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Why The Chinese Regulators Were Right To Cancel Ant Financials’ IPO

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By Nuno Fernandes, Full Professor of Finance at IESE Business School and the author of Finance for Executives: A Practical Guide for Managers

The recent suspension of Ant Group’s IPO is producing increasingly clear aftershocks, including eroding the value of Ping An Insurance Group’s Lufax Holding Ltd., which in its attempt to change from a finance firm to a tech giant has become a prime target of short sellers.

But Ant’s story should serve as a cautionary tale for the entire Chinese fintech sector. And also offers valuable lessons for the financial industry in general.

After all, Ant, an affiliate of Alibaba founded by Jack Ma and spun out from the Chinese tech giant in 2011, was on track to be the most valuable FinTech company in the world. And the $34.5 billion it had raised, eclipsing the $29.4 IPO record set by Saudi Aramco, valued the company at $313 billion. (To offer some perspective, Citigroup on November 12 had a market cap of $101.9 billion.)

Despite controversies (including criticism of its data protection standards) over its past five years of fundraising, Ant garnered investors including China Investment Corporation, CCB Bank and China Life. Its June 9, 2018 haul of $14 billion was called the biggest-ever single fund-raising by a private company.

Yet despite these jaw-dropping numbers, plus the $3 trillion in bids from retail investors in China and Hong Kong (oversubscribed more than 800 times in their assigned tranche), the Chinese regulators that had approved the IPO on October 19 abruptly reversed course on November 3 and suspended the listing. 

 What went wrong? Ma’s blunt critiques of the Chinese banking system didn’t help. But the crux of the issue is the identity crisis facing Ant, which began as a mobile payments platform before offering savings solutions deposits, money market funds and, now, credit.

In other words, despite labeling itself a TechFin player (itself a reinvention from its FinTech debut), Ant functions quite similarly to a bank, receiving deposits, pulling those deposits together and transforming them into loans (and thus charging a financial margin ).

That identity crisis—a company operating like a bank while ducking the standards required of them—provided good reason for regulators to suspend the IPO. It poses perilous risks for investors and for the financial system.

What’s so problematic about this confusion?

For one thing, it leads to insufficient capitalization. All European and American financial institutions, and most of them in most other countries across the word, are subject to strict criteria on how to assess and manage credit risk. This credit risk leads to the famous, or infamous post-2008, capital ratios of banks that, depending on credit score and the risk of balance sheet assets, is needed to hold more or less capital.

Ant’s level of capital would place it below any reasonable capitalization benchmark. Indeed, the company’s capital ratio, according to its financial statements, is between 2 and 3%, in dramatic contrast with the 12 to 15% capital ratios held by most financial institutions worldwide. (The average in China sits at 8%.)

Another problem with Ant is that its credit scoring and allocation is performed by an opaque algorithm unverified by an external party. This algorithm has also avoided being stress tested. 

This is a serious problem. In Europe and the US, banks suffered catastrophic losses during the 2008 financial crisis and the turmoil that lingered in its wake. It was precisely that damage that the credit scoring models now in place came to be as defense mechanisms. If Ant’s risk measurement has been subject to scrutiny or stress tests, the company has obscured the results from outside observers.

All this puts the safety of deposits placed in Ant at risk. And the chief goal of regulation in the banking sector is to protect depositors and the money they’ve entrusted to a bank. In this case, the lack of capital buffers, or at a minimum the inability to see those buffers from the outside, is unacceptable in a multibillion-dollar balance sheet.

Even Ant’s 674-page prospectus could conceivably raise more questions than answers. It’s a confusing document, conspicuously low on the sort of crystal-clear financial information a prospectus is meant to present. Where within the over 100 pages discussing financials is a clear balance sheet? And where are the analyses of capital ratios and capital requirements that are the backbone of bank prospectus? 

It’s understandable that news of the Ant IPO suspension disappointed many observers. Innovation is essential to a robust economy, and a lot of FinTech companies have been particularly instrumental in bringing useful innovations to consumers and the broader market. But green lighting a wolf in sheep’s clothing will only hinder financial stability.