This is the second part of a two part series on Ant Financial. Click here to read the first part on Ant Financial’s history, ecosystem, and growth.
In a 2017 interview, Jack Ma stated very emphatically, “We have to step ahead of the regulators; we have to. Otherwise, we go nowhere.”[note] Bloomberg TV Markets and Finance. Alibaba’s Jack Ma on Alipay, Tencent and Regulation, September 14, 2017. https://www.youtube.com/watch?v=DJlHqPqf6k8.[/note] This game of leapfrog between third party payment applications and regulators has helped served the Chinese market by letting the market decide the future of finance. Chinese fintech has clearly benefited from the boldness of companies such as Ant Financial and Tencent setting bold paths ahead of regulators, but now that regulators are getting involved, it is beneficial for the future of competition, mobile payments, and Chinese financial markets. In this blog post, will shift my focus to the implementation and effects of the 2016 clearinghouse regulation.
2.1 Introduction to Clearing & ACH
In finance, clearing is the procedure by which an organization acts as an intermediary, taking on the role of both a buyer and seller as a means of reconciling the order between the transacting parties. This process ensures the availability of funds, records the transfer, and ensures delivery to the buyer. The third-party organization that manages this transfer is a clearinghouse.
In the United States, the dominant electronic payment method is the automated clearinghouse (ACH) system. In fact, this network supports more than 90 percent of the total value of all electronic payments in America.[note]“NACHA Membership Approves Same Day ACH.” NACHA: The Electronic Payments Association, May 19, 2015. https://web.nacha.org/resource/same-day-ach/nacha-membership-approves-same-day-ach.[/note] This settlement process takes 3-4 days, purposefully slow as a risk management measure; unlike credit and debit card transactions, ACH transactions are not authorized immediately and can be reversed after they’re submitted to the customers bank. These transactions are processed in batches once per day and have to be cleared by the Federal Reserve before they’re sent to the customer bank, as seen in this infographic which depicts the process of an ACH payment to a power company in the United States.
In 2015 the Federal Reserve Board approved same-day ACH processing to be rolled out in phases. The first thing to know is that it will not replace regular ACH payments; it’s an elective option with a 5.2 cent fee per transaction. The Board already implemented two phases including all ACH credit transactions and debit transactions a morning and afternoon processing time for same-day ACH transactions, and the third phase, live on March 16, 2018, required banks to make funds available by 5:00 PM daily for any ACH credit transaction processed at 1 PM on the same day.[note]“Same Day ACH: FAQ.” NACHA: The Electronic Payments Association, August 1, 2017. https://web.nacha.org/system/files/resource/2017-08/Same-Day-ACH-FAQ-2016_0.pdf. Further planned improvements include further enhancing funding speed in March 2019 and increasing the per-transaction dollar limit to $100,000 in March 2020. [/note] While their long-term goal is to add a third processing window, they can’t even provide an estimation on when that will be feasible.[note]Venable, Cheryl. “Federal Reserve Banks Respond to NACHA Same Day ACH Request for Comment.” The Federal Reserve, January 26, 2018. https://www.federalreserve.gov/paymentsystems/files/frfs-staff-comment-letter-to-NACHA-20180126.pdf.[/note] Perhaps this is indicative of change in the United States financial markets – a steady, slow, deliberate tango with regulators towards long-term vision and goals. In the next section, I will explore comparisons with the Chinese mobile payment market, which have played out more similar to a game of follow the leader than a slow dance.
2.2 Brief Summary of Mobile Banking in China
First, it’s important to note the fundamental difference between mobile payments and mobile banking. Mobile payments are typically nonbank entities that use mobile devices to provide payment services between peers (including C2C or C2B) and utilize electronic value that is exchanged for cash when a third party matches the value through a licensed bank. Meanwhile, mobile banking revolves accessing financial accounts through a mobile device, using existing intra-bank and inter-bank payment networks that rely on existing bank-consumer regulation that treat mobile technologies as an extension of the bank account.[note]Congdon, Stephen. “What’s in Your Wallet: Addressing the Regulatory Grey Area Surrounding Mobile Payments.” Case Western Reserve Journal of Law 7, no. 1 (2016): 99.[/note]
The PBOC responsibilities according to law are to, “Maintain the normal operation of payment and clearing services in China.”[note] “Payment, Clearing, and Settlement Systems in China.” The Committee on Payment and Settlement Systems, November 2012, 31. https://www.bis.org/cpmi/publ/d105_cn.pdf.[/note] Since 2002, PBOC has developed a number of interbank clearing systems including the China National Advanced Payment System (CNAPS), China Domestic Foreign Currency Payment System, and local clearing systems. [note]“Payment, Clearing, and Settlement Systems in China.” The Committee on Payment and Settlement Systems, November 2012, 34. https://www.bis.org/cpmi/publ/d105_cn.pdf.[/note] At the end of 1010, PBOC branches owned and operated 1017 local clearinghouses, with supervisor coordination by CBRC, CSRC, and CIRC.
The largest institution authorized by the PBOC to provide clearing services for bankcard transactions is China UnionPay. It was established jointly by the four major Chinese banks in 2002. Because of a lack of competition for bankcard transactions, despite 99% of UnionPay’s cards belonging to China, it makes up 43% of cards globally. In 2012 the WTO declared UnionPay had an unfair advantage in the domestic market, paving the way for the state council’s liberalization in 2015. However, UnionPay is well poised to continue its growth overseas, as it charges a low rate of .6% for clearing payments, compared to the 1-2% of overseas cards. [note] Dyke, Dan Van. “Visa Challenges UnionPay in China.” Business Insider, September 21, 2017. http://www.businessinsider.com/visa-challenges-unionpay-in-china-2017-8. [/note]
2.3 Mobile Payments Clearing Regulations in China History
China is a very unique case because as the fintech ecosystem of mobile payments’ has rapidly expanded (the following graph illustrates the rise in market share), it has begun adopting many of the roles traditionally served by banking. Yet, it was not constrained by the clearing regulations detailed above by the PBOC because technically it was not mobile banking. Thus, despite mobile-payment transaction volumes growing to the equivalent of world-class bankcard associations, their regulations prior to 2016 were an ad-hoc regulatory gray area.
Prior to the 2016 clearinghouse implementation mandate, every mobile-payment payment transaction, from requests to clearing, was handled by the third-party payment providers. This raised a number of concerns from a regulatory perspective. Most importantly according to the Caixin was the fact that the blurred boundaries between payment and clearing meant that payment companies would pool money in their accounts, raising concerns that the money could be used for unintended purposes including laundering. Another concern was that while Ant Financial and Tencent were the dominant companies offering mobile payments, the fact is that there were over 200 payment companies operating under different protocols with different partnerships with banks, all outside of the central bank’s oversight.[note] Dong, Junfeng. “Five Things You Need to Know About China’s First Online-Payment Clearinghouse.” Caixin Global, July 6, 2017. https://www.caixinglobal.com/2017-07-06/101111363.html.[/note] As a result, it has been difficult for banks to maintain consistent standards and control risk.
Another key risk that regulators sought to contain was the potential of top mobile-payment companies becoming so-called ‘data monopolies.’ As companies like Ant Financial and Tencent accelerated knowledge growth of consumer behavior, they have used this advantage to increase the technological and informational gap over their rivals. For instance, Ant Financial is able to leverage data analytics as a strategic resource for risk management and credit assessment. In part because of this, Alipay’s fraud rate is less than 1 out of 100,000, compared to 1 of 100 (US credit card companies) and 1 out of 1000 (online payment companies).[note] Sia, Siew, Shuyan Xie, and Boon Neo. “Fintech and Finance Transformation: The Rise of Ant Financial Services (Draft).” AsiaCase.Com, September 2017, 13. [/note] However, this advantage turns into a risk as the larger companies become so dominant that they stifle newcomer and potential innovation. In fact, according to Sun Guofeng, head of the PBOC research center, “Data monopoly could potentially be even more harmful than technological monopoly.”[note] Pan, Yue. “Chinese Central Bank Requires All Online Transactions Clear Via New Central Clearing Platform.” China Money Network, August 7, 2017. https://www.chinamoneynetwork.com/2017/08/07/chinese-central-bank-requires-all-online-transactions-to-clear-via-new-central-clearing-platform.[/note]
2.4: 2016 Clearinghouse Regulation
In August 2016, the PBOC unveiled an ambitious plan to create a unified platform to clear all mobile-payment transactions. By doing so, the central bank would ensure unifying payment standards and place this vast and growing market under closer scrutiny. Appendix F shows the full equity structure of the online payment clearinghouse (网 联) , which will connect with 115 licensed payment service providers and 300 commercial banks. The below graphic indicates the standardized transaction process by which all mobile payments must follow by later in 2018.
Key to the future success of this mobile clearinghouse has been its priority on scale. China’s mobile payment market is the world’s largest, in 2016 it saw 120% YOY growth to reach a total of 54.3 trillion yuan. Thus, it needed large capacity from the beginning, but also the scalability necessary to not impede future growth. From a point of comparison, VisaNet can handle 65,000 while Alipay’s system can process 86,000 transactions per second. The clearinghouse system was designed to handle between 120,000 and 180,000 transactions per second, but because of its decentralized data center approach, it easily scalable in the future. As pictured in the above infographic, it adopted a multicenter structure to ensure security, and if any technical error occurs at one center, is can switch to another within seconds. Each center can handle 20,000-30,000 transactions per second, and more centers can be added when the necessity arises.[note] Zhang, Yuzhe, Huawei Ling, and Wei Han. “First Online-Payment Clearinghouse Takes on Mission Impossible – Caixin Global.” Caixin Global, July 6, 2017. https://www.caixinglobal.com/2017-07-06/101111357.html.[/note]
In addition, this clearinghouse tactic provides the crucial benefit of being highly centralized. Rather than having individual payment firms on entirely different business operation levels managing their own security and risk control, this centralization will play a crucial role of leveling the playing field. Rather than playing survival of the fittest, in which Ant Financial and Tencent have clear advantages, all payment firms will be granted equal access to clearing services and will be subject to the same standards of business operations and risk control. In addition, authorities will be empowered by being able to turn to one central source for money laundering claims on mobile platforms. Alipay and Tencent have been slow to act on old regulations, in fact, only 51% of online payment accounts had real-name registration at the end of 2015.[note]Wu, Yujian, Yuzhe Zhang, and Yuqian Wang. “Real-Name Registration Negligence Lands Alipay, Tencent in Hot Water.” Caixin Global, May 11, 2017. https://www.caixinglobal.com/2017-05-11/101089328.html.[/note] This centralization is certainly one step towards preventing money laundering.
While this clearinghouse was widely praised as necessary to level the playing field between small and large companies, western sources seemed to focus about privacy concerns, specifically access to sensitive data. Technode wrote that while the clearing house was, “Set up ostensibly to safeguard consumers… [actually] it is very much about data.” Through this clearing house, critics argued that the government will get direct access to transaction details and be able to amass huge amounts of data about spending and consumer behaviors. While this has the benefit of helping contain financial crimes, western media chose to focus on privacy. Business Insider coverage reported that this new regulation would hurt prospects for financial mergers and acquisitions by Chinese players, specifically Ant Financial’s bid for MoneyGram. Business Insider reporters wrote that this regulation weakened claims that data could be protected from the Chinese government and other sources.[note] Dyke, Dan Van. “Alipay and Tenpay Give up Transaction Data in China.” Business Insider, August 14, 2017. http://www.businessinsider.com/alipay-and-tenpay-give-up-transaction-data-in-china-2017-8.[/note]
In June 2017, Tencent became the first mobile payment provider to migrate to this new platform. Tests are still underway, but in 2018 the other top eight players in China’s third-party online payment market will also migrate to the online clearinghouse.[note]Zhang, Yujie, and Huawei Ling. “In China, World’s First Online-Payment Clearinghouse Goes Live.” Caixin Global, June 30, 2017. https://www.caixinglobal.com/2017-06-30/101107960.html. The top nine players, which make up 96% of the mobile-payments market, also include Ant Financial’s Alipay, JD.com’s Chinabank Payments, Wanda Group’s 99bill, Baidu’s Baidu Wallet, and Ping An Group’s 1Qianbao[/note] Despite potential privacy concerns, it must be noted that this is a vital development for Chinese financial markets. By forcing an even playing field, payment providers will all need to follow the same standards, thus saving on risk management and ensuring the future of mobile payments will continue to be bright in the most advanced fintech market in the world.