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New CBRC rules intend to curb excesses of P2P lending sector

By Yang Dong, Wu Tao | 2016-10-10
(Chinese Social Sciences Today)

The new rules will strengthen government oversight of P2P lending companies, crack down on illegal fundraising activities and prevent financial risks.

 

China’s top banking regulator released new rules for peer-to-peer lending in August, laying the groundwork for the healthy evolution of the sector.


The China Banking Regulatory Commission (CBRC) and three other ministries released a series of regulations based on wide consultation and insightful discussions among scholars, lawyers and industry experts. The aim is to rein in the runaway expansion of P2P lending and guide it with the steady hand of regulation.


The new rules will strengthen government oversight of P2P lending companies, crack down on illegal fundraising activities and prevent financial risks.

 

Significance
The rules adopt new management principles and patterns. Previously, oversight occurred prior to the approval phase of lending. Presently, monitoring lasts until the end of the loan. A negative list has been established to draw distinct boundaries within which P2P lenders are allowed to operate.


Also, the CBRC has introduced an array of policies, institutions and services, such as third-party deposit, information disclosure, investor protection, thus sustaining the healthy market and avoiding a vacuum of supervision that could result from a missing link of institutional innovation.


The regulations set a good example of financial supervision reform. It is a move unprecedented in the history of financial monitoring and legislation in China. It is the first law to deal with P2P lending in the global market, which shows financial regulation and legislation are keeping pace with the times.


The P2P sector is the most crucial form of Internet finance but also the most chaotic and risky. It provides ample space for criminal activity. For example, Ezubao, a Chinese P2P lending platform based in Anhui Province, started a giant Ponzi scheme and threw a shadow over China’s  online finance industry. Therefore, measures are needed to streamline the industry and prevent fraud.


The regulations were scheduled to be released in the first half of this year, but it was delayed because national regulators were focused on cracking down on illegal activities concerning online financial services in the same period of time. In this way, the postponed rules drew on the thorough investigation of the P2P industry in terms of problems, statistics and measures so that it fits more into the Chinese circumstances.


The regulations can help to summarize experience and promote methods of management. It is hard to regulate P2P lending in a balanced way because the sector functions as an intermediary for both information and credit services, and its operating model involves both direct finance and indirect finance, leading to legal ambiguity.


To clear up the legal ambiguity, the regulations have introduced an innovative management model in which the CBRC and financial service offices of local governments will perform their own responsibilities autonomously while collaborating with each other. The CBRC will be responsible for drafting regulations and policies about P2P lending platforms while supervising related business activities, operation and management. The financial service offices of local governments will be responsible for the registration of P2P lending enterprises, information records as well as risk control and prevention.


The previous management model only governed the pre-approval stage, while the new rules employ a dynamic model covering the whole process. The huge innovation has provided an example for other realms of online finance to follow.


In the current context, the regulations can be seen as a major move in supply-side structural reform, implying that Chinese regulatory organs have the ability to take the initiative in aspects of financial innovation, risk prevention and regulatory reform.

 

Highlights
In additional to supervision and regulation, the significance of the rules also lies in the directive function of law and healthy environment of the P2P industry, which can be seen in the following aspects.


The division of responsibilities between the CBRC and financial service offices of local governments is a form of regulatory innovation in financial industry that allows banking regulators to monitor business activities while local departments remain responsible for compiling the necessary information about P2P lending companies. P2P platforms are an emerging field that can hardly be regulated by any single party due to resource and cost constraints. In such an atmosphere, collective regulatory efforts are needed, while the responsibilities of each organization must be clarified.


The regulations stress conformity to the law. The preparatory work for their implementation includes various measures, such as regional pilot projects, industrial consultation and referring to international counterparts in order to bring P2P and other emerging industries under the authority of the legal system.


The regulations are administrative rules and were jointly released by four ministries and organizations. They were also approved by the State Council, which means they have a higher legislative authority and stricter requirements. It should be noted that the regulations are still immature in terms of legal force and hierarchy, so the establishment of regulatory standards and measures should give way to a higher magnitude of law and legal system conformity.


For example, disputes remain about fundraising quotas. The regulations pay attention to the stability of the legal system and emphasize action against illegal online fundraising activities. They have also considered difficulties in the process of execution, which embodies a sustainable and dynamic concept of management. P2P lenders need to seek opportunities amid the current “risks,” which can be the driver of sustainable development. Only excellent and normative P2P platforms will be able to survive in the sector after the introduction of the rules.


Therefore, setting a fundraising quota is in accordance with China’s conditions, i.e. its immature market entities and regulatory institutions. The P2P sector is ill equipped to singlehandedly solve all problems, such as the huge difficulties and high costs of fundraising activities, because they are the outcome of the ongoing economic downturn and many other factors. Countermeasures require the involvement of a diverse financial service system.


The regulations are a testament to excellent legislative capabilities. They have created space for the introduction and optimization of institutions in the future. Laws in a number of realms require further refinement, including specific terms on information disclosure as well as financing models that will help guarantee companies and small-loan companies can establish online lending information clearinghouses. In addition, the negative list reflects regulatory principles. It draws on the experience of other countries and other administrative laws as well as industrial practices, which leaves space for financial innovation while staying focused on the bottom line.


The dynamic regulatory model emphasizes the obligations borrowers and lending platforms have toward each other regarding information disclosure. The regulations also release risk warnings, general information reports and yearly audits.These functions demonstrate  the great focus on information feedback channels and market regulatory mechanisms.


In terms of protection and education of investors, the author suggests setting up a venture deposit system that can be managed by an Internet financial committee. It should be noted that whether a venture deposit system is a form of credit intermediary is controversial. P2P platforms act as information service intermediaries but they function as  intermediaries for financial services as well. In the future, P2P lendingwill become an innovative bridge between the two forms of intermediaries.


The regulations have no terms governing venture deposit, which is another concern that the CBRC and other organs have concerns about current institutions. Mechanism innovation in line with regulatory guidelines is needed. But at the same time, there is no ban on venture capital deposits in the rules, creating ample space for future institutional innovation. In order to protect investors, the regulations include requirements on information disclosure, third-party deposits, risk warning, dispute resolution and technical safety.


In the future, P2P and other Internet financial sectors will all change their roles. However, the financial development of human society follows the same trajectory, so laws and regulations will eventually cover each aspect of the financial system. In terms of the legal status of the P2P sector, the author holds that it is a form of emerging financial information intermediary. Its blurry nature will become a focus of financial supervision and the legal system.

 

Yang Dong and Wu Tao are respectively from School of Law and the National Academy of Development and Strategy at Renmin University of China.