Jul 11, 2013 04:45 PM

Regulatory Questions over Online Investment Service Linger


(Beijing) – In the two weeks after it launched, the Yu E Bao online investment service offered by Alibaba Group has been warmly welcomed by investors.

But questions over the nature of the service and who has regulatory responsibility have been a cause for concern. Also, regulators have raised questions over how the funds in its accounts are managed, and they have said the company is downplaying the risk to investors, which could lead to larger problems down the road.

The service, launched by Alibaba's online payment unit, Alipay, and Tian Hong Asset Management Co. on June 13, had 2.5 million registered users by June 30. The rapid growth can be attributed to high returns on offer. Also by that date, the total balance of Yu E Bao accounts was 5.7 billion yuan.

The rapid growth boosted Tian Hong's Zenglibao, a currency fund product designed for Yu E Bao users, making it the country's largest fund in terms of number of investors.

Yu E Bao has also been a hit in the capital market; companies related to it and Tian Hong have seen share prices surge.

All of this has gotten the attention of the market. "There are more than 20 fund companies in talks with Alipay for potential cooperation, and new products may be launched," said Zu Guoming, the director of Yu E Bao.

The success has come despite the fact Yu E Bao is still facing regulatory hurdles. The China Securities Regulatory Commission (CSRC) said on June 21 that the service broke fund management rules.

Gray Area

Yu E Bao targets younger and non-professional investors. It allows individuals to buy money market funds or other financial products from Tian Hong using idle cash in their Alipay accounts. Users can also spend their funds in Yu E Bao accounts on e-shopping.

A regulatory official said the service broke central bank rules. "As a new financial product, Yu E Bao has the dual function of online payment and investment, thus, its operation contradicts some of the regulations of the central bank."

But Zu said Yu E Bao was a payment platform of Alipay that complies with regulations that apply to Alipay as an online payment service.

"Tian Hong embeds its system into our platform and monitors the transaction data," he said. Yu E Bao cannot be seen as a fund sales business, Zu said.

In May 2012, the CSRC licensed Alipay as a third-party marketing venue for fund transactions. The license allows a third-party payment provider like Alipay to handle transactions for fund purchases, but is vague on participation in fund sales.

In short, it is unclear whether the funds in Yu E Bao accounts are managed by either Alipay or Tian Hong, and regulators have not weighed in.

On June 21, the CSRC said at a regular press conference that the service violates fund management rules because part of its service had not been registered with regulators. The regulator told Alipay to submit extra documents for registration or risk punishment.

"We submitted the supplement materials in early July," Zu said. He said it was only a matter of time before Yu E Bao received full approval.

The confusion regarding Yu E Bao leaves the management of its fund in a regulatory gray zone.

Under current rules, third-party payment services must put all of the payment funds it receives from customers into a special account and the company cannot use these funds.

If Yu E Bao is seen a fund investment instrument, the money transferred into its accounts does not have to be set aside.

Meanwhile, there are questions over whether Yu E Bao should be supervised by the central bank or the CSRC.

This issue relates to how funds in Yu E Bao accounts are redeemed, for which there are two methods. The first is to transfer the money immediately from Yu E Bao back to users' Alipay accounts. The second involves funds used for online shopping. The company said it is also exploring allowing funds to be returned to users' bank accounts.

Alipay is using its own cash to repay investors when they ask for immediate redemption. A source close to the central bank said its research found that if a large number of investors wanted their money, Alipay and the fund companies could face a liquidity crunch.

A regulatory official said if Yu E Bao is classified as payment service provided by Alipay, then it will under the supervision of the central bank and all of the funds Yu E Bao received from users should be treated as online payment cash and transferred to a special account. Thus, Alipay should buy fund products with its own cash and offer them to Yu E Bao users.

But if Yu E Bao is identified as a fund investment service in which Alipay only provides a bridge between investors and fund companies, funds in Yu E Bao should be managed directly by fund companies under the supervision of the CSRC. In this case, fund companies partnered with Alipay must acquire an online transaction license from the central bank, the official said.

Either way, regulators should set up clear rules regarding the management and operation of funds in Yu E Bao accounts, the official said.

Risk Warning

Regulators are concerned about risk associated with Yu E Bao, which has promoted itself as a safe investment choice. Jiao Jinpu, director of the central bank's investor protection bureau, said that "Yu E Bao has described itself as having little possibility of a loss, but there are still risks in money market fund investment."

Earlier, Tian Hong said funds from Yu E Bao users are only invested in government bonds, bank deposit agreements and other low-risk products. Zu has said that for now the service will only consider cooperation with fix-income and low- risk fund products.

But in a press conference in Hong Kong on July 9, Alibaba CEO Jonathan Lu said Yu E Bao is eyeing a more diversified product menu that includes low-risk products and higher-risk offerings.

Regulatory officials have expressed concern that should Yu E Bao users suffer a large loss because they were not properly warned, investors may become suspicious of anything related to the online payment system.

Zhou Xiaoming, vice president of Tian Hong, said the huge amount of data collected by Alipay and Taobao, Alibaba's consumer-to-consumer platform, would help Yu E Bao monitor potential liquidity problems.

"We can also deal with an unpredictably large-scale redemption through fund buyback, bond issuance and company's bank deposits," said Zhou.

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