Regulation of Digital Financial Services in China: Last Mover Advantage?

• Author: Zhou Weihuan, Douglas W. Arner, and Ross P. Buckley
• Pages: 26-61

26 TSINGHUA CHINA LAW REVIEW [Vol. 8:25

REGULATION OF DIGITAL FINANCIAL SERVICES IN

CHINA: LAST MOVER ADVANTAGE?

ZHOU Weihuan

Douglas W. Arner

Ross P. Buckley

Abstract

Since 1979, C hina has made tremendous progress in its transformation to a socialist market

economy. As part of this process, China’s financial system has evolved to one characterised by

a high degree of marketization. At the same time, China today faces new challenges to growth

and development, particularly from the necessity of restructuring its economy to focus

increasingly on innovation and away from government led investment and low-wage labour. In

the context of digital financial services, China has been a late mover but this has changed

dramatically in the past five years, to the point today where China is one of the major centres

for digital financial services and financial technology (“Fintech”). Looking forward, Ch ina

needs to provide an appropriate regulatory basis for the future development of digital financial

services and Fintech, balancing growth and innovation with financial stability. China today is

exhibiting signs of a last mover advantage in this respect that may see it leaping regulatory

developments elsewhere.

I. INTRODUCTION

The rise of digital financial services (DFS) over the past three

decades is an important global phenomenon. Today, financial services

is probably the most digitized industry, as well as the most globalized,

in addition to being for at least the past two decades the single largest

component of global technology spending.1

In China, DFS developed much later than elsewhere, with major

development only beginning in the late 1990s as the financial services

sector modernized and developed in the context of the overall process

of economic liberalization. Likewise, more recent developments in

digital finance (such as internet payment services and peer-to-peer

(P2P) lending) began to emerge only in the middle of the last decade.

Innovations in DFS in China beyond internet banking and electronic

payments are even more recent phenomenon, dating only from the

beginning of this decade. Nevertheless, in many ways, China is

experiencing a “last mover” advantage in the context of DFS and now

appears to be developing more rapidly than most other jurisdictions.

Many factors have contributed to this rapid development, including

technological innovation, rapidly increasing use of digital devices and

changing consumer behaviour, explosive growth of DFS providers,

and the policy objective of the Chinese government to enhance

1 See Douglas W. Arner, Jànos Nathan Barberis & Ross P. Buckley, The Evolution of Fintech: A New

Post-crisis Paradigm? (Sept. 2015), available at http://ssrn.com/abstract=2676553.

2015] CHINESE REGULATION OF DIGITAL FINANCIAL SERVICES 27

financial inclusion via digital finance to support growth and encourage

greater innovation. The significance of digital finance to the

achievement of full financial inclusion has been firmly endorsed by

the Chinese government. The expansion of financial inclusion for

underserved segments, ranging from rural areas to the urban poor to

(perhaps most importantly) non-state small and medium sized

enterprises (SMEs), has been one of the key elements of China’s

financial sector reforms which in turn have been an integral element

of China’s overall economic reform and innovation strategies.

As well as promoting the development of digital finance, the

Chinese government is now dedicated to establishing a regulatory

framework to oversee and supervise DFS so as to ensure its healthy

growth. The approach seeks to balance the needs for innovation and

growth in the economy, particularly in relation to non-state firms and

SMEs, with the requirements of financial stability. However, the

regulatory efforts of the Chinese government have yet to lead to the

establishment of a comprehensive framework, such that DFS remain

under-regulated, and in some areas, unregulated in China. In

particular, the rapid development of non-traditional forms of DFS such

as non-bank electronic payments and P2P lending have often occurred

prior to the establishment of a supporting regulatory framework, often

to take advantage of gaps in existing legal and regulatory systems.

With the release of a new policy framework in July 2015, the Chinese

government is seeking to implement a strategically designed

framework to balance the sometimes competing objectives of

innovation, growth and financial stability.

This paper is organized as follows: Section II provides an overview

of China’s financial sector reforms since 1978, including the early

development and evolution of DFS. It highlights the lack of financial

inclusion in China, a significant and longstanding issue that has

attracted considerable government effort in the past decade. Despite

these efforts, financial services for underserved sectors continues to be

a major issue and a roadblock to future growth and innovation. Section

III analyses the evolution of DFS over the past decade setting out

various forms of digital finance provided by major internet and e-

commerce companies, other non-financial institutions and banks. The

section shows that the number and scale of digital finance providers

has grown phenomenally since 2013, paralleling the increase in the

acceptance of DFS by consumers in China.

China’s regulatory framework for DFS can be divided into two

periods: the initial period before 2015 and the development period

since 2015. The initial period witnessed the promulgation of several

rules by China’s banking regulators on certain types of digital finance

such as internet payment and third-party payment services. While

these rules contributed to the development of a regulatory framework

on DFS, they are inadequate in many respects such as a lack of detailed

28 TSINGHUA CHINA LAW REVIEW [Vol. 8:25

and comprehensive provisions for the protection of consumers.

Moreover, regulations of many other forms of digital finance will need

to be developed. Since early 2015, there has been growing recognition,

from both official and unofficial sources, that China needs to

accelerate the development of DFS regulation with an aim to establish

a preliminary regulatory framework by the end of 2015. On 18 July

2015, ten central government ministries and commissions jointly

issued a ‘Guideline on the Promotion of the Health Development of

Internet Finance’2 (2015 DFS Guideline). The Guideline clarified a

number of important issues and addressed various types of DFS.

Further, the Guideline mandates the relevant authorities to develop

detailed rules on the areas of digital finance for which they are

responsible. The issuance of the Guideline, therefore, reflects a great

effort and achievement of the Chinese government. Sections IV and V

thus offer a comprehensive study and analysis of China’s regulation

of DFS by discussing, respectively, China’s DFS regulations before

2015 (section IV) and the 2015 DFS Guideline (section V). These

sections show that digital finance is considered by the Chinese

government as being essential to achieve full financial inclusion, and

that regulatory efforts have been made to ensure the healthy

development of DFS. Section VI concludes, arguing that China is now

on the verge of moving from last mover to first mover in respect of

both DFS and its regulation.

II. THE MODERN EVOLUTION OF CHINA’S FINANCIAL SECTOR

REFORMS

As one of the central elements of China’s economic reforms since

1978, the modern evolution of China’s financial sector reforms can be

divided into four stages.3

The first stage encompassed 1978-1990, in which the foundational

transformation of China’s financial system from one of central

planning and control was commenced. Most significantly, in this

period, four state-owned banks – Bank of China (BOC), China

2 Guanyu Cujin Hulianwang Jinrong Jiankang Fazhan de Zhidao Yijian (关于促进互联网金融健康

发展的指导意见) [Guideline on the Promotion of the Health Development of Internet Finance]

(promulgated by PBOC et al., July 18, 2015, effective July 18, 2015) (Chinalawinfo).

3 The description of the first three phases of China’s financial reforms (i.e. 1978–2013) is mainly

based on: Maria M.N. DaCosta & Jennifer P.N. Foo, China’s Financial System: Two Decades of Gradual

Reforms, 28 Managerial Finance, no. 10, 2002, at 4–5; Franklin Allen, Jun Qian & Meijun Qian, China’s

Financial System: Past, Present, and Future, in CHINA’S GREAT ECONOMIC TRANSFORMATION 506,

509–11 (Loren Brandt et al. eds., 2008); Patrick Hess, China’s Financial System: Past Reforms, Future

Ambitions and Current State, in CURRENCY COOPERATION IN EAST ASIA 21, 25–29 (Frank Rövekamp

et. al. eds., 2014); PETE SPARREBOOM & ERIC DUFLOS, CGAP & WORLD MICROFINANCE FORUM

Geneva, FINANCIAL INCLUSION IN THE PEOPLE’S REPUBLIC OF CHINA: AN ANALYSIS OF EXISTING

RESEARCH AND PUBLIC DATA 1–45 (Aug. 2012). For a comprehensive analysis of China’s financial

reforms especially the reforms of the banking sector before 1998, see NICHOLAS R. LARDY, CHINA'S

UNFINISHED ECONOMIC REVOLUTION (1998).