The rise of internet finance and regulation of capital markets

By Wu Jian, Zhonglun W&D Law Firm
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Finance is the core of a modern economy and a major force in promoting economic development. Innovative and diverse financial models can effectively take up idle funds in society for allocation in a rational way, thereby boosting economic growth. With the development of internet and information technology, finance works closely with the internet, giving rise to internet finance.

武坚 Wu Jian 中伦文德律师事务所 合伙人 Partner Zhonglun W&D Law Firm
武坚
Wu Jian
中伦文德律师事务所
合伙人
Partner
Zhonglun W&D Law Firm

Under the internet finance model, payment becomes convenient, market information asymmetry is very low, the parties for supply and demand of funds deal directly without having to go through financial intermediaries such as banks, brokerages and exchanges, and a new and convenient investment and financing channel is made available to meet the financial needs of ordinary people.

Apparently, internet finance has impacted the conventional financial industry substantially. What impact does this new financial model have on the capital market as part of the financial market? And how is it being regulated by law? This article gives an overview using the securities industry as an example.

Far-reaching impact

In China, internet finance primarily covers third-party, internet-based payment (e.g. Alipay), peer-to-peer (P2P) online lending, financing from a pool of funds (e.g. dreamore.com), big-data supply chain finance, and online sales of financial and wealth management products. Internet finance can achieve the efficiency of resource allocation similar to that of nowadays direct and indirect financing, and reduce transaction costs significantly while promoting economic growth. This will have a far-reaching impact on the securities industry, mainly in the following areas:

  1. marketing channels in the securities industry are changed so that the service boundary is expanded;
  2. the “big data” concept helps contribute to the long-term development of the securities industry;
  3. the securities industry is functionally positioned as customer-centred instead of the role of intermediary;
  4. online credit will reconstruct the pattern of investment and financing in the securities industry; and
  5. internet finance will intensify competition in the same industry and among industries.

During the development of the securities market, internet finance, as an innovative trend in the securities market, is bound to accelerate the development of the securities market. However, there is a lot of asymmetry and mismatch between regulations and the rapid development of internet finance. The immediate impact is the presence of many ambiguous areas in the responsibilities, rights and obligations between legal subjects in the market.

Internet finance has already alerted regulators as a result of its stormy development. The central bank’s deputy governor, Liu Shiyu, said at an internet finance forum in December 2013: “Internet finance cannot touch upon illegal fundraising and illegal taking up of deposits from the public. In particular, P2P platforms cannot operate any pools of funds, or as those that integrate the provision of guarantees and borrowings. We need to encourage the development of innovative internet finance and show tolerance to mistakes, but zero tolerance to frauds and other illegal and criminal activities.”

China Securities Regulatory Commission vice chairman Liu Xinhua also commented at another internet finance forum in January 2014 that China needs to strengthen real-time, effective regulation of internet finance and information disclosure, including setting up an integrity system and management of information security, to cope with the risks and challenges posed by internet finance to China’s capital market.

Possible improvements

Improvement to the legal regulatory regime for internet finance can be made in the following areas. First, accelerate the set-up of a regulatory regime for internet finance, and then improve the regime. The primary task is to put laws in place for internet finance to abide by, so that laws can be enforced stringently and offenders prosecuted. The regulatory regime must be a forward-looking and anticipatory one. It is proposed to speed up the building of an internet finance regulatory regime at three levels. The first level is to correct and improve the financial and legal regimes; the second level is to enact fundamental laws in relation to the development of internet finance; and the third level is to devise administrative regulations, departmental rules and national standards related to internet finance.

Second, step up the supervision of internet finance to create an orderly internet finance regulatory regime. With respect to the problems and risks involved in the development of internet finance, it is proposed to redefine the business scope of various financial companies in combination with the latest status of the development of internet finance. On this basis: further define the regulatory authorities that deal with counterpart companies and businesses; crack down on internet finance platforms without regulators’ approval; and build up a unified data platform for internet finance.

Consumer rights

Third, strengthen the protection of the rights of consumers engaged in internet finance, step up education for these consumers, and raise their risk awareness and self-protection capabilities. Consumers are already disadvantaged groups in the market, and are in a more unfavourable position because information about internet finance is asymmetric and inconsistent. This author suggests stepping up education for consumers, raising their risk awareness and self-protection capabilities, combining knowledge of the internet with financial knowledge, and providing effective education, particularly for consumer groups engaged in internet finance. Moreover, the protection of the rights and interests of these consumers needs to be strengthened from a system perspective.

True motivation

Finally, a sound legal regulatory regime is the only incentive to truly motivate those who are reluctant to claim their rights. The rise and development of internet finance entail the building and improvement of a legal regulatory regime. These two are complementary, jointly to facilitate the development process.

Wu Jian is a partner at Zhonglun W&D Law Firm

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