Ep. 76: Lufax IPO and the end of P2P lending in China

In episode 76 of Tech Buzz China, co-hosts Rui Ma and Ying Lu take advantage of the recent Lufax IPO filing (Chinese name: 陆金所 lùjīnsuǒ) to talk about the P2P lending industry in China, which has been an oft-requested topic! We get into China’s (lack of) regulation of the nontraditional form of financing, drivers behind the industry’s quick boom and bust, and some of the reasons Lufax is one of the few, and biggest, survivors. 

We have started uploading all of our past episodes onto the new Tech Buzz China YouTube channel and putting them together into playlists by sector — check it out. You’ll soon be able to find this and other relevant episodes under the “fintech” category. 

Yes, Rui is still researching and writing on ByteDance, for publication as an ebook! You’ll want to get front-row updates on it by subscribing to our newsletter, at techbuzzchina.com. As always, our past transcripts and other content are also viewable at pandaily.com and supchina.com

If you enjoy our work, please do let us know by leaving us an iTunes review (drop us a note saying you did, and we’ll send you an Extra Buzz newsletter subscription), and by tweeting at us at @techbuzzchina. We also read your emails, at rui@techbuzzchina.com and ying@techbuzzchina.com. Thank you to our growing community for your always valuable feedback! 

Thank you to our ever-talented producers, Caiwei Chen and Kaiser Kuo, as well as to Jason MacRonald at SupChina.

Transcript

[00:00]Hey guys, so we were struggling a bit this week to find something interesting to talk about in China tech, because truly, nothing momentous happened. Sure, you have some rumored delays on the Ant IPO, and your usual scuffles between the big internet companies, like Meituan no longer accepting Alipay, Douyin banning third-party e-commerce links, etc. But that’s just life as usual in China internet.

But then the Lufax IPO filing hit, and it hit us that oh hey, we’d always been meaning to tell the story about the whole peer-to-peer AKA P2P lending industry in China, and this might be a great time to do so, before the whole thing fades entirely from view. Because it was legitimately a very big deal in China, and the way it blew up was just so super fast and dramatic. So, this seems important to understand.

[01:00]So thank you Lufax, Chinese name 陆金所 Lujinsuo for giving us the opportunity to talk a bit about P2P like we’ve always wanted. It kind of continues our exploration of fintech in China in general, by the way, since our next episode is going to be on the digital currency proposed by the Chinese government. Speaking of which, now that we’ve started to have multiple episodes on the same industry, like this must be our fourth or fifth on fintech, we’re going to start putting them together into YouTube playlists for those of you new to the show, or even existing listeners who just want a refresher like I know I do sometimes, so that there is a way to get quickly up to speed on a sector.

Quickly up to speed on what we know, anyways, because we’re learning as we go along too. But yes, definitely check our revamped YouTube channel and subscribe! We’re just starting to get all our episodes uploaded, and are working on some video-first content too. Subscribe so you can be the first to know!

[02:24]Hi everyone! We are TechBuzz China by Pandaily, powered by the Sinica Podcast Network by SupChina! We are a biweekly podcast focused on giving you a peek into what’s buzzing within the tech community in China. We uncover and contextualize unique insights, perspectives and takeaways on headline tech news that don’t always make it into English language coverage. So you can be smarter about the world of China tech.

Tech Buzz China is a part of Pandaily.com, an English language site that tells you “everything about China’s innovation.” I’m one of your two co-hosts, Ying Lu.

And I’m your other co-host, Rui Ma. We are a part of the Sinica Podcast Network, created by SupChina! In addition to Tech Buzz, you can also find Sinica which covers current affairs. And we are also proud to be partnered with Financial Times’ Tech Scroll Asia, a newsletter on Asia tech news from one of the best publications in the business. Sign up today!

And as always, we are still looking for more reviews on Apple Podcasts! Send either of us a screenshot of your review, and we will gift you a free three month subscription to our Extra Buzz newsletter. You can send me an email at ying@techbuzzchina.com. Several of you have already claimed this, and we love it when you do. Thanks so much!

[03:49]So this episode is really two different stories, kind of like back when Tech Buzz first started, and how we’d try to cover two different headlines in the same show. However, unlike in those first episodes where the stories had no relationship to one another, these two do. Peer-to-peer or P2P lending is actually a big part of Lufax’s early history and is the main story we want to tell today. So it only makes sense to begin there.

Right. So let’s talk about P2P lending, or let’s just refer to it as P2P, since that’s how everyone talks about it. In the US, we can probably use the founding of Prosper in 2005 or LendingClub in 2006 as the sector’s birthdate. As for China? Not far behind. Most people would point to the founding of PPDai or 拍拍贷, as it’s known in Chinese, in 2007 as when P2P was introduced to the country.

For the first five years or so, it grows pretty quickly, but because it’s growing from such a small base — only about $30mm in 2009 — it only gets to about $940mm by the end of 2012. A mere drop in the bucket when it comes to the total demand for loans, of course, but actually already exceeding the US market at the time, which was about 8% smaller.

[05:16]But then 2012 and onwards, though, the industry in China really starts to explode. A lot of this is due to soaring smartphone penetration of course, and consumers’ growing familiarity with internet finance. In 2013, outstanding loan volume went up to $4.3Bn, which is nothing to sneeze at, but just two years later, that amount had gone up to $71Bn. Now we’re talking real money and China is also leaving the US in the dust, even though no one is making a serious dent in the multi-trillion dollar consumer credit business in either country.

No, but excitement was at an all time high. I don’t know if you guys remember this, but LendingClub was the biggest tech IPO of 2014. The next year, it soared to a $15Bn market cap, and it was originating like $8Bn in loans. And basically a ton of P2P lending companies got funded, became unicorns, had record-breaking quarters. And that was just in the US. It was crazier in China. I was doing early stage investments then and I was getting pitched P2P platforms left and right. Luckily, for me, it looks like most of them failed.

Yup, they did. 2015 might have been the height of the craze because there were over 3,500 P2P lending platforms in China at that time. Other estimates put the number even higher at closer to 6,000. Anway, by the following year, about a third would fail and by 2018, only a little over 500 companies would still exist. As of today, it’s said that less than three dozen are still around. Almost all of the large players have exited the P2P business, including PPDai, the thirteen-year-old company that we said started it all, and also Lufax, the company that just filed for IPO.

[07:17]Yeah, as far as China goes, P2P is dead. And anyways, no one trusts P2P anymore in China, because it lost people so much money, including many of my friends. But what happened exactly? Why were there so many implosions? Were they all scams? Or just poorly run?

The answer, as it often is, is all of the above. But let’s talk about the scams first. First, the largest P2P platform in China, Ezubao e租宝, turned out to be a Ponzi scheme. The management fabricated projects, asked the secretaries to dress only in luxury brands like Hermes and Chanel to appear successful, and siphoned $9Bn from unwitting victims. They’re all in jail now, but the poor investors only got 35% of their money back.

And they aren’t the only one, just the biggest and one of the first to fail. You see, Ezubao failed in 2016, which was right after that peak that we talked about earlier. But more and more continued to fail, and one report asserts that up to 40% of China’s P2P lenders were Ponzi schemes. I couldn’t access the underlying government document that supposedly made this estimate, so I’m not sure what to believe, but it’s definitely more than a handful ofplatforms. In fact, if you Google P2P and Ponzi scheme together, you’ll get lots of results asking “are P2P platforms Ponzi schemes?”

[08:54]Quick aside here, lots of people lost lots of money on these platforms — sometimes most or all of their life savings! — and there are many stories of ordinary citizens committing suicide after they discovered their investments just went poof. Super sad. Others, including some people I know, organized protests, sought out lawyers, and demanded their money back. But most of them probably won’t ever see their principal returned, especially if they were in the market early, because for a long time, P2P was completely unregulated in China.

Right. It wasn’t until mid-2015 that the first guidelines for regulating P2P came about. Mid-2016 was when actual measures came into effect, with additional rules coming in the year after that. Before 2016, P2P existed in this sort of no man’s land, free from any oversight. This was completely different from the US, which has a much more robust consumer credit system than China to begin with. Here in the US, we also benefited from the early action of the SEC, which began requiring registration of the P2P loans with the agency as a note. While this increased operating costs and so meant fewer P2P platforms would be created, it did protect users, and I think if you ask all the Chinese people who lost their money to bad actors which scenario they’d rather have, I’m pretty sure they’d opt for the system with more oversight.

That regulatory vacuum was pretty fatal, but even after authorities stepped in, there continued to be a ton of problems. First of all, a lot of them just weren’t good businesses. They didn’t really understand how to evaluate credit risk. They were like good salespeople who were really good at fundraising. The companies were barely fintech businesses. In fact a lot of them had a significant offline presence for customer acquisition.

[10:55]A lot of them barely diligenced their investors or their borrowers. Actually, the ignorance goes even deeper than that. As some analysts have pointed out, a lot of China’s so-called P2P platforms weren’t actually in the P2P business at all, but were actually just operating kind of like underground banks. That is, they were supposed to match lenders with borrowers, but instead, they were pooling money from lenders, separately lending them out to borrowers, and then guaranteeing the payback to lenders, basically much like a bank would, except without any of the compliance, controls, and risk management that a bank would have.

I know, it sounds completely nuts, but that’s just what happened. People were playing with fire and got burned. How could everyone involved be this stupid though, you ask? Well, it obviously worked some of the time. But if you listened to any of our fintech episodes on Tech Buzz so far, you’ll know that non-bank financing is just a relatively new thing in China; it’s a country where traditional banks have a greater share of the credit system than elsewhere.

I mean, even in the very developed US market there remains a gap, which is why players like LendingClub got started in the first r place, but in China that was much more massive. I mean, you probably remember from our episode 74 on Ant that consumer finance in China is a $1.4Trn market today, and small businesses have an unmet financing need of $7Trn in China today, so there you go, there is no lack of opportunity.

[12:38]And if you were a lender looking for alternative investments, you could get more than 8x the interest rate offered by banks. Average rates offered to you would’ve been around 13%. Managed products were half that. No wonder a lot of people got greedy and put in a ton of money. Especially since in China there was this concept of 刚性兑现 gangxingduixian, or 刚兑gangdui, that really just meant, an implied promise on the part of the platform to repay the loan, no matter what, even if the borrower defaults.

Completely nonsensical, but that’s what it took to get people to put money on the platform, and so that’s what was offered. It also led to things like “runs” on the platform, ie when everyone tried to pull out their money at the same time, things that shouldn’t happen, if only the platform were operating as a true platform. Unfortunately, as I hope we’ve hit home the point by now, most were not.

So, all of this added together? Disaster. Eventually, even though the local governments didn’t want to shut down some of these platforms, because they were funding some of the municipal projects that banks didn’t want to finance, they had to. It was just too out of control. One province after another began banning P2P platforms. It wasn’t a great solution but having people’s lives be destroyed? That was causing too much panic and was too socially destabilizing.

[14:11]Today, something like $115Bn may have been lost by investors. Not a large number when you compare it to the entire lending market, but when you consider that it was all lost by regular investors like you and me, then the tragedy of it becomes pretty clear. Anyway, the Chinese government is pretty fed up with this and late last year, they told all P2P platforms that they must become small loan providers within the next two years. Which is where we can pick up the story with Lufax.

Founded in 2011, Lufax is basically a subsidiary of Ping An Group, China’s biggest insurer. It started with P2P lending as the only service, and then Ping An injected some more assets into it, and now owns 42% of the company. Since founding, Lufax has raised more than $3bn from a wide variety of investors, a lot of banks and financial institutions, and it was last valued at $38Bn, although apparently Ping An has been carrying it at a lower value on its books, so we’ll see how much it goes out at.

Anyway, since we just spent the last fifteen minutes talking about how P2P didn’t work out so well for China and how it’s been effectively banned, then you can probably guess Lufax’s current business model. Yes it still has some “legacy business” from the past, but Lufax has been eagerly replacing its P2P with other asset management products, such as bank products, mutual funds and the like. And it says it’s been successful converting those existing investors to these new products.

As for the loan business, it still exists. In fact, in the first six months of this year, service fees from facilitating these transactions amounted to $2.9Bn USD, or about… wait, is this right? Substantially all of its “technology platform-based income.” Only about $100mm came from its wealth management business. That’s like a ratio of 30 to 1 in terms of size.

[16:18]That’s correct. That’s because this business, AKA “retail credit facilitation business,” was acquired by Lufax in 2016, right when all those P2P companies started failing and new regulations came in. Actually, it was not a real acquisition and more just another Ping An business called Puhui 普惠 that got merged in. The details are pretty complicated and uninteresting so we won’t go over it here, but as of now, the source of capital for all these loans are institutions, ie banks and trust plans. And that’s how Lufax is making most of its money– by facilitating these loans. In fact, that small amount of wealth management income is not even as much as in years past, which the company attributes to the challenging conditions this year. Its total revenues though is still slightly up from last year.

Yeah, it’s still really profitable. $1Bn in net income just in the first half. Almost 30% margins. Which Lufax explains by insisting that it’s really different from all those fintech companies. You know, Ant Group, JD Digits, etc.? Those guys have a tech DNA, and are new to finance. Thus they tend to focus on consumers and use things like “social behavioral data,” which only give you the confidence for those smaller sized, shorter-termed loans. Lufax? We can do better.

We’ve got the finance DNA! We can do those more advanced products. We’ve got years worth of models, but also analytics and AI! Which for some reason, hint hint wink wink, we are also better at than those tech companies, just trust us. Okay, I’m poking fun a little here, but that really is what the prospectus says.

[18:19]Is there a company that isn’t touting their analytics and AI these days as a core advantage though? And it’s true Lufax does have two things that are not tech that they are strong in: their 56,000-person strong salesforce and 9,500-strong collections team. That’s right. They have an immense direct salesforce, channel partners, and everyone’s favorite – online telemarketing. Actually, 4,000 people in telemarketing alone is what the prospectus says.

Whereas, at least for the collections part, a lot of fintech firms and even banks outsource that stuff, which is bad, according to Lufax, when it comes to larger loans and “challenging points in the credit cycle.” I mean, this all sounds logical, although I’m not sure of the actual impact. But let’s just take their word for it.

I think the main takeaway here is that Lufax just doesn’t have that much tech. It’s not really doing super innovative fintech in the sense that Ant Group is, for example. It’s still very much a finance organization, which makes sense given its parent company is Ping An.

Right, and I’m not really sure there is too much else we can tell you about Lufax, so I think it’s time to wrap up this episode, which, if I’m being honest, was really mostly on P2P, the more interesting subject by far anyway.

[19:54]Yes, peer-to-peer lending, the nontraditional financing that went unregulated in China from 2007 to 2016 and did help some borrowers, yes, because China has trillions of dollars of financing need that isn’t met by banks. But it also hurt a lot of lenders, who invested money into platforms that either turned out to be Ponzi schemes, or just didn’t have the right systems in place to make good loans.

The biggest problem though, might have been the platforms’ own fault, by implying a guarantee that the loan will be repaid, even though common sense tells us that of course there is risk of default. But the combination of greed and the fact that there aren’t many investment products at the time resulted in a sharp rise of P2P platforms so that by 2015, China was easily the largest P2P market in the world and had thousands of P2P companies.

All the irrational exuberance though was exactly that. Irrational. Platforms failed en masse, and by 2020, we’re looking at just a few dozen platforms left, all of whom are switching to become small loan providers, by government mandate. Of those that have survived, Lufax is one of the biggest, and began its life as a P2P subsidiary of Ping An, China’s largest insurance group.

[21:16]Founded in 2011, it’s actually tried to go IPO several times, with the first round of rumors as early as 2015, but continued uncertainty and regulatory upheaval in the sector as well as a major reorganization have delayed it to this year. One surprising thing though is that it decided to go IPO on the NYSE instead of the Hong Kong Stock Exchange as has been rumored inyears past, and as has been increasingly popular with Chinese companies this year, due to the geopolitical tensions.

One source is saying that this is because existing investors include a number of foreign firms who are more comfortable with New York. That seems like a weak reason, but who knows? The company isn’t afraid to be a bit unconventional. For one, it’s one of the few Chinese companies to have an American leader. Gregory Gibb, the current CEO and Chairman, was at McKinsey for nearly two decades before joining Lufax.

[22:15]Lufax has mostly benefited from its association with Ping An, a trusted company in China. But it does have its work cut out for it. As a distributor of wealth management products, it’s been in the news more than a few times in the past three years for selling funds that eventually lost clients money, and were basically scams, leading to physical protests and lots of bad press.

Yeah, Chinese users are still not used to losing their principal, especially if a company like Ping An is attached to the product, even super indirectly. So what do you think guys? Did you ever invest in P2P? It was just one of those things that had such a quick boom and bust. I mean, one of the companies that started it all, LendingClub, just announced that it would stop its peer-to-peer retail solutions by the end of this year. It will now become just a bank.

The rest of the US market still exists though, even though it’s not growing very fast. What do you guys think? Will P2P ever make a return to China? Or is its exit complete? And did Lufax make the right decision to list in the US? Or should it have gone to Hong Kong? What are your thoughts? Let us know!

[23:37]Thanks for listening and don’t forget to write us that review for your free Extra Buzz subscription. Have any questions or suggestions? Email us! We really enjoyed putting this together, and we’re always open to any comments or suggestions. You can find us on twitter at thepandaily, at techbuzzchina, and my personal Twitter account is YINGLU2020.

And my Twitter is spelled RUIMA. Tech Buzz China by Pandaily is powered by the Sinica Podcast Network on SupChina. Pandaily.com is an English language site that tells you “everything about China’s innovation.” Our producers are Caiwei Chen and Kaiser Kuo. Thank you for listening!