The still-playing drama of the US presidential election took pride of place over a blockbuster development in China: the eleventh-hour halting of what was to have been the biggest IPO evah, the dual listing of Ant Group for over $34 billion.

Even though China’s financial system is not terribly transparent, and English language reporting on China’s politics should be taken with a fistful of salt, regulators stomped on a globally high-profile company widely deemed to be one of China’s stars to send a message. And even from the other side of the world, mediated through the Anglo press, the message seems very clear: China is going to leash and collar businesses, whether banks or fintech players, that profit by giving consumers high interest rate loans and rely on securitization to shift the risk of loss on to other parties.

By way of background, Ant was originally Alipay, part of Jack Ma’s Alibaba, and was spun out in 2014. It has become the largest payment processor in the world. However, Ant’s expansion into higher-profit lending is what has aroused official ire.

The idea that regulators woke up a few days before the Ant IPO and blindsided the company with unexpected rules isn’t remotely credible. Yet the press is parroting Ant’s and disappointed brokers’ spin. The reality is that regulators signaled their requirements months ago (the Chinese appear to be less explicit in their public remarks than Western regulators typically are) and without a doubt informed Ant and any similarly-situated concerns of their requirements. Ma apparently thought he could defy the Chinese government. He’s learned otherwise.

The Financial Times comment section confirmed this take and criticized the pink paper’s account, which mentioned but didn’t tease out the significance of Ma criticizing the government for being leery of unsecured personal lending:

At the end of October, Mr Ma criticised China’s state-owned banks at a financial summit in Shanghai. He suggested the big lenders had a “pawnshop mentality” and that Ant was playing an important role in extending credit to innovative but collateral-poor companies and individuals.

From the Financial Times’ peanut gallery:

Hater of Simpletons

For those who didn’t know what happened : check the new regulation which limits Ant’s leverage and enhances consumer protection, which also limits Ant’s valuation as a “tech” company. That was the main reason Jack fired at regulators in his speech [at the end of October] – and to be honest, there was no way he didn’t know the regulation long before the listing date and the speech (gov spent months on a policy, if not longer and would consult industry leaders)! If the IPO were not halted, investors would have suffered from major losses, not to mention the high leverage (60x+) and ABS put Ant’s customers at risk. Jack fired the speech to evade regulation and made sure HE made enough money from the listing. Not investors, not Ant users. Being sarcastic is easy. Try to get clear of what REALLY happened.

Now to the substance of the dispute, which led to the halt of the IPO and will require Ant to substantially restructure its business. Ant originates personal and small business loans to parties with little in the way of assets. These loans command higher interest rates than more conventional loans and from what we infer, “higher’ can mean “pretty high”.

As we have written, China hasn’t been shy about using leverage to boost growth, even though as we and others have written, over time, the incremental lending has produced less and less in the way of GDP lift. China has also had multiple mini-financial crises involving its “wealth management products.” These are typically uninsured investments that provide a fixed interest rate for a set period of time, typically five years. They have often provided funding for state-level real estate investments. Nevertheless, even if you allow for Michael Hudson’s view that land should be taxed aggressively to limit real estate rentierism, economists have found that borrowing to make productive investments in businesses, equipment, and buildings adds to growth, while increases in personal borrowing are a brake.

Another reason for China to take a dim view of personal borrowing is that the government prioritizes wage growth and improving living standards as its basis for legitimacy. There’s no reason, as in the US, to use consumer borrowing to mask stagnant worker wages. And the Chinese may even have recognized that overly financialized economies have lower rates of growth than ones at a more modest level of financial “deepening”. The IMF found that Poland was at the optimum level, but argued that more finance might not create a drag if the sector was well-regulated.

Mind you, we aren’t saying that China is a paragon of regulatory virtue. They still allow for stunning amounts of margin lending against stocks. And they’ve also sat pat as ghost cities, too often shoddily built, continue to rise, a textbook case of trading sardines.¹ But they appear to want to avoid having a finance-driven economy, and also appear to have learned from some of our mistakes.

Now to the specifics of why Chinese officials came down on Ant. First, from the Wall Street Journal:

Some of the writing was on the wall earlier. While Ant was gearing up to launch its IPO, regulators had begun taking aim at the company’s fast-growing microloan business, which provides short-term credit to hundreds of millions of individuals and scores of small businesses.

On Sept. 14, China’s banking and insurance regulator issued a private notice to some commercial banks warning them about the risks of making loans in partnership with third-party institutions, according to a copy of the notice seen by The Wall Street Journal. It said banks should not be outsourcing their loan underwriting and risk controls.

When Ant partners with banks to make loans, the lenders provide the funding and bear the risk of defaults, while Ant collects fees for facilitating the transactions.

Two days later, the regulator published a guideline that placed caps on the volume of asset-backed securities that could be issued by microlenders. Two subsidiaries of Ant have bundled many loans into securities and sold them to raise funds for lending operations.

In other words, Chinese officials tried halting Ant’s practice of originating risky individual/small business loans and selling them to banks, both on the bank and Ant ends of the pipeline. That apparently didn’t lead to a change of course at Ant or its allied banks or lead to any change in appetite for its IPO.

Ant restricted how many could attend its roadshow presentations and required them to submit questions in advance. It also directed brokerage firms to assign coverage to tech analysts rather than financial services experts.

Back to the Journal:

On Monday, Mr. Ma, who is Ant’s controlling shareholder, Executive Chairman Eric Jing and Chief Executive Simon Hu were summoned to a rare joint meeting with four Chinese regulators. Ant said that evening that the group discussed the “health and stability of the financial sector.”

On the same day, China’s banking regulator released draft regulations that will likely force Ant to come up with $30 for every $100 in consumer and business loans it originates in conjunction with banks. That would require the company to use significantly more capital to support its lending unit.

“The government’s goal is to remind the company who is in charge of the financial system, not to put it out of business,” said Andrew Batson, director of China research in Gavekal Research.

The suspension of the IPO is proving to be messy, since many investors used margin loans to fund their allocation. Initially, investors were to take the hit for the interest charges; now it appears at least some brokerage firms will eat them.

Additional detail from the Financial Times:

A commentary posted on the websites of prominent Chinese state media outlets including People’s Daily late on Tuesday said the suspension of Ant’s listing would “safeguard the rights and interests of financial consumers” and investors. “The top priority of the Ant Group is to earnestly rectify and reform according to the requirements by regulatory authorities,” it added.

Guo Wuping, an official at the banking regulator, advocated greater regulation of Ant and other financial technology companies in an opinion piece for state media on Monday, noting their consumer lending products charged higher fees than credit cards issued by banks.

Mr Guo said fintech companies often lured young people into overspending so that “some people in low income groups and young people fall deep into debt traps”.

Some Financial Times readers saw this as a power play by Ma that backfired:

ves

I think the main reasons are: Firstly, Ant as a company attempts to take part in setting rules. Secondly, the criticism about mortgage loan in Ma’s talk is basically challenging the dominant position of the real economy in China. Both of these are touching CCP’s bottom line, so they kicked Ant out of the game… Also Ma’s attitude in Shanghai definitely angered some people, who will allow their dog to start bargaining with them

It’s refreshing to see a government that isn’t afraid to slap down a rich businessman, even a high profile billionaire, who thinks he can call the shots. Sadly, the importance of political donations means that sort of thing is distant history in the US.

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¹ Our explanation from ECONNED:

Consider this classic Wall Street joke. On a slow day, some market-makers decide to start trading a can of sardines. Trader A starts the bidding at $1, B quickly bids $2, and several transactions later, E is the proud owner of the tin for $5.

E opens his new purchase and discovers the sardines have gone bad. He goes back to A and says, “You were selling rotten sardines!”

A smiles broadly and says, “Son, those aren’t eating sardines. They are trading sardines.”