China Internet Giant Leading Finance Revolution

Before launching “ZengLiBao” money market fund in June 2013, Tianhong Asset Management Co was rather unknown and far outside of the league table of top fund companies in China.  It had only a handful of funds with returns that were not remarkable.

In less than a year, ZengLiBao” became one of the top ten largest money market funds in the world.  With that, Tianhong dethroned long-time market leaders and ranked first out of 83 fund management companies by assets-under-management.   

Such astronomic climb is only possible in China where the rules of the game are still being written and re-written.  It is also fueled by China’s low deposit interest rates that has its huge population of savers thirsting for better returns – an environment ripe for financial products innovation.

What lies below Tianhong’s phenomenal success is actually China e-commerce giant Alibaba’s challenge to traditional financial services.  Never mind that it is through a simple idea, and one previously adopted in the U.S. by PayPal.

Users of Alibaba e-commerce platform in China establish Alipay accounts for online payment of products and services on Alibaba’s popular sites such as Taobao.   Rather than leaving funds in the account idle, Alipay offers users the choice to invest the balance amount in Tianhong’s “ZengLiBao”. The sweetener is potential returns much higher than bank deposit rates.  That is essentially “Yu’eBao”, meaning “treasure of the balance” or “leftover treasure”.

In October 2013, Alipay’s parent company Zhejiang Alibaba announced that its Small & Micro Financial Services Group was acquiring a controlling stake in Tianhong Asset Management and will inject capital of 1.18 billion yuan.   By the end of first quarter 2014, Alipay “Yu’eBao” raised funds in excess of 500 billion yuan or US$80 billion.

The “Yu’eBao – ZengLiBao” scheme offered potential annualized return of around 5 or 6%, a clear edge over bank interest rates of less than 1% for normal saving deposit rates.  Fixed deposit rates in China of around 3% are also just half of Yu’eBao’s expected returns.

Deposit interest rates in China remain tightly regulated, although there have been talks of interest rate liberalisation to allow rates to be driven by market forces, as part of China’s financial reform.   In July this year, the People’s Bank of China removed the floor on the discount that banks can offer on the centrally set interest rate, but the ceiling for interest rates remains capped.

Yu’eBao also attracted users by allowing any amount of investment and the liquidity of withdrawals at any time.  Happy to be able to earn higher interest rates on amounts in their Alipay accounts coupled with conveniences for making online transactions, a lot of Taobao users moved funds out of bank accounts into Alipay.

Alibaba’s entrepreneurial founder Jack Ma identified an opportunity in the existing regulatory and market framework, and acted ahead of the curve. Although Alipay, and its parent company Zhejiang Alibaba, are not part of the Alibaba Group whose shares are recently listed on the New York Stock Exchange, Zhejiang Alibaba is held as to 80% by Jack Ma and 20% by one of his close business allies.   Zhejiang Alibaba is now called Zhejiang Ant Small & Micro Financial Services Group following a company name change.

With Yu’eBao and Zhejiang Alibaba’s investment into Tianhong, Jack Ma made his foray into China’s fund management industry and broke new ground for the online distribution of fund products.   While mutual funds in China are typically distributed through banks, securities firms or the fund companies’ own distribution network, with Alipay’s 81 million users that have poured funds into Yu’eBao, that is more than the number of retail investors in the China stock exchanges.

While many other platforms have sought to emulate Yu’eBao’s success, it was Alipay’s lead that moved internet finance into the fore.  Other e-commerce companies Baidu and Tencent looked into offering their own versions of Yu’eBao, in trying to follow suit.   Tencent tied up with China Asset Management Co, which had long time been China’s largest fund management company.   Online fund supermarket, Fund Eastmoney, also begun operating an online and mobile platform that offers several funds and enables users the ease of switching between funds.

Yet, Yu-eBao wasn’t so much a game-changer for the fund industry but for the banks.  The platform’s underlying products, “ZengLiBao”, is not too different from other money market funds that the China fund market has had in the past.

The success of “ZengLiBao” is also almost exclusive and not enjoyed by other Tianhong funds or by other competitors. Based on numbers from Wind which is a dominant operator of China financial terminals, “ZengLiBao” had a net inflow of around 360 billion yuan in the first three months of 2014.  58 fund companies suffered a net outflow of about 195 billion yuan, which roughly equals the amount of net subscriptions into the Tencent – China Asset Management product.

With the feverish and skewed interest in money market funds, it may be the banks that are experiencing the biggest shake-up.

In data released by the People’s Bank of China, the nation’s central bank, bank deposits reduced by as much as 940 billion yuan in January 2014, and the overall increase in deposits for first quarter 2014 was also significantly lower than over the same period last year.   In an analysis by China Merchant Securities, total size of money market funds increased by around 700 billion yuan to 1.44 trillion yuan in the first three months of this year, from 696 billion yuan at end of 2013, which happens to coincide quite closely with the amount that left China bank deposits pool and the stellar success of Yu’eBao in that time .

Still just only a little more than 0.5% of China banks’ total consumer deposits of around 74.2 trillion yuan, it was the speed that assets had accumulated in Yu’eBao that was alarming. One online commentator had said Yu’eBao’s phenomenal growth had translated to an asset accumulation rate of 3 million yuan per minute.    China International Capital Corporation, a domestic securities brokerage firm, earlier issued a report in which it estimated that, in three years, money market funds could manage 8 percent of bank deposits.

In February, a prominent CCTV news anchor referred to Yu’eBao as a vampire that sucked the blood of the banks.  This was followed by calls for more regulations to clamp down on Yu’eBao and similar platform.

Besides loss of deposits, banks may also have had their margins squeezed. Tianhong’s money market fund actually invests 80 to 90 percent in interbank deposits and other money market instruments.   Its large size gave it the ability to command higher interest rates from banks with whom the Fund deals. 

In an interview with Caixin, Tianhong’s fund manager, Wang Dengfeng, described “ZengLiBao”’s investment strategy and advantage, “We allocate investments and match maturities based on data analysis.  At different stages a bank’s ability to take deposits varies.  On one hand, there are banks that can only take, say, 10 billion yuan, but we have 11 billion yuan that needs to be taken care of.  That is when we hit the limit of their deposit-taking ability.  We can deal with other banks or lower the interest rates we charge.  On the other hand, a larger size brings greater negotiation power.  We can ask for higher interest rates.”

With the situation that confronted banks’ bottom-line in the outflow of deposits plus the pressure on interbank deposit rates from money market funds, these unexpected challenges from players such as Jack Ma may have finally forced China banks to innovate.  While China financial regulators have for a long time encouraged innovation, China banks that are predominantly state-owned have been mostly stuck in their ways.  Interest rate spread from deposit-taking and lending activities remains a key source of income.  The other source of revenue is the distribution of investment products, including third party securities investment funds. 

In 2007, China’s banking regulator issued rules allowing the establishment of bank’s own wealth management units and wealth management products, in the hope that banks could develop asset management capabilities.   However, with limited real changes in business models and weak risk management, it turned into mounting market concerns on the risky trust products and shadow banking activities that stemmed as a result.

After Yu’eBao, numerous banks employed their own counter measures in attempts to safeguard their core deposit-taking business and related margin.   Banks including Industrial & Commercial Bank, Agricultural Bank of China, Bank of China and China Construction Bank put a cap on the amount that customers may transfer to Alipay, such as limited to 5,000 yuan per transaction and maximum 50,000 yuan per month.   Another measure banks had taken was to renegotiate the terms of the loan agreements that had allowed money market funds to withdraw deposits early but still enjoy a pre-agreed interest rate.

Beyond such steps aimed to limit growth of Yu’eBao, some banks established their own Internet finance platform to offer similar “treasure” products.  Bank of Communications, China Merchant Bank, Industrial & Commercial Bank and Minsheng Bank all offered online money market fund platform similar to Yu’eBao.   Citic Bank even offered “first-of-its-kind” features of allowing customers the convenience of automatic investment into the money market fund and automatic ATM withdrawal or on customer card spending.

In the face of strong contenders like Alipay and other market-driven enterprises, China banks may increasingly have little choice but to step up their game. As Jack Ma said in June last year, “The financial industry needs spoilers to make a revolution.”

On 26 September 2014, Zhejiang Ant Small & Micro Financial Services Group, together with several joint venture partners, received approval from the China Banking Regulatory Commission to establish a privately-owned bank.  This is under a pilot scheme introduced earlier this year for the private sector to operate banks in China, moving away from stated-owned banks.   Zhejiang Ant will have a 30% interest in the bank, which may be expected to commence operation within a 6-month preparatory period and applying to start business.      

More is to come of Jack Ma and his financial services ventures,  beyond Yu’eBao and Tianhong.