|Illustration: Barry Downard|
Lufax is the unacknowledged dynamo of Chinese internet banking. BAT – Baidu, Alibaba and Tencent – get all the press as they convert e-commerce and social media businesses into emergent financial service enterprises with customer bases the size of continents. But Lufax, which is preparing what could be Hong Kong’s biggest IPO of the year, is in some ways the most interesting of them all.
Founded in 2011, Lufax – known locally as Lujiazui, or in full, Shanghai Lujiazui International Financial Asset Exchange – started out as a peer-to-peer lender. That is not unusual. As many as 3,000 P2P businesses were operational in China by 2015, although many have since vanished or collapsed.
But Lufax had two distinguishing features: the backing of the Ping An group and a great deal of ambition.
Six years on, it has expanded to become a large wealth management, consumer finance and institutional trading business, with 25.5 million registered users, Rmb390.92 billion ($57 billion) of retail assets and Rmb111.65 billion of loans under management. As is the way of Chinese internet finance business, its growth numbers border on the absurd. In the nine months to September 30, 2016, its number of registered users was up 39.3% from the start of the year, number of active users rose 80.4%, retail transaction volume was up 239.3% and institutional transactions up an astonishing 428.8% (to Rmb3.22 trillion).
“These guys,” says a bank economist in Beijing, “are going to be the death of the bank deposit in China.”
How so? By connecting retail buyers with institutional sellers, Lufax is offering something far more alluring than a low-interest bank account. Tech-savvy and increasingly wealthy young people in China use Lufax’s online and mobile platforms to earn more from their savings, just as equivalents like Lending Club and Prosper do in the US, the difference being that Lending Club could never dream of an underserved domestic market of well over 1 billion people.
Moving from its P2P roots to something bigger has required a leap of faith. “If we had stuck with where we began, we could never scale,” says Gregory Gibb, CEO of Lufax, speaking to Euromoney in his Shanghai office among the incongruous blonde granite columns of the Ping An building.
“When we started with peer-to-peer, there was never enough product to meet demand. The first year, we operated about five minutes a day; when what you’ve got on the platform sells out, you’re done. It’s not really an internet business.”
So the company set out to expand beyond its P2P origins and added more and more investment classes to the platform. “You need products that meet different parts of the cycle,” he says. “It’s like traditional banking: once you’ve got two or three products from a customer, they become much more sticky.”
The resulting business today is what CFO James Zheng describes as being like a bike with two wheels serving different purposes. The front wheel is retail investors looking to put cash to work, the back wheel is the institutional end, supplying product for them to buy. It all works for a number of reasons.
“One of the things that has made internet finance happen so fast in China is that there is a lot of demand, both for borrowing and investing, that is not being well met by traditional players,” Gibb says. He means the banks and their heavy focus on corporate work, accounting, he estimates, for 70% to 80% of the system, in contrast to western markets.
He adds: “The other thing is that you’ve got this interesting combination of high adoption, including mobile, and relatively young demographics at the same time as reasonably good income.” Spain, he notes, has the same penetration, but no income; other places might have money but no penetration of technology for finance. “It’s a perfect storm of market demand, demographics and penetration of first-world technology with a fast-growing footprint.” On top of that, “if mobile payments wasn’t developed, we could never have taken off.”
Another crucial point is the arrival of individual wealth at an age when people are still up to speed with the latest developments of technology.
“In the rest of the world, there is very good technology but it just doesn’t scale like this,” he says. “In the US, needs are well met and people who have money are probably slightly older; your friends in their 40s aren’t waiting for Google to offer them financial products, whereas the Chinese in first- or second-tier cities who are in their mid 20s to 30s are quite happy to try something new.”
As the business has changed, so too has Lufax’s relationship with banks, which remain competitors but are also now customers too. “Certainly at the beginning, when we knocked on banks’ doors back in 2011, they would be closed in our face very quickly,” says Gibb. “They thought we were very weird, and they didn’t know what we were up to or what the regulator’s attitude was going to be.”
Now, Lufax has a team of 400 people in 25 large cities who do nothing but knock on the doors of banks and securities companies to get product on to the Lufax platform, and thus become a channel for distribution. “Now, the conversation we have with bankers is in a language they understand. If we came at this purely from an internet angle, we may not be able to solve their problem. You need a mix of traditional finance capability to solve the provider’s problem, then the strength of the online platform to make it work reasonably cheaply.”
Lufax is still a big competitor to the banks in terms of the deposit base and wealth management, but is also a useful channel for their products to be sold. “It allows them to take more off their balance sheet,” says Gibb.
This highlights a key difference between Lufax and Ant Financial (the financial services arm of Alibaba) and WeChat (part of Tencent and possibly the most widely used financial services channel in the world, despite being entirely domestic). “We are very purpose-based,” says Gibb. “We don’t sell shirts. So people who come to us are really coming for investment.
“The BAT guys have already got the flow of the customer, who is buying XYZ on Tabao [Alibaba’s online shopping marketplace], and has some spare funds in their payment account that can be swept into a money market account to provide some convenient interest. Customers who buy a product on Lufax will probably have an account at Ant Financial, but they won’t be using it to invest Rmb500,000.”
As for the banks, even if they have accepted Lufax as part of the financial ecosystem, they remain gnarly that internet finance companies do not face the same level of regulation as the banks, although this has changed over the last year.
“There is increasing regulatory scrutiny on the P2P lending space in China as the sector grows,” writes Citi in a benchmark report on internet finance in China.
In August 2015, the State Council issued new rules on P2P lending to tighten control of the sector, stopping online lenders from accepting deposits or guaranteeing principal or interest on the loans they give out. There are caps on borrowing, both individual and corporate, and they are banned from securitizing assets.
Gibb certainly does not describe regulation as particularly simple or accommodative. “The regulatory environment has been designed around verticals of the business,” he says. “So there’s a set of regulations for peer-to-peer, there’s a set of regulations for selling mutual funds, there’s a set of regulations for selling insurance online, there’s a set of regulations for payments.”
Some of his business is regulated by the People’s Bank of China, some by the China Banking Regulatory Commission, some by the China Securities Regulation Commission; in wealth management it is still not entirely clear who will end up overseeing the activity. Lufax has had to set up several firewall companies beneath the overall platform to meet each regulator’s set of rules.
“The cake is about 70% baked in the sense of the regulations being clear,” says Gibb. “For mutual funds, insurance, payments, peer-to-peer, it’s basically all set. But for some areas around fixed income, wealth management, that’s still being cooked.
“I would argue that the formation of regulation for this industry was probably a year, a year and a half too late in the industry’s development.”
That might have helped, for example, with Ezubao, a peer-to-peer lender that collapsed after it became clear it was nothing more than a Ponzi scheme. It owed Rmb50 billion to 900,000 investors, who had been promised returns of up to 15%, when it went under in December 2015. “If the regulation had been out a year earlier, that would probably have been Rmb5 billion rather than Rmb50 billion in size,” Gibb says. “Some of the mega stories that have captured headlines on fintech in China would have been much better controlled with earlier regulation.”
What to make of the P2P industry now, then? “People talk about this tail of 2,000 to 3,000 people, but the market structure has always been that the top 10 had at least 30% to 40%,” Gibb says. “With all this regulation, the top 10 end up with 70% or 80%. It’s not necessarily M&A consolidation, but the bar goes up and customers become more picky as well. They don’t just want high yield. They want their money back.”
Ping An connection
Lufax, so far, has stayed on the right side of this, offering a return that is outstanding on a world scale – 7.2% is a typical rate of return on one P2P product – while also appearing trustworthy and stable. Two things assist it here: the Ping An backing and an apparently robust approach to risk assessment.
“The brand connection [with Ping An] is very important”, says Gibb. “If people are going to try something new, it’s easier to do it if people can assume you are not going to run off into the night. Having Ping An as a major shareholder certainly helps with that brand.” It has helped in other ways too.
“Ping An has 25 or 26 financial licences, so when we started to go from being a P2P player to working out how to work with a bank or trust company or securities company, our first client was clearly Ping An. All the guinea pig issues of how you structure contracts, how you make all the tax and regulatory issues work, we would figure out with Ping An.
“Then, when we knocked on a door outside, the first question they would ask is: have you done this with Ping An Securities? If the answer was yes, they’d say: ‘Come in’. If no, they’d say: ‘I don’t want to be the guinea pig.’”
Ping An has also been useful on the asset side and in the vital business of risk assessment. “It’s hard to build up the risk skills on day one, so if you are working with a trusted provider like Ping An Trust or Securities, you know they are not going to shift their worst assets on to you.”
Gregory Gibb, Lufax
The presence of Ping An has also helped in discussions with regulators and in customer referral – although not in Ping An Bank, which is pretty much a direct competitor to Lufax. “Cross-selling has been part of the Ping An strategy for 10 years or more. The chairman says: ‘In principle, I want everyone to cooperate, but you guys have to go figure it out.’”
On risk assessment a key element is Puhui, a consumer lending company Lufax bought from Ping An Insurance for $2 billion in 2015. Apart from adding more than 2 million borrowers to Lufax’s platform, it also brought a great deal of risk assessment capability.
“In unsecured lending – the highest risk part of the business – we’ve got 10 years of data from this Puhui institution. They’ve done over 4 million loans over the last 10 years,” Gibb says. “That gives you an enormous amount of data points that allow you to say: this next borrower looks like one of our existing borrowers. Our charge-offs are probably about a third of the industry, because we have that historical database.”
The question of delinquencies is unclear, although it will probably become clearer once the IPO process starts rolling. Today the best source of data is quarterly results from the Ping An group, but they do not disclose delinquencies specific to Lufax. Nevertheless, in a sector where defaults of around 20% are not uncommon and entire businesses continue to founder, analysts estimate that Lufax’s are in the mid-single digits for P2P. For comparison, default rates at Lending Club ranged from 1.3% to 10.6% depending on the loan grade, as of December 16 2016.
“In internet finance, you can’t get away from certain financial DNA principles, one of which is that when you choose an asset, you’ve got to see it,” says Gibb. “You can’t just all be online hoping that big data is going to save you. You need to figure out where the fraud could happen, where are all the control points in the relationship with the customer. You have to think about how obligations are really delineated in the contract if something does go wrong, what it is that you have as recourse, all those things that are built in to Ping An’s financial experience in China over the last 20 years.”
Additionally, he says that working with some of the biggest banks and payment companies in China adds a layer of risk insulation. “It puts you in the mainstream of that infrastructure.”
Lufax does its own screening of institutions it works with – perhaps 20 out of about 70 trust companies, for example. “We make a choice and they make a choice. There is a network implication in fintech and it’s a big issue. And there is no way you can build a leading fintech platform without working closely with the existing bank infrastructure.”
The sense that Lufax has moved beyond being a fly in the ointment for banks and become a part of the financial establishment was cemented when it set about a private funding round in January 2016, raising $1.2 billion, from investors including Bank of China, Guotai Junan Securities and Minsheng Bank.
What does it mean when institutions like this want to participate in the company? “A lot of people on the banking side, particularly when we started with our peer-to-peer business, were just curious, wanting to know what we were up to and if there were bits they wanted to replicate,” says Gibb. “When you talk to these guys, they know technology is going to be a huge thing. The big banks in China will figure it out – China Merchants Bank is not going to just sit there and wait for someone to eat their lunch. But them investing in us is saying: ‘We are curious, let’s see how this plays out,’ and a little bit of hedging their bets too.”
Some are apprehensive, however. He recalls being visited by a leading Australian bank whose 15-strong delegation spent an hour asking about the business model, before asking: “You don’t have any plans to come to Australia, do you?”
Gibb laughs. “It’s like: come and stay on our beaches, but as a company, we’d prefer it if you didn’t come.”
In this tale of a company growing at a breakneck speed, a new milestone is fast approaching: its IPO. Lufax cannot discuss it, but Citic Securities, Citigroup, JPMorgan and Morgan Stanley are believed to be mandated and the deal is expected to raise around $5 billion in Hong Kong later this year.
“You will see the retailization of finance in the next five years... It will start to account for a much more meaningful part of the whole financial system”
One has to wonder, given the ease with which Lufax has raised private capital, why it needs publicly listed funds at all, with all the scrutiny and reporting that requires.
“The rationale is that you have to assume that over time you are going to pursue various forms of vertical or horizontal integration in the value chain, to keep a sustainable advantage,” Gibb says. “Having a listed entity just gives you more flexibility in share swaps or potential mergers down the road. If you decided you wanted to raise capital quickly for a big deal, you have that access. In a private placement world, you don’t have as many tools in the toolbox.”
There is also reputation. “There’s an aspect of saying what we’re doing is being recognized at an international level by the world’s best institutional investors. It’s a verification of the business model.
“Is the easiest way to get money to become a public listed company? Probably not. After you become publicly listed it is much more painful, because you’ve got a lot more to do on a quarterly basis. But if you look five years down the road in terms of strategic flexibility and branding benefits, it’s still worth doing.”
Ant Financial has gone international, buying a stake in its closest equivalent business in India, PayTM, and more recently buying US business MoneyGram. But, asked if Lufax will do something similar, Gibb says the company’s expansion will be based on following its own customers overseas rather than trying to grab domestic markets themselves.
“Our customer base is on average mid-40s, in a lot of first-, second- and third-tier cities,” he says. “Many of them are thinking about sending their kids to school overseas, having a house overseas, and so having some currency overseas. There is clearly a lot of demand for offshore investment,” recent policy on capital flight notwithstanding.
“The point of it is to get the best-of-breed global product integrated on one platform in the Chinese language and tailored for Chinese investors so that the day the renminbi is liberalized, you can just create the direct pipe. It’s worth starting now.”
How will the environment for internet technology look five years from now? “You will see the retailization of finance in the next five years,” Gibb says. “It will start to account for a much more meaningful part of the whole financial system.” He also expects to see greater progress in the use of big data and artificial intelligence.
“China is still in the relatively early stages of an S-curve of asset management and wealth management development,” he says. While everything in China – urbanization, growing per capita GDP, the expansion of the middle class – points to greater discretionary wealth, still more than half of all savings are in deposits, he says. “That is going to push trillions of US dollars out of deposits and into wealth management in China.”
How did a gweilo end up running a Chinese internet finance leader?
Among the many points of differentiation between Lufax and the Baidu/Alibaba/Tencent crowd, one is unmistakable – it is run by a westerner.
Greg Gibb says the situation came about “of course by chance”. An American educated at Middlebury College in Vermont, he is a long-standing fixture in Asia, having visited for the first time in 1987 and moved there for work in 1989. He started at Merrill Lynch and spent 15 years at McKinsey before becoming COO at Taishin Financial Holdings in Taiwan in 2006.
“About six years ago, I said: ‘I’m going to be too old if I want to do anything in China’. So I decided I would quit everything I’d done and I’ll just go to China.”
A friend advised him that for a foreigner seeking senior work in financial services on the mainland, there was really only one place he could go: Ping An. He was introduced to chairman Peter Ma, who hired him as the group’s chief innovation officer.
His arrival coincided with Ma wanting to move forward with an idea. “In the back of his head, a vision had been forming of an exchange,” Gibb says. “He was always looking at the US, since long before I showed up, and he had seen that 80% of debt was coming from the bond markets and not from the banks, and that 90% of savings in the US did not sit in bank deposits but everywhere else.”
He saw a natural opportunity in connecting the asset and the liability side of the equation online, and in doing it in China where reliance on bank deposits created so much potential.
“He had this vision,” Gibb says. “He didn’t tell us it was peer-to-peer, but he knew it was a connecting of the dots.” So Gibb was entrusted to form Lufax within the group to join those dots. Six years on the resulting business may be the largest financial services IPO in the world this year. Based on the last private funding round, the company is worth $19 billion.