I have been reading and thinking of the halted/suspended Ant Group IPO, one of the most dramatic head-on collides between governmental regulators and China’s celebrity entrepreneur Jack Ma, with his Fintech empire Ant Group — on the eve of a highly anticipated and presumably the largest IPO in the world last November.
To get a sense of its unrealized IPO size, according to a Forbes contributor, “The offering was oversubscribed 870 times – $2.8 trillion of orders just from retail investors in mainland China.” (Emphasis original). The suspense of IPO shocked almost everyone — except the China regulators, with dire financial impacts. For example, “(T)he investment bankers (the usual suspects, including Goldman, JP Morgan, Morgan Stanley) were out $400 million in fees.”
What Happened Before The Ant IPO
A halted or suspended IPO of this size inevitably invites rumors and conspiracies. This one from NYT is representative of the prevailing interpretation: “China sent a different message: No private business gets to swagger unless the government is on board with it.” or “the authorities made clear that international bragging rights mattered less than ensuring private companies know where they stand next to the state.”
If you heard what Jack Ma said at the “Bund Summit,” the top financial conference last October, days before the scheduled Ant Group IPO — attended by Wang Qishan, China’s vice president, and Yi Gang, the central bank governor — you would totally agree with the NYT analysis. When it was Jack Ma’s turn to speak at the summit, he throw multiple bombs by claiming China’s “financial regulators for being obsessed with minimizing risk, even though, he said, ‘there is no innovation in this world without risk.’ He accused China’s banks of behaving like ‘pawnshops’ by lending only to those who could put up collateral.”
In another analysis published by the Bloomberg, “Ma said ‘systemic risk’ is not the issue in China. Rather, China’s biggest risk is that it ‘lacks a financial ecosystem.'” Ma did not stop there and further attacked the international banking regulation and supervisory practices — the Basel Accords. “Basel Accord is more like a club for the elderly. What it wants to solve is the problem of the aging financial system that has been in operation for decades, and the problem of system complexity. But China’s problem is just the opposite. China has no financial systemic risk but has a risk of lacking the financial ecosystem.”
In addition to the Bund Summit talks, I also heard that Jack Ma once called Xi, Jinping a “Beast” in private and was later reported to Beijing by someone overheard the word.
Anyway, the story seems crystal clear: Jack Ma, “a celebrity entrepreneur in China comparable to Elon Musk or Bill Gates or Warren Buffett, or all three together” according to this Forbes contributor, had a miscalculated, mistimed and yet sweeping criticism of every regulator and regulation, ranging from Basel Accords to domestic regulations and regulators. And as a result, the offended and annoyed governmental officers — from Xi, Jinping down to the central bank governor — decided to teach Jack Ma a lesson who is the real boss. This piece from CNN looks at it as another case of “Beijing’s tech crackdown.”
Getting The Sequence of Events Right
About three months later, after the initial dust has settled, I believe we can see a more complete story. The first thing to do is to sort out the time sequence of events. Jack Ma delivered his famous speech on October 24th. On November 2nd, Jack was summoned by the regulators to a meeting, exactly one week after Ma’s speech. The next day, on November 3rd, China issued draft rules for online micro-lending by the People’s Bank of China (PBOC) and the China Banking and Insurance Regulatory Commission (CBIRC) to “increase the bar for micro-lenders to be able to provide online loans directly to consumers or jointly with banks, while limiting the amount they can lend.” According to this Reuters report, which provided the best summary and highlights of the draft rules.
The above just threw out a simple fact that can be stated like in later report: “In the weeks before the financial-technology giant was scheduled to go public, a previously unreported central-government investigation found that Ant’s IPO prospectus obscured the complexity of the firm’s ownership, according to the officials and government advisers, who had knowledge of the probe.” (Emphasis added by me).
The timing of an unreported governmental investigation into the ownership structure before the Bund Summit adds the strongest evidence that the halted Ant Group IPO was not merely a power play — or worse, a personal revenge — between the government and the entrepreneurs like Jack Ma. There had been something bigger going on. The Bund Summit was just something of a trigger — although at a time so close to the finale that it is almost impossible to link of anything else other than the trigger.
But even if we ignore the ownership investigation, it is highly unlikely that this 15 pages draft rules for the online micro-lending was one-week’s work. Rules like that require much thoughts and surveys. Financial Time was right that “In normal cases, Beijing’s regulators consult with key industry players and, when a consensus is reached, announce the new rules. That way the market impact is minimized.” It is safe to assume that the regulators have been thinking about — and working on — it for a while to get this far.
Also as pointed out by this Forbes analysis — the best I have seen from the US — “China is trying to establish a world-class financial system. Moves that evoke memories of a Mandarin past – hostile, peremptory and perhaps predatory – would seem to undermine this effort.”
This analysis (in Chinese) made an excellent point: The three public events appeared in this order: (A) Jack Ma’s speech at the Bund Summit —> (B) The announcement of the draft rules —> (C) Ant IPO suspension. But behind the scene it is highly likely that (B) —> (A) —> (C). That is, the regulators had the unpublished draft rules and somehow Jack Ma learned about — and was upset by — the rules. He then decided to give the speech in front of governmental top regulators in a bid to change their minds. This article (in Chinese) noted a seemingly trivial detail that actually told us something: Jack Ma typically prefers to speak without the prepared script but this time he was reading straight from his notes. He was serious and well prepared for the speech. Unfortunately his words worked exactly the opposite direction: It provided the new stimulus for the regulators to act fast before Ant going public.
What Did The Draft Rules Say?
I have downloaded the 15 pages (in Word) draft rules from this government site and its short English introduction from this site. After reading the draft I got the impression that the rules are thoughtful and timely, pointing to Jack Ma’s Ant Group. The new rules are imperfect, but still qualify as an example of smart regulations — especially considering the danger without them. As I said it in my title, we have China’s regulators to thank for, as they identified a “grey rhino” for us, a highly obvious yet ignored threat.
The general principle of online micro-lending business, according to the new rules, is small amount (小额）and diversified locations (分散). The targeting populations should be small enterprises, farmers and low income urban residents, utilizing the low cost and channel advantages.
Other key measures include, I will simply quote the words from the Reuters and Fitchratings.com, which calls online micro-lenders as Online Microloan or OM:
“A new requirement for small online lenders to provide at least 30% of any loan they fund jointly with banks.”
“They also set a 5 billion yuan registered capital threshold for micro-lenders that offer loans online across different regions. The current threshold varies between provinces but is well below 1 billion yuan.”
“Micro-lenders which source borrower data from ecommerce platforms to assess their credit will be required to share the credit information with the central bank, according to the draft rules.”
“Online microloan OM companies’ exposure to single borrowers at the lower of CNY300,000 or one-third of three-year average income for individuals, and CNY1 million for non-individual borrowers.”
“They require additional central government regulatory approval for OM companies to operate outside of the province in which they are registered, and registered capital of at least CNY5 billion to qualify, significantly higher than the levels currently required, which vary by region but are usually below CNY1 billion.”
“the proposed requirement for bank or shareholder loans to not exceed 1x of net assets, and for funding backed by bonds or ABS to not exceed 4x of net assets,”
Why Ant Is Dangerous To Consumers
Jack Ma’s Ant has been huge in transactions and market shares. It is “50% bigger than Goldman Sachs. Ant’s most recent valuation came in at $150 billion, compared to Goldman Sach’s $99 billion.” According to this report. Furthermore, “estimates of Ant’s pre-offering valuation set it above JP Morgan Chase (the world’s most valuable actual bank).” And “More payment transactions processed than Mastercard & Visa.”
So Ant possesses not only cost and channel advantages, but also economy of scale. But of course, size and number of transactions do not necessary pose risk on their own. The problem with Ant, as this excellent article on Forbes has said, “is so many different things, perhaps too many. We have nothing like it here in the U.S., and we never will. (American anti-trust regulators would block it.)”
The best article on the topic is from a Forbes contributor “In a sentence – Ant is creating the conditions for a repeat of the same sort of “sub-prime” credit crisis that triggered the 2008 financial debacle in the U.S.” (Emphasis original).
The comparison with the subprime mortgage loaners in the US is interesting and helps readers in this country to understand the risks associated with the same type of consumers — those with low credit scores and underserved by regular financial institutions, especially the big ones. Perhaps the largest difference is that the Chinese consumers of Ant micro-loan platforms like Huabei (which in English means “Just spend!”) and Jiebei (which in English means “Just borrow!) are mostly youngsters and students, who want to follow the fashion trend and to buy anything their peers wanted or had. In my view, Ant has encouraged “consumption on borrowed money” against the Chinese tradition of savings or “delayed gratification,” unlike the culture of “instant gratification” in the west.
This is the first source of danger created by Ant. its danger degree goes up proportionally with the size of consumers served by the micro-lending platforms. The bad news is that for Ant, “(c)onsumer credit is now Ant’s largest operating unit – 40% of the company’s revenue generated in the first half of 2020” according to the Forbes contributor cited earlier. According to this Reuter report, the Ant consumer lending platform “sources demand from retail consumers and small businesses and passes that on to about 100 banks for underwriting.”
Why Ant Is Dangerous With ABS
The same Forbes contributor was right to point out the danger of Ant’s consumer lending business by pointing out the link with the “originate-to-distribute model that was at the heart of the sub-prime mortgage crisis in the United States. In brief – the mortgage originators who fueled the subprime crisis did for mortgages exactly what Ant does with Chinese consumer credit. They worked with customers (home-buyers) to secure a mortgage, performing all the credit qualifications, and then passed off the loan and its payment stream to someone else. In the sub-prime crisis, many of these loans were securitized – that is, packaged into financial instruments (bonds, “asset backed
securities”) sold to investors.”
In the case of Ant, the game of ABS is a part of the business model. Like in the sub-prime crisis, Ant serves as the originator of the consumer loan, with the risk of credit default passing to the underwriting banks. This is the first layer originate-to-distribute model.
Jack Ma’s game did not stop there. With the money lent out to consumers, Ant becomes a creditor or lender, the money it lent out can be used as claims for borrowing more money from financial institutions. How much can it borrow? Depending on which way Ant goes. To borrow from banks using the claims as collaterals, the money Ant can receive will only be a portion of the claims (e.g., you have $100 claim, banks will only lend you $70 based on the claims as collateral).
Ant decided to go another way, which is the ABS or Asset Based Securities, the second layer of originate-to-distribute model. In the game of securitization, Ant sells the package of consumer debts to investors and no longer assume risks of credit default. Unlike the 2007-08 global financial crisis, however, the second layer of originate-to-distribute mainly aims at expanding the capital for more lending. For that purpose, Ant has divided its securitized “loan receivable” into categories of A, B & C, with C being the highest risk but also highest returns. This category is made viable through cross guarantee and cross purchases between subsidiary firms within Ant, a questionable practice.
This video is an excellent talk (in Chinese) why Ant’s ABS moves are dangerous.
Both layers of originate-to-distribute can be summarized by the term Lemon Socialism, meaning privatized profits but socialized losses or risks, when government intervention to subsidize weak or failing firms, effectively absorbs part or all of the recipient’s losses.
Why Ant Is Dangerous With Low Transparency
The report by WSJ told us that “When the PBOC (People’s Bank of China) tried to regulate Ant’s payment and wealth management business about five years ago, Ma bypassed the central bank after failing to reach a consensus with regulatory officials and lobbied the central government. The PBOC later dropped those regulation plans.”
This time however, at the direct and written instruction of Vice Premier Liu, He, the watchdog moved fast. Now all micro-lenders in China must “fund at least 30% of any loan they fund jointly with banks. Only 2% of the loans Ant had facilitated as of end-June were on its balance sheet, its IPO prospectus showed.” Even though Ant knew the coming new regulation, “Ant’s executives did not mention the possible regulatory changes during its two main calls with global investors during its roadshow last week, two other investors said.”
An Imperfect Move By China Regulators
Again, from the Forbes contributor: “At the very least, the regulatory response seems too violent. The normal way to rein in a company like Ant, slowly and without shocking the markets, is to impose gradual new regulations (e.g., higher capital reserves, or line-of-business restrictions) or new taxes. With plenty of discussion, and time for all parties to adjust.”
I want to add that having a decisive move has its own advantage, especially consider that we only had a few days away from the Ant IPO. The cancellation inevitably will have high impacts. That said, to cancel the IPO is far better than saving it and then making gradual adjustments, because by then individual investors will suffer the most, as they will buy Ant shares at higher prices but would have to sell it at a lower level.
I would also wish that the draft rules had provided more details on how to protect consumers and what penalties will micro-lenders receive if they violated consumer rights.
Will Ant Just Be Another Boring Bank?
Not really. This much is still true that despite micro-lending is high risk, Ant can utilize its huge amount of online payment records to figure out who is more credit worthy than others. That is something that regular banks do not have.