By Stanley Zhou, Janet Gu and Leimin Yu 金杜律师事务所金融资本部
Nowadays payment service is increasingly interweaving into commerce and the Internet in China. Its role as the last-mile infrastructure provider connecting the two arenas for many business models is increasingly being appreciated by the market. Not long ago, China’s payment sector was, by and large, not accessible to foreign players, although many foreign players wish to enter into the rapidly growing Chinese payment market and many domestic payment service providers wish to have certain foreign participation as a way to gain access to the offshore capital market.
This situation may soon be changed with the promulgation of The Announcement Regarding Certain Issues on Foreign Investment in Payment Institutions (the “The Announcement”) by the People’s Bank of China (the “the PBoC”) in March 2018. In this article we will discuss the regulatory barriers for foreign accession to the Chinese payment market prior to the Announcement, key provisions of The Announcement, and the implications for foreign investment in payment industry in China.
Before the promulgation of the Administrative Measures of Non-financial Payment Institutions (the “Circular No. 2”) by the the PBoC in 2010, payment services provided by institutions other than banks were largely unregulated in China. The Circular No. 2 established a preliminary regulatory framework for payment services provided by such non-bank payment institutions (the “NBPIs”). According to the Circular No. 2, the payment services of the NBPIs, as defined therein, refer to the NBPIs providing the following fund transferring services as an intermediary between payees and payers:
|Network payment[i]||Online payment, mobile payment, fix phone payment, digital TV payment etc.|
|Issuance & acceptance of prepaid card||Issuing / acceptance of e-money stored in a card or digital codes for purchase of goods or service|
|Bank card acceptance||Acquirers collecting funds for franchised merchants through terminals such as POS|
Among other things, Circular No. 2 laid down a ground rule that the NBPIs providing payment services in China must obtain a payment business license (the “Payment Business License”) issued by the PBoC and shall be supervised and administrated by the PBoC. The NBPIs wish to continue operation in China will have to apply for the Payment Business License within one year from the date Circular No. 2 came into effect, i.e. one year from 1 Sept 2010. Since 2010, the PBoC has issued a large volume of regulations regulating the payment industry including without limitation the implementing rules of Circular No. 2 (collectively, the “Third Party Payment Rules”).
Barriers for foreign investment in the past
sIn fact, according to the Circular No. 2, matters in relation to foreign invested NBPIs such as their business scope, qualifications of foreign investors, capital ratio etc. shall be separately stipulated by the PBoC, subject further to the approval of the State Council. However, until the issuance of The Announcement, no such regulation was promulgated. As a result, the PRC payment market was de facto not open to foreign investors as there are no rules available for the establishment of foreign invested NBPIs in China and there is no way for them to apply for the Payment Business License.Prior to the promulgation of Circular No. 2, there already existed cases of foreign investors operating the payment business in China, either through foreign invested companies incorporated in China or under a VIE structure. Subsequent to the promulgation of Circular No. 2, two foreign invested NBPIs[ii] obtained the Payment Business License from the PBoC for prepaid card payment services. These limited instances are seen by the market as the PBoC recognizing and legalizing such entities’ pre-existing operation in China prior to Circular No. 2 as special cases, hence they are not of general significance.
Key provisions of the Announcement
The Announcement clearly states that its purpose is to usher the formation of the full opening-up of the payment service market and its promulgation has been approved by the State Council. Based on the PBoC’s press release, the Announcement aims to achieve unified market entry standards and unified regulatory requirements for both domestic and foreign payment institutions, hence extending “national treatment” to foreign players. Key provisions of The Announcement include:
Qualifying foreign parties desire to provide electronic payments services in respect of both domestic and cross-border transactions must set up local incorporated legal entity in China and obtain the Payment Business License in accordance with the conditions and procedures set out in the Circular No. 2.
Foreign invested NBPIs are required to have safe, standardized, and independent payment processing systems and disaster prevention and backup systems in China.
All personal data and financial data collected by foreign invested NBPIs in China must be stored, processed, and analyzed in China. If transmission of data outside China is necessary for the purpose of the payment service, the foreign invested NBPIs should comply with the PRC data protection regulations, procuring non-disclosure undertakings from the offshore counterparties, and procuring consent from the data subject.
Foreign invested NBPIs shall also comply with supervision requirements of the PBoC regarding NBPIs’ corporate governance, daily operation, risk management, fund processing, provision funds, etc. that equally apply to the domestic NBPIs.
Implications & Challenges
The Announcement effectively lifted the restrictions on foreign investment in the payment sector which have existed since the Circular No. 2. For foreign investors, the door to China’s payment sector is officially opened. However, the Announcement also brings about certain implications and challenges that foreign investors need to consider carefully.
|Implications and challenges of local presence|
In order to obtain the Payment Business License, a foreign party will need to establish a foreign-invested enterprise in China to act as an applicant for such license. The applicant for the Payment Business License must demonstrate to the PBoC that it could meet the requirements set out in the Circular No. 2, including among other things:
- minimum registered capital (i.e. no less than RMB100 million if it is a national license and no less than RMB30 million if it is a provincial license);
- qualified investors (i.e. with a track record of at least two consecutive years of experience in providing information processing for financial institutions or in relation to e-commerce, profit-making for two consecutive years, no violation of law for three years, etc.) ;
- having a localized payment processing system and disaster prevention and backup system;
- having a qualified management team with expertise in the payment industry. In practice, dawn-raids on NBPIs by regulators are becoming more frequent, so such a team will need to be based in China.
|Implications and challenges of regulatory supervision|
PRC regulatory supervision measures on entities engaging in payment services may be very different from those in other jurisdictions such as the European Union or the United States, as the latter two have developed more sound systems over the years. Under the Third-Party Payment Rules, the NBPIs are required to comply with certain supervision measures, e.g. centralized placement of reserve funds with the PBoC, classified payment accounts with different account limits, restrictions on online payment settlement etc. and such PRC regulatory supervision requirements may impose a heavier burden on foreign invested NBPIs as compared to their offshore counterparts.
Taking the reserve funds as an example, in the U.S., payment service operators are required to put reserve funds in non-interest-bearing accounts covered by a deposit insurance. In Japan, payment service operators may keep 50% of the reserve funds in accounts opened in their own names. In South Korea, there is no mandatory requirement on reserve funds. In comparison, the regulatory requirements on reserve funds under PRC law are more stringent. Since 2013, all customers’ funds handled by the NBPIs must be placed with qualified depository banks. Since 2017, a certain percentage of customer funds must be placed in accounts designated by the PBoC for centralized management and the ratio has been raised to as high as 50% since January 2018. It is worth noting that although currently there are 28 qualified depository banks, only one of them is a foreign bank. This means for those foreign investors that may have an existing banking relationship with foreign banks may need to work with domestic banks for the purpose of regulatory requirements on the placement of customers’ funds.
|Implications and challenges for foreign investors intending to provide cross-border payment services|
For foreign investors, providing payment services for cross-border transactions can be a very natural choice. However, it must be noted that obtaining the Payment Business License per se do not automatically gives the NBPIs permission to handle cross-border payment transactions. Under the current regulatory regime, all cross-border payment transactions other than e-commerce must be handled exclusively by banks, and the NBPIs are permitted to provide cross-border payment services in relation to e-commerce if a separate permit is obtained from the Sate Administration of Foreign Exchange (the “SAFE”) under a pilot program[iii] run by the SAFE. Under such SAFE pilot program, a permit from SAFE will only be granted if the applicant is a payment entity which has operated for at least two years in China. This in effect means it is not legally feasible for newly-incorporated foreign NBPIs with a Payment Business License to engage in cross-border payment services right away.
|Implications and challenges for data protection requirements|
The Announcement expressly requires that applicable PRC laws on data protection must be complied with by foreign invested NBPIs when dealing with cross-border payment transactions. Such applicable PRC laws mainly refer to PRC Cybersecurity Law, the consultation draft of the Measures for the Security Assessment of Personal Information and Important Data, and the consultation draft of the Regulations for the Security Protection of Critical Information Infrastructure (collectively the “PRC Data Protection Laws”). Under such PRC Data Protection Laws, an assessment on security must be conducted when the operators of critical information infrastructures transmit personal information and data abroad. The NBPIs may be considered as operators of critical information infrastructures for the purpose of PRC Data Protection Laws. In this regard, foreign investors will need to prepare to undertake such security assessment in order to comply with the PRC Data Protection Laws.
|Implications and challenges for foreign investors intending to provide bank acceptance services|
If a foreign investor wishes to provide bank acceptance services, it may need to apply for both a Payment Business License for Internet payment as well as a separate bank card acceptance license under certain scenarios. Under the Administrative Measures of Bank Card Acceptance Business, three categories of entities are eligible to engage in bank card acceptance services, e.g. banking financial institutions providing bank card acceptance services, NBFIs with bank card acceptance license providing bank card acceptance services for offshore merchants and NBFIs with bank card acceptance license providing bank card acceptance services for online merchants. However, in a notice[iv] issued by the PBoC in April 2018, it is required that if an NBPI provides bank card acceptance services using code scanning technologies, then it is required that such NBPIs shall obtain both bank card acceptance license and the Payment Business License for network payment.
|Implications and challenges for using offshore card clearing houses|
The foreign invested NBPIs may need to enter into clearing arrangement with clearing service providers in China for the purpose of providing payment services in China. Although the PBoC has issued the Accession Service Guide for Bank Card Clearing Organizations in 2017, which sends a clear message that China’s bank card clearing market is opened, no detailed work progress has released so far although some offshore news agencies reported that the PBoC has officially accepted application of American Express to conduct bank card settlement and clearing services in China. Hence if foreign investors intend to enter into clearing arrangement with their offshore clearing service providers, they also need to keep an eye on the development of those foreign clearing service providers’ application in China.
|Implications and challenges for M&A of domestic NBPIs|
As newly established foreign invested NBPIs may be subject to certain business restrictions when first entering the China market, it is expected foreign investors will also look for opportunities to acquire existing domestic NBPIs, in lieu of setting up one from fresh. The Third-Party Payment Rules expressly provide that change of the main investor[v] of a NBPI shall be subject to review and consent by the PBoC before conducting company change registration. In the past, many M&A transactions of domestic NBPIs tried to structure the deal as an indirect share transfer to avoid review by the PBoC, in particular, when the qualifications of the main investor do not meet regulatory requirements or when parties simply do not want to go through lengthy PBoC review process. However, recent cases show that the PBoC has tightened review on M&A transactions involving change of main investor (whether directly or indirectly). So, when foreign investors want to enter the Chinese market through acquiring an existing domestic NBPI, they must note whether the PBoC review would be triggered and, if yes, it is advisable to engage in communication with the PBoC at early stage of the deal and to ensure application documents are in line with regulatory requirements.
|Implications and challenges for NBPIs using the VIE structure|
Until very recently, there was no IPO precedent[vi] of payment service providers in the domestic capital market. Given this, many domestic payment service providers are looking for opportunities in the offshore capital market and many of them have adopted a VIE structure for this purpose. This approach may now face challenges. For example, the Hong Kong Stock Exchange declared in its listing guidance that “the contractual arrangements must be narrowly tailored to achieve the listing purpose and minimize the potential conflict with the PRC laws and regulations” and “where possible, the listing applicant would be required to demonstrate genuine efforts to comply with such laws and regulations”. As provisions of the Announcement (together with the provision of the PRC Foreign Investment Law) effectively lifted the restrictions on foreign investment in the payment sector, the reasonableness of using a VIE structure to get listed on the Hong Kong capital market is subject to question.
Although China’s payment sector is now highly competitive, lured by the opportunity to harness the benefit of the massive Chinese market, many foreign players may still welcome this belated opening-up of the Chinese payment market, particularly those who have already had large customer bases when doing other business with China. With the Announcement, the door is now open. But foreign players will have to be prepared to do some necessary adjustments in terms of business models and establishing tailor-made PRC compliance system to cater to the operation in the PRC commercial and regulatory environment.
- In 2015, the PBoC issued another regulation, (i.e. the Administrative Measures of Non-bank Payment Institution’s Net Work Payment Business), which further provides that network payment business refers to fund transferring service where payment instructions were sent by payers or payees via their respective electronic equipment based on public or private network with the payer’s electronic equipment not interacting directly payee’s equipment.
- Shanghai Sodexo Pass Service, Ltd. and Edenred (China) Ltd.
- The pilot program is run in accordance with the SAFE Notice on the Pilot Scheme of Cross-border FX Payment Services (No. 7  of the State Administration of Foreign Exchange).
- The Notice of the the PBoC on Issuing the Standards for the Barcode Payment Business (for Trial Implementation) (Yin Fa No. 296 ), implemented and effective on April 1 2018.
- Under the Third Party Payment Rules, a main investor of a NBPI refers to a person who has actual control of the NBPI or a person holding more than 10% equity interests in the NBP. Further a person who has actual control of the NBPI refers to a person who holds aggregate more than 50% direct and indirect equity interests of a NBPI, or the investor who can influence the resolutions or business decisions of a NBPI notwithstanding the equity interests held by it does not is less than 50%. A person who holds more than 10% equity interests refers to a person who hold more than 10% equity interest of a NBPI directly or a person who holds more than 10% equity interests directly and indirectly.
- The Notice of the the PBoC on Issuing the Standards for the Barcode Payment Business (for Trial Implementation) (Yin Fa No. 296 ), implemented and effective on April 1 2018.
- As of this article, it is reported two payment institutions, being Lakala Payment and Hui Fu Tian Xia is on the IPO track.