Inexperienced Chinese investors are getting stung by fintech scams
China is witnessing a fintech boom. Companies providing electronic payments, cryptocurrency trading and other online financial services there are not only mushrooming, they are among the biggest and most highly rated in the world.
The Fintech 100, a ranking of leading global fintech innovators for 2015 compiled by KPMG and H2 Ventures, chose China’s first online-only nonlife insurance company, ZhongAn Insurance, as No. 1. The insurer was jointly established by Alibaba Group Holding, Tencent Holdings and Ping An Insurance Group. Online investment product Yuebao, offered by one of Alibaba’s group companies, has attracted 270 million investors.
But amid all the dizzying numbers, another — more sobering — reality is emerging. Crooked companies are exploiting under-informed investors. Many of these fraudsters are using peer-to-peer financing platforms, online services that directly connect borrowers with lenders.
PONZI VICTIMS “I just increased my investment in the company because it paid interest without fail for over a year,” said one investor who got burned. Grumbled another, “The website was up until this morning.”
They were among the dozens of riled up investors gathered in the Bund, a major Shanghai tourist spot, on April 6. But they were not there to see the sights; they had rushed there to see what happened to Zhongjin Capital Management after hearing that police raided the wealth management company, which had attracted investment money via the internet with a promise of high returns.
By the time the investors arrived, Zhongjin’s executives had already been whisked away by the authorities. All they could do was share their frustration. Frazzled investors came the following day and the day after that, but to no avail. At some point during that time, the “Zhongjin 1824” nameplate was quietly removed from the entrance hall of the office building.
The brochure for “Golden Key No. 3,” an investment product the company had been offering just before it folded, claimed it was a private placement fund and investors would be limited-liability partners. The fund would, according to the brochure, invest in or extend loans to 40 companies of the Zhongjin group for official projects initiated by the city of Shanghai. These claims were false, of course, and upon close inspection hardly believable, but investors jumped at the chance to earn an annual return of 8-12%.
It turned out that the group’s business was a Ponzi scheme. One of its financial products had an annual return of 40% last year. The group collected 30 billion yuan ($4.5 billion) from investors.
Media reports about the lavish lifestyle of Zhongjin owner Xu Qin made the victims even angrier. His upscale condo in Shanghai had a 300-sq.-meter guest room where, Xu reportedly told police, he kept a peacock.
Zhongjin is not the only crooked P2P player. In December 2015, a police investigation revealed a financial scam by Ezubao, which had collected more than 50 billion yuan from investors by promising annual returns of between 9% and 14.6%. But Ezubao used most of the money to pay returns to earlier investors, just as Zhongjin did.
Some of the people who had pumped money into Ezubao descended on the state-run China Central Television, insisting that the broadcaster bore responsibility because it ran ads that prompted them to take a chance on the company.
OVERFLOWING WITH CASH Perhaps the main reason P2P platforms attract so much money is the excess liquidity generated by China’s easy monetary policy. Stimulus measures introduced to help the country weather the global financial crisis inundated the financial market with cash. Initially, investors funneled the money into condos in coastal areas. When Beijing tightened regulations on condo investment, they shifted to wealth management products. But authorities tightened rules on these products in 2014 over concerns that they were being used to support shadow banking. Investors’ next choice was Chinese stocks. But share prices tumbled after peaking in June 2015, and investors once again began looking for new places to park their cash. Internet finance is the latest stop in this bubble cycle.
Because P2P financial services are relatively new in China, many investors there are not familiar with how the products work. Financial novices are often dazzled by TV ads trumpeting big returns without giving much thought to the risk involved. The combination of low financial literacy and large nest eggs — many Chinese have built up hefty savings to compensate for an inadequate social welfare system — makes the country ripe for scams.
Another problem is that Chinese laws and regulations are often vaguely worded, and officials have plenty of room to act at their own discretion. A legal system riddled with loopholes provides fertile ground for new fintech services to emerge, said Takashi Nomura of Japanese law firm Nishimura & Asahi. That is in fact one of the key reasons why China has become a fintech powerhouse.
Chinese authorities have finally started addressing the problem. On Aug. 24, the government imposed limits on the amount that can be borrowed from a single P2P platform, setting the ceiling at 200,000 yuan for individuals and 1 million yuan for businesses. The change is aimed at making it hard for Ponzi scheme operators to extend large-lot loans using money collected from investors.
As of the end of June, the China Banking Regulatory Commission had found dubious practices at 1,778 P2P platforms, or 43% of the total. In its semiannual report on P2P services, the commission says 515 platforms discontinued business in the first half of this year; of those, 268 refused to redeem cash or simply fled.
CRYPTOCURRENCY BLUES The hustling and cheating is not limited to P2P services.
Imagine someone losing money because his online bank account has been hacked. As a customer of the same bank, you do not suffer a loss. But the next day, you receive a call from the bank telling you that the losses will be spread between all customers.
This is similar to what happened following a cyberattack at a popular bitcoin exchange in August. Those who had their virtual currency stored at Hong Kong-based Bitfinex had to share 36% of the $65 million in losses, after some 120,000 bitcoins were reportedly stolen. The hack triggered a 20% crash in the currency’s value within a day. Bitcoin was trading around $600 on Sept. 4.
Bitfinex is the largest exchange for dollar-denominated cryptocurrency transactions. OKCoin and BTC China are even bigger, but both base their trade in the Chinese yuan.
“Losses must be generalized across all accounts,” Bitfinex said in a statement. As for outstanding losses, Bitfinex issued new digital tokens for its hacked customers to exchange for an equity stake in its parent, iFinex, and later offered to buy back 1% of the tokens.
This is just the latest drama surrounding bitcoin. Frequent hacks, price volatility, ongoing lawsuits and claims by victims have rekindled fears about the prospects of the currency. In February, Chinese exchange BTER lost $1.75 million worth of bitcoins, a month after $5 million was stolen from Slovenia-based Bitstamp. But the biggest scandal was the bankruptcy of Tokyo-based Mt. Gox in 2014, after the loss of $500 million — over seven times the size of Bitfinex’s debacle.
“These controversies give serious investors the impression that bitcoin is a not-so-serious business,” said Simon Lee, a senior lecturer at Chinese University of Hong Kong Business School. “Trust is the first and foremost reason you’ll choose a currency.”
Bitcoin has thrived as a laissez faire currency since its birth around 2009. While some mystery remains about the beginnings of bitcoin, the cryptocurrency is prized among its proponents for its decentralized nature. Unlike credit cards and other forms of mobile payment, like Apple Pay or China’s Alipay — linked to Alibaba Group Holding — anyone can move bitcoins anywhere on the internet without having to verify his or her identity or be subject to approval by banks and central authorities.
But one downside of this is that there is little institutional backup when things go wrong, leaving users with limited recourse to refunds from the unregulated exchanges they trade on. Few countries, especially those outside Europe, have regulations over bitcoin trading. The central bank in China, a country that accounts for about a third of bitcoin trading globally, declared in 2013 that the currency has no legal status. Chinese internet group Baidurecently removed bitcoin ads from its search engines.
The anonymous nature of bitcoin also means it can be manipulated for seedier transactions involving drugs and money laundering. Despite the patchy regulatory regime, some argue that the blockchain technology behind bitcoin, which enables the creation and sharing of a digital ledger of transactions across a network of computers, is still safe.
“It’s kind of like when you hear about users having their credit cards hacked on the internet. You wouldn’t think the internet is broken,” said Jack Liu, chief strategy officer at Chinese exchange OKCoin. He does, however, stress the need to heighten security.
Liu said OKCoin keeps about 95% of its user deposits offline. The percentage of deposits it maintains online is small compared with rivals such as Bitfinex, which stores bitcoins online to allow for quick withdrawals. “If [we] ever do get hacked, the losses are not going to be severe enough to bring insolvency,” he said.
Still, skeptics doubt whether bitcoin will ever become mainstream. Lee from Chinese University said that without fixing security loopholes that erode trust in the currency, “I’m afraid bitcoin might lose favor and fade out like many fintech products do.”
Source: Asia Nikkei
