Abstract: While third-party internet platforms in China are going through rectification with respect to their deposit business, some of them still engage in irregularities in the fields such as sales of trust products or privately-offered asset management schemes. This article proposes several policy suggestions for improving regulation of the distribution of financial products via online platforms.
I. Background
Over the past decade, with the rapid development of information technology and platform economy, Internet platform companies start to utilize their advantages of client base and technology and cooperate with financial institutions to monetize Internet traffic. One of the main ways for platform companies to monetize online traffic is cooperating with financial institutions to sell financial products.
Cooperation between Internet platforms and financial institutions in selling financial products plays a positive role in strengthening the ability of financial institutions to draw clients, expanding the scope and depth of inclusive finance and improving the convenience of financial services. But meanwhile, in this process, some problems and potential risks arise, some of which have been regulated but some still need further investigation. For example, the deposit business emerged on third-party Internet platforms in the past two years has brought many risks and challenges and therefore is being rectified.
Recently, the market finds that some Internet platforms are again displaying and selling products like trust fund, privately-offered investment fund (private investment fund) and asset management plan to non-specific individuals, which violates regulatory rules. After an investigation by the regulatory authority, these platforms have pulled related products off shelves.
II. Banning platforms from displaying and selling private investment products to non-specific individuals
Private investment products mainly include trusts, private wealth management products, private asset management plan (securities companies, fund management companies, futures companies and their subsidiaries), insurance asset management (insurance asset management institutions), private investment funds, etc.
Among the business cooperation between Internet platforms and licensed institutions, some are related to displaying and selling private investment products to non-specific individuals. Take one Internet platform’s mobile application as an example. After clicking on “high-end wealth management” on the wealth management channel of this app, all the viewers can see the page displaying trust products of certain trust companies and private asset management plans by several securities and futures institutions. Meanwhile, at the bottom of the page shows an inconspicuous note “the sales service is provided by ×× Fund Sales Co Ltd. and Trust Co.”.
After clicking on a certain trust product, there will be a redirect page showing the viewer “it is now redirected to ×× trust section” and meanwhile at the bottom the page inconspicuously shows a disclaimer asserting that “products of the section are provided and sold by ×× Trust”. The redirect page only lasts for a short period of time, leaving little time for viewers to read the previous words. After the page is redirected to the sales page, viewers can check detailed information and sales documents of the product. When they click on “buy”, the page will turn to operating processes like verification of qualified investor and payment.
If viewers click on private asset management plan, there is no redirect page, but instead, the sales page immediately pops up with a disclaimer at the bottom of the page. All viewers can check the sales documents on the sales page, and click on “buy now” or “book now” to turn to the following operating processes.
After an investigation by the regulatory authority, platforms concerned have removed these trust products. But many private asset management plans are still on sale.
Displaying and selling private investment products to non-specific individuals violates multiple laws and regulations and poses potential risks:
First, it violates the regulation that prohibits public marketing and advertising of assembled funds trust plan and one that bans the publicity of particular private asset management plan to non-specific individuals via media like newspaper, radio, television and Internet.
Second, by showing a high-return feature and a tag of “high-end wealth management”, investors who are unable to identify and bear the risks might be induced or misled to buy such private investment products.
Third, the display/sale processes operated on the platform’s app and its pages do not clearly disclose the financial service entities, which will make investors become blindly loyal to the platform while ignoring the fact that these private investment products are of high risk.
In the business cooperation between Internet platforms and licensed institutions, displaying and selling private investment products to non-specific individuals must be banned and heavily penalized. When unlicensed Internet platforms directly display or introduce and promote private investment products rather than showing them on the page of licensed institutions, such behavior should be criminalized as illegal selling of financial products, strictly investigated and penalized.
In an era of digitalization, Internet platforms, licensed sales institutions, and regulators should work on how to standardize online selling of private investment products. For example, some Internet platforms put private asset management plans only on the page under the fund sales institution section (meaning that the platform does not directly display products), and set three thresholds including real name verification, risk alert and risk evaluation, and qualified investor status commitment which only allow individuals who meet the standard to check product information. Meanwhile, in the following purchase process, only those who submit qualified investor proof like proof of assets can purchase (including video interview). The feasibility of this model could be explored on condition that the business and operating process (such as video interview) comply with regulations.
III. Distributors of publicly available financial products must be licensed as required
1. Distribution of publicly offered funds by internet platforms
At present, most of the internet platforms engage in fund distribution by having their subsidies licensed for this business, and some of them also work with independent fund distributors. In August 2020, China Securities Regulatory Commission (CSRC) issued Provisions on Issues concerning the Implementation of Measures for the Supervision and Administration of Distributors of Publicly Offered Securities Investment Funds, which laid out further stipulations to standardize the practice whereby fund managers and distributors rent third-party online platforms for the sales of financial products.
First, fund managers and distributors, when renting third-party online platforms for fund sales, shall clearly inform investors of the entity providing fund distribution services while observing the principles of independence, technological security and data protection. They shall undertake business in strict accordance with applicable laws, regulations and rules, and assess the compliance and safety of third-party online platforms on a continuous basis. They shall report to regulators within 10 days since the signing of the service agreement.
Second, third-party online platforms, in their capacity as fund service institutions providing information technology systems, shall be subject to the regulation of CSRC on a reporting basis in accordance with application rules. Their role is limited to provision of online sites for business operation and other IT services, and they shall not engage in any fund sales business or collect, transmit or retain any fund trading information of investors.
These regulations further clarify the boundary between licensed fund distributors and non-licensed online platforms as well as the requirements on their collaboration. They also help solve the compliance issues as a result of non-licensed online platforms having their subsidiaries licensed for fund distribution business.
2. Insurance sales by online platforms
According to Measures for the Regulation of the Internet Insurance Business amended and released in December 2020 by China Banking and Insurance Regulatory Commission (CBIRC), non-insurance financial institutions shall not engage in internet insurance business including but not limited to providing consultations on insurance products, comparing insurance products, calculating premiums, price quoting and comparison, designing insurance portfolios, handling insurance procedures and collecting premiums. At the same time, internet companies are required to obtain license as insurance agencies before running related business.
Therefore, internet platforms shall not directly engage in insurance business unless appropriately licensed, or it would be deemed illegal.
In reality, although many Internet platforms themselves have not obtained licenses, their subsidiaries usually hold insurance broker and agent licenses, and sell insurance products on the Internet platforms. To be specific, a licensed subsidiary can set up a special page on the APP of an Internet platform to display and sell various insurance products.
But there are some issues that require further discussion. When Internet platforms themselves do not have a required license, and they only have business partnership with their licensed subsidiaries, do such Internet platforms need to be included in the scope of registration? When the Internet platforms cooperate with other insurance brokers and agents, should regulatory departments make clear the corresponding qualification requirements?
The above-mentioned issues call for further discussion as no consensus has been reached.
3. About third-party Internet platforms selling deposit products
The deposit business on third-party Internet platforms that has emerged in the past two years has brought many risks and challenges. In terms of business models, such platforms not only centrally display deposit products from multiple banks, but also provide customers with a purchase interface. Customers log in to a platform and select a deposit product, and then they can complete the entire process of opening an II electronic bank account, depositing, and withdrawing deposits on the platform. The platform has the authority to display deposit products and perform operations, and it can also acquire customers and data. Some platforms even restrict customers from using other business channels. Customers can only inquire, deposit and withdraw funds on such platforms, and cannot operate on banks’ self-operated platforms (such as mobile banking, online banking, etc.).
The hidden risks of third-party Internet platforms selling deposit products
First, it is an illegal financial activity to conduct deposit business without approval. It is not a "running red light" issue of whether the interest rates are allowed, but the deposit business itself is a "black car" on the road without a license.
Second, the fact that local banks cooperate with Internet platforms to absorb deposits and issue loans across the country actually deviates from their business positioning of serving the local area and does not match their risk management capabilities.
Third is to increase the interest rate of deposit products in disguise by shortening the interest payment cycle. Some platforms display deposit products by the ranking of interest rate, pushing up the cost of bank funds.
Fourth is the abuse of the basic protection mechanism of deposit insurance, especially when some high-risk banks absorb deposits from third-party Internet platforms on a large scale to quench thirst by drinking poison, and the hidden dangers are prominent. The deposit products on third-party Internet platform offered by high-risk small and medium-sized commercial banks accounted for almost half of the deposits of the whole country (to a certain extent, "bad money drives out good "; or the lemon market theory).
Fifth, small and medium-sized banks will inevitably pursue high-yield assets after baring high-cost liabilities and are prone to seek high-risk projects with high interest rates, which can lead to increased asset-side risks.
Sixth, the unique attributes of deposit business on third-party Internet platforms have increased the potential liquidity risks of small and medium-sized banks.
Seventh, there are compliance risks in account management, fund access and anti-money laundering.
As for third-party Internet platforms engaging in deposit business, the financial regulatory departments have issued regulation documents in a timely manner. In January 2021, the China Banking and Insurance Regulatory Commission and the People’s Bank of China issued a notice stating that commercial banks are not allowed to conduct fixed term deposit and time or demand optional deposit business through non-self-operated online platforms, including but not limited to allowing non-self-operated online platforms to provide promotional marketing and product display, information transmission, purchase surface, and interest subsidy among more services. Recently, the financial regulatory departments have talked with some big platforms to urge them to make rectifications, and planned to increase penalties for related violations of laws and regulations. Recently, there is news that some of the demand deposits jointly developed by some platforms and financial institutions enjoy 2%-3%interest subsidy from banks. Such activity must be rectified.
The question here is whether it is necessary to establish a deposit broker license, and can Internet platform companies use this license to conduct deposit business?
Let’s have a look at the foreign practice. Taking the United States as an example, bank regulatory agencies enforce very strict regulation on brokered deposit. They believe that it is neither safe nor sound for banks to absorb deposits from intermediaries. In a number of bank failure cases, acquirers were unwilling to accept deposits from intermediaries or pay a premium to such deposits. Therefore, in regulatory practice, regulatory departments have put forward tight regulatory requirements for banks' receiving deposits from intermediaries (setting higher deposit insurance rates, limiting banks with insufficient capital to absorb brokered deposits, etc.).
Regarding the involvement of third-party technology companies in the deposit business, the Federal Deposit Insurance Corporation (FDIC) refined its definition on deposit broker on December 15, 2020. Under the proposed rule, third-party technology companies would meet the "facilitation" prong of the "deposit broker" definition by, while engaged in business, engaging in any one, or more than one, of the following activities: The person has legal authority, contractual or otherwise, to close the account or move the third party's funds to another insured depository institution; The person provides assistance or is involved in setting rates, fees, terms, or conditions for the deposit account; or, The person is acting, directly or indirectly, with respect to the placement of deposits, as an intermediary between a third party that is placing deposits on behalf of a depositor and an insured depository institution, other than in a purely administrative capacity.
Speaking of China’s legal provisions and actual conditions, Article 8 of the Regulations on the Administration of Savings stipulates that "no agency or individual is allowed to handle deposit business except for depository institutions", and Article 12 stipulates that “with the approval of the local branch of the People’s Bank of China, depository institutions can set up depository agencies". It is an illegal financial activity for third-party platforms to carry out deposit business without approval. At the same time, brokered deposits are not safe at the moment in consideration of corporate governance of small and medium-sized banks, external constraints, micro-supervision, and risk resolution mechanisms.
4. About Internet platforms selling wealth management products launched by banks
At present, only wealth management companies affiliated to banks and banking financial institutions that absorb deposits from the public are allowed to sell banks’ wealth management products, and there is no independent business license. In May 2021, the China Banking and Insurance Regulatory Commission issued the Interim Measures for the Administration of the Sales of Wealth Management Products by Wealth Management Companies, which clarified that the sales of wealth management products include some or all of the following business activities:
(1) Promote wealth management products by displaying, introducing, and comparing part or all of the characteristic information of a single or multiple wealth management products, and directly or indirectly providing subscription and redemption services; (2) Provide investment advice for a single or multiple wealth management products; (3) Handle the subscription, purchase and redemption of wealth management products for investors; (4) Other business activities recognized by the China Banking and Insurance Regulatory Commission. Without permission, no non-financial institution or individual is allowed to sell wealth management products on a commission basis.
Can Internet platform companies engage in the sales of wealth management products? Some market institutions hold that the wording of the Interim Measures for the Management of the Sales of Wealth Management Products by Wealth Management Companies above has indicated that Internet platforms can be allowed to involve in the activities of presenting, introducing and comparing wealth management products.
More in-depth discussion and evaluation is needed to answer the above question. On the one hand, in the digital era, how to clearly define the boundaries of display, introduction, comparison and sales? On the other hand, in principle, public financial products are publicly-issued asset management products. From the perspective of regulation, management of such products can be in line with public funds. At the same time, it must be taken into consideration that currently wealth management products launched by banks are still at a stage of development and transition. At the moment, they are highly similar to deposit products. Regulation on such products is yet to improve. Objectively, investors still take wealth management products offered by banks and non-bank institutions very differently. It should be treated prudently.
Ⅳ. Information protection of the financial products sold on internet platforms
Getting involved in financial products selling enables the internet platforms with access to massive highly sensitive personal information, which might lead to:
(1) Improperly collecting, managing, or utilizing personal financial information through general authorization terms, such as excessive collection and discretionary saving of personal identity, browsing records or transaction records; in the process of product matching recommendation and accredited investor certification, the platforms might also excessively provide customer information to financial institutions.
(2) Limiting access to data or permission to use. For example, after making a deposit in a third-party internet platform, the individual’s access to data might be limited to the app of the platform; or the user who is in a city with powerful financial administration might be blocked from being showed or sold certain financial products.
(3) Lowering the standard of information collection for anti-money-laundering. For example, the platforms might collect incomplete information from clients to provide better experience; or they might reject sharing the trading address with cooperative financial institutions.
(4) Security pitfalls in the information system, such as the absence of standard shield of bankcard number, ID number and other sensitive information, secondary encryption on sensitive information transmission, or cyber security classification protection test on its business system.
The selling of financial products on internet platforms should therefore be taken as an important field of information protection. Regulations should be made and implemented as soon as possible.
V. Summary
When digital economy rapidly grows, off-counter rate of commercial banks rises, interest rates are liberalized, and the reform and opening up of the financial sector go deeper, the government could be generally supportive if the integration of internet platform and financial institutions is legitimate and sustainable. Being supportive requires the government to fully consider the maturity of investors/financial consumers and the level of financial institutions, with effective micro-supervision and justice. Pure idealism ends up in bad reality.
Here are suggestions on regulating the selling of financial products on internet platforms:
First, no platform could show/sell private investment products to unspecified objects.
Second, due to the externalities of financial activities, the sales entities of financial products should have relevant capacities and fulfill fiduciary obligations. Therefore, such sales should be operated with a license; unlicensed sales are illegal. It should apply not only to the internet platforms, but all companies' digital platforms selling financial products. The single display and centralized display (with or without purchase interface) of deposits, insurance, private investment products, and public placement products need to be clearly regulated. The display of product elements of publicly-offered products can be defined as selling behaviors and strictly regulated.
Third, the intersecting business between internet platforms and financial institutions is likely to become a weak link in information protection. It should be taken as a priority area, for the sake of consumers, to improve supporting data security regulations, clarify the rights and responsibilities of internet platforms and financial institutions, and implement them as soon as possible.
Fourth, major financial enterprises and platforms could play a bigger role in safeguarding the financial order in a digital world.
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