Caixin Insight: What Blew Up the Ant Group IPO?

Why did the Ant IPO blow up?

As you have almost certainly heard by now, the much-anticipated IPO by Chinese fintech giant Ant Group blew up in fairly spectacular fashion this week. Both the Shanghai and Hong Kong components of its dual listing have been suspended, and it now seems unlikely that Ant will be able to list without going through the entire process again, potentially after being forced to spin off some of its businesses.

Few people saw this coming, and much coverage of the event in Western media has focused on the speech Jack Ma gave at the Bund Summit in late October, casting the IPO suspension as retribution for his criticism of regulators. CNN, for example, made their story’s headline “Beijing just yanked Ant Group’s IPO to show Jack Ma who’s really in charge.”

But there’s a lot more going on here, and while this whole debacle probably could have been handled better by all of the parties involved, regulators’ qualms with Ant Group have a lot more to do with the company itself than they do with Ma’s abrasive attitude.

The most frank discussion of those issues has been a series of three articles recently published pseudonymously by “senior scholars” associated with the central bank:

- “Potential Risks and Regulation of Large-scale Internet Companies Entering Finance” by Zhou Jueshuo (周矍铄) in Financial Times, (the central bank-backed paper, not the more famous international paper of the same name)

- “Issues to be Considered and Clarified in the Development of Financial Science and Technology” by Shi Yu (时雨) also in Financial Times

- “A Few Points on Financial Innovation and Regulation” by Zhang Feiyu (张非鱼) in Caixin

Their most important arguments are that:

- fintech companies distort the focus of finance and entice consumers to over-borrow

- Guo Wuping (郭武平), director of the CBIRC consumer protection bureau noted (link in Chinese) on Monday that regulators’ top priority is controlling risk and protecting the rights and interests of the consumers of financial services

- Guo sees Ant’s Huabei lending unit and bank credit card businesses as basically the same, but with higher fees charged. He considers this inconsistent with the concept of promoting financial inclusion: “universal but not beneficial”

- Ant is a winner-takes-all monopolist that takes advantage of network effects

- with significant anticompetitive implications; this was the number one point raised by Zhou Jueshuo

- fintech firms rely too much on big data and AI

- this ends up making business models of fintech companies converge, so different operators end up taking on the same kind of risks, increasing potential for financial risk contagion

- and should not be overestimated in terms of its risk-control utility

- fintech companies over-collect customer data and may violate privacy rules

While these articles were generally careful not to specifically name and shame Ant, they were very clearly targeted. The number one takeaway is that regulators do not consider Ant substantially different from traditional financial institutions in most aspects of its business, and as Zhang wrote, “financial supervision departments should dare to say “no.”

New online microlending rules

Perhaps the best example of regulators listening to Zhang’s advice and saying “no” is the new regulation on microlending, released the same day China's financial regulators summoned Jack Ma and other top Ant Group executives.

On Nov. 2, the People’s Bank of China (PBOC) and China Banking and Insurance Regulatory Commission (CBIRC) released draft rules (link in Chinese) on online microlending which introduce a number of restrictions on Ant.

Ant makes roughly half its profits from online microlending. These new rules are the reason the IPO was halted — they will have a major impact on the company’s business model, revenue structure and future growth, so the company will need to assess the full impact and disclose it to investors.

The three most important aspects of the new rules for Ant are:

- online microlending businesses can only operate within the province or region they are registered, and won’t be allowed to do business outside that area without regulatory approval

- it seems nearly guaranteed that Ant will obtain approval to do business across provinces, but will be supervised by the PBOC and CBIRC instead of local bureaus

- this will subject them to closer scrutiny, but is also likely to benefit Ant in the long run, potentially shutting would-be competitors out of the market

- capping loans at 300,000 yuan ($4,494) per person, or one-third of individuals’ average annual income in the past three years, and 1 million yuan for businesses

- many online microloan borrowers don’t have formal proof of income, and defining “income” is a challenge; if authorities only recognize stable wage income (as they do for mortgages), it will greatly limit the scale of Ant’s business

- the majority of microloans go to rural residents and low-income households; under the new rules, they will only be able to access a small amount of credit that may not even exceed 10,000 yuan

- online microlenders must self-fund at least 30% of any joint loan with financial institutions

- this rule seems tailor-made for Ant, which has only come up with 1% to 2% of the 1.8 trillion yuan in loans made through its platform

- this would force it to put at least 540 billion yuan onto its balance sheet on top of 170 billion yuan of ABS loans, meaning it would need to expand its capital from some 35 billion yuan to 140 billion yuan, according to Sun Haibo (link in Chinese), director of the Financial Supervision Research Institute

- this would essentially limit it to either:

- 16x leverage under an optimal scenario (i.e. assuming it can securitize the vast majority of its loans, which may not be the case)

- 10x-12x leverage under a more likely scenario, putting the limit at just about the same level as banks’ capital adequacy ratio requirements

14th Five-Year Plan recommendations, explained

The fifth plenum concluded last Thursday, and the Communist Party’s recommendations for the 14th Five-Year Plan (FYP) and 2035 vision have now been published, along with Xi’s explanation of them (both links in Chinese).

The recommendations contained few surprises for those that either read our predictions (which were right on the money, as always) or read the communique from the plenum last week. For those that didn’t read the communique and want a recap, it set out a dozen priorities for the 14th FYP:

• upholding the central position of innovation in China’s overall modernization drive and taking self-reliance in science and technology as strategic support for national development

• accelerating the development of a modern industrial system and promoting economic optimization and upgrading

• forming a strong domestic market and a new pattern of development

• deepening reform in an all-round way and building a high-level socialist market economy system

• developing agriculture and rural areas, and promoting rural revitalization

• optimizing the layout of land to promote coordinated regional development and new-style urbanization

• boosting development of cultural undertakings and industries, and enhancing cultural soft power

• promoting green development and harmonious coexistence between man and nature

• opening up to the outside world at a high level and opening up new prospects for win-win cooperation

• improving quality of life and raising the level of social development

• balancing development and security, and building a more peaceful China

• accelerating modernization of national defense and the armed forces

If that seems generic to you, it’s because ... it is. Plenum communiques are always steeped in jargon, and while they can be read for political signals by nerds like us, they really don’t provide much in the way of policy detail.

Xi’s explainer helped clarify, reiterating in particular the top priority to adjust China’s development model. As regular readers of this newsletter may recall, we’ve been talking about the “dual circulation” strategy for some six months now, and the concept is now finally coming into focus.

While foreign investors have voiced concerns that the strategy reflects an inward turn of China’s economic policy, Han Wenxiu (韩文秀), deputy director of the Central Financial and Economic Affairs Commission, took pains in a Friday press conference after the plenum to make clear that the strategy is

• an active action, not a passive response

• a long-term strategy, and not a stopgap measure

• in no way implies any retreat from opening up

Xi elaborated further in his remarks on the 14th FYP recommendations, discussing how the domestic and international components work together: “By promoting the formation of a large, smooth domestic economic cycle, we will be able to better attract global resources, meet domestic demand, raise the level of China’s industrial and technological development, and gain new advantages in international economic cooperation and competition.”

As a final note, you may notice Xi used the word “smooth.” That’s one aspect of the strategy that’s been relatively under-emphasized in English media coverage. This isn’t just about import substitution and expanding domestic demand — it’s also about literally “smoothing” circulation of goods with things like stronger logistics networks and production factors with deregulation to allow freer flows of land, labor and capital. That “smoothing” is where the real meat of the strategy will be.