Some Thoughts on Innovation and Regulation of Financial Technology -- Taking Ant Financial Services Group as an Example

The recent years witness innovative development of financial industry, which attributes to fast progress and in-depth application of information technologies such as big data, artificial intelligence, and blockchain. But, at the same time, they bring challenges to financial regulation and accelerate rise of regulatory technology. Based on challenges to regulatory agencies brought by financial technology development, this study proposes suggestions for the coordinated relationship between financial innovation and financial technology regulation from the perspective of technology empowerment, in order to improve efficiency of financial markets, and reach a balance between financial technology and prevention of systemic financial risks.


Introduction
In recent years, new finance represented by financial technologies transforms service model and development pattern of traditional finance, bringing opportunities and risks for Chinese financial system. On the one hand, the organic combination of technology and finance can improve quality and efficiency of financial services, and broaden boundaries and audiences of finance. On the other hand, as a "disruptive innovation", financial technology not only intensifies derivative development of traditional financial risks, but also makes liquidity risks greater, identification more difficult, spread faster, and influence more extensive. In the meantime, new risks are caused, such as innovation risks, cross-border risks, technical risks, operational risks, data risks, and compliance risks, which increase vulnerability of the financial system. In view of this, it has become an important issue to be focused and addressed urgently by relevant regulatory agencies on how to improve efficiency of financial market, achieve a balance between financial technology and prevention of systemic financial risks. [1]

Major Business Formats and Functional Attributes in China
Internationally, business formats of FinTech mainly include online mobile payment, payment clearing of digital currency, P2P online lending, equity crowdfunding, electronic transactions, intelligent investment consultants and other online investment management, as well as Internet insurance. From the perspective of implementation entities, FinTech is divided into two categories: "Finance+Technology". [2] In other words, traditional financial institutions transform business models and management concepts by virtue of emerging Internet and information technology to innovate product services. Another is "Technology+Finance", that is, information technology companies build a network platform and adopt emerging information technology to develop financial services (such as payment and settlement, fund raising, etc.) or support financial services.
In China, existing FinTech mainly includes the following formats: Internet payment, P2P lending, equity crowdfunding, Internet investment and wealth management, Internet banking, and Internet insurance. In terms of implementation entities, domestic FinTech operations include two types. "Finance + Internet": Licensed financial institutions apply Internet information technology to upgrade and transform traditional payment and settlement, deposits, loans, wealth management and other financial services, as well as operational modes. "Internet + Finance": Internet companies or platforms carry out financial services or financial support services, such as Internet payment, P2P lending, equity crowdfunding, Internet investment and wealth management, etc. (see Table. 1) through Internet information technology. [3]

Cross-Regional, Cross-industry, and Cross-institutional Risks
Digital financial technology platform of Ant Financial provides digital financial services for 729 million users annually, and 1 billion users use Alipay App. There are as many as 350 financial institutions in cooperation with it across the country. [4] Its sub-businesses include Alipay, Yu'E Bao, Zhaocaibao, Ant Fortune, MY Bank, Ant Credit Pay, and Sesame Credit. Different businesses are interrelated and penetrated, with cross-border mixed businesses more obvious. A single market risk may spread to multiple markets along the capital chain and guarantee chain, enhancing cross-border contagion. At the same time, it is hopeful to effectively improve convenience and availability of financial services because of the application of big data, cloud computing, blockchain and other information technologies. However, financial risks will spread in cross-regions, industries, and institutions if they are improperly applied and surpass regulation. [5]

Regulatory Arbitrage and Legal Compliance Risks
In the context of financial technology, it is common to see mixed financial operations where multiple businesses intersect and financial essential businesses are hidden. Specifically, some finances or financial products have been whitewashed and wrapped in the name of financial technology, making it difficult to define and identify financial regulation and to prevent risks.
Ant Financial continuously expands through loan assistance and joint loan by relying on cooperative financial institutions. According to Table. 2, as of June 30, 2020, on-balance sheet loans and advances total RMB 36.2 billion, but the actual credit funds reach RMB 2.15 trillion. Ant

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Volume 13 (2021) 129 Financial operates a joint loan with leverage ratio of 1:60, nearly 18 times higher than required ratio, which intensifies social risks and goes against reduction of leverage in society. It shows from Article 15 of New Internet Microcredit Regulations that proportion of capital contribution of a single joint loan of a small online loan company shall not be less than 30%. Among RMB 2.1536 trillion of credit facilitated by Ant Financial micro-loan technology platform, loans and advances on the balance sheet are only RMB 36.242 billion, accounting for only 1.68%, which lags far behind the 30% stipulated by the regulatory agency. [6]  Note: Data comes from the prospectus of Ant Financial (as of June 30, 2020).

Systemic Risks Caused by High Leverage
In nature, Ant Financial provides debit and credit with a higher leverage. Seduced by loose review system of the platform, consumers will loan online easily, without considering the high interest rates. According to Jiebei APP, the daily interest rate is as low as 0.4‰; for instance, RMB 10,000 is borrowed from Jiebei online, and borrowers need to repay in 12 installments with equal amount, with each payment of RMB 953.33 that includes the principal of 10000/12=RMB 833.33, and the interest of 10000*0.04%*360/12=RMB 120. However, under this calculation model, borrowers need to pay interest in each installment same as the beginning of the installment (monthly interest is calculated based on initial loan amount). But according to bank model, it is calculated after each repayment of principal, so that the principal owed is becoming less and less, and the interest to be repaid will be reduced correspondingly. In summary, interest rate of money borrowed from Jiebei APP is much higher than 0.4‰. Actually, borrowers should repay the principal and interest in one time a year later, but they are required to do so monthly. After calculation of annualized interest rate, there is: Among them, the annualized interest rate is R*12, N is the number of months of borrowing, NCFt means the monthly repayment amount, and C represents total amount of borrowing. The actual annual interest rate is as high as 25.59%, which is more than four times the rate quoted by ordinary banks and has violated protection line of private financial lending. Due to limited repayment ability of borrowers, it is extremely prone to risks that get bigger and bigger like snowball. With such a high loan interest rate, any changes in external environment will intensify consumers' credit default risk.
As shown in Fig. 1 and Fig. 2, after the outbreak of COVID-19 in 2020, the overdue rate of Ant Financial consumer credit balance has risen from 1.56% in January 2020 to 2.99% in June 2020, with an increase of 1.43% during the epidemic period. It indicates from Fig. 2 that the overdue rate of credit balance of Ant Financial small and micro operators goes up from 2.06% in January 2020 to 2.72% in June 2020, with an increase of 0.69% during the epidemic period. The risk of consumers'

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Volume 13 (2021) 130 credit default will increase provided that the COVID-19 spreads continuously so that lots of online lenders are unable to repay their loans at all. In the long run, the loan chain will be broken, risks will gradually spread, and financial chain of derivative products involved will be broken too. Eventually, it will trigger a systemic risk similar to the subprime mortgage crisis in the United States.

Regulatory Technology Empowers Financial Technology Regulation
According to the British Financial Conduct Authority (FCA), regulatory technology means that regulatory agencies innovate regulatory methods and models to improve regulatory effectiveness via modern information technologies such as big data, cloud computing, blockchain, artificial intelligence, and application programming interface (API). As the twin brother of "one mother compatriot" of financial technology, regulatory technology can technically dock the development of financial technology, alleviate asymmetry of scientific and technological resources between two parties, expand regulatory methods, and improve regulatory efficiency. The important role of regulatory technology is not only to improve regulatory efficiency as a technical tool, but also propose technological solutions, to establish regulatory concepts advanced and suitable for development of financial technology, or reconstruct regulatory system to play overall effectiveness of financial regulation.
Different from traditional financial regulation means, regulatory technology has the following characteristics and advantages.
Real-time. With the help of artificial intelligence technology, it directly connects regulatory end with the regulated institution through end-to-end data management function, so as to realize real-time monitoring of corresponding transaction activities and market indicators, and meet requirements of financial regulation and compliance management at a minimum cost.
Digitalization. Regulatory technology manages whole financial business process digitally through big data, cloud computing and other related technologies, which can collect, transmit, integrate and analyze complex data promptly, and improve capabilities of regulatory agencies in rapid deployment and response.
Intelligence. Based on machine learning, natural language processing and other technologies, regulatory agencies can learn independently and automatically generate required analysis reports and response plans. The reports are generated from manually to automatically, realizing automatic collection of data and information required by reports.
Sharing. Innovation of regulatory technology shall help improve convenience of regulatory data recording, storage and contribution, which is conducive to realizing sharing of data resources between regulatory agencies and financial institutions, and within regulatory agencies, and forming a unified standard for regulatory compliance data.

Transform Supervision Method and Introduce "Supervisory Sandbox" Mechanism
Although China's financial market policies and institutional mechanisms are different from those of Western developed countries, it is possible to improve top-level regulatory design and integrate financial reform pilot systems by learning effective mechanism of "supervisory sandbox" in developed countries such as the United Kingdom. Moreover, financial technology regulation should be enhanced in accordance with penetrating principle, in order to achieve financial technology development characterized by refinement, specialization and differentiation. In light of realities of national system, economy, culture, etc., measures can be taken to build a "supervisory technology sandbox" in Chinese version, incorporate outstanding regulatory technology projects into the sandbox, and allow them to test in practical scenarios application within a safe and controllable range. Meanwhile, it should ensure the compliance of financial technology development, improve efficiency of financial regulation, balance innovation and legal compliance supervision, and eliminate information asymmetry between regulators and the regulated. According to experience summary of the test, continuous self-learning and self-correction are required to form a benign feedback mechanism to improve innovation efficiency of regulatory technology [7].

Improve Regulatory Framework and Implement Functional Regulation
With respect to regulation on financial technology companies represented by Ant Financial, it depends on whether financial profit model involves five main functions of finance -high leverage, asset securitization, maturity mismatch, information and data advantage, and diversified risk hedging through Financial Holdings Group. They shall be regulated accordingly and at different levels as long as any one of five functions is involved. Opportunistically, based on advantages of information and data, Ant Financial reduces risks through the cooperation of small loan companies and other traditional financial institutions for joint loans, which implies an external financing leverage ratio of more than 5 times. In other words, Ant Financial must be regulated in terms of functions rather than traditional institutional supervision because its financial business models are related to information and data advantages, high leverage, and asset securitization [8].

Conclusion
This study mainly coordinates the relationship between financial regulation and financial technology innovation from the perspective of technology empowerment, hoping to reach a balance between efficiency of financial technology and the prevention of systemic financial risks. It aims to build a financial supervision mechanism meeting national conditions, which not only tolerates reasonable innovation, but also holds the bottom line of avoiding systemic financial risks, so as to create a healthy financial technology ecological environment ultimately.