the aim is to strengthen the protection afforded to financial consumers. False publicity and compulsory tie-up sales during online sales of financial products are expressly prohibited by the Guiding Opinions, while the principles, standards and operating procedures for personal information protection in relation to Internet finance business are expected to be refined and improved as required by the Guiding Opinions.

As part of the government’s plan to strengthen cyber security, the Guiding Opinions also request Industry Players to effectively enhance their technical security levels in response to cyber security requirement trends in China.

Another important obligation imposed by the Guiding Opinions on Industry Players is an anti-money laundering obligation. Financial institutions, when cooperating with Internet enterprises or appointing Internet enterprises as their agents, must ensure that anti-money laundering and financial crimes’ prevention standards are not lowered as a result of such cooperation. Industry Players must cooperate with the public security authority or the judicial organs when requested.

As the first comprehensive regulation that contains extensive rules for Internet finance businesses, the Guiding Opinions will have extensive and far-reaching implications for Internet finance and related sectors in China. The increasingly complex regulatory environment reflects the determination of Chinese regulators in strengthening their control over the Internet finance industry. More detailed regulations are expected to be published in the near future.

For instance, the People’s Bank of China has issued a Draft Administrative Measures for the Online Payment Business of Non-bank Payment Institutions (Draft Online Payment Measures) on July 31, 2015 for public consultation until August 28, 2015. Aiming to minimise risk in the payment business and safeguard legitimate rights, the Draft Online Payment Measures set out a number of specific requirements regarding the security of online payment business, such as the verification of client identity, the use of Internet payment account and the protection of client’s private information. The security standard of Internet payment business may well be raised and in order to meet such requirements, the online payment process may become more complicated. The Draft Online Payment Measures also prohibit Internet payment institutions from opening accounts for financial institutions or other institutions engaging in financial services, such as the P2P lending platforms.

In light of the various regulatory measures set out in the Draft Online Payment Measures, it would affect the online payment market significantly if published in the current version. Thus, companies intending to participate in the Internet finance industry in China should evaluate the benefits and risks carefully and watch out for further regulatory developments in this sector.