Embattled financial technology businesses in China, which have come under tightened regulatory scrutiny, are becoming acquisition targets for banks accelerating their digitalization drive, according to global management consultancy McKinsey. Joe Ngai, Managing Partner for Greater China at McKinsey, said that tremendous changes are taking place in China’s fintech sector amid the clean-up campaign by regulators to ward off financial risks. “The fintech businesses originally envisioned mounting a challenge on established banks, but the new trend is that more partnerships and acquisitions will be seen as the lenders count on the latest technologies to bolster their development.”

Since 2011 peer-to-peer (P2P) lending platforms, third-party mobile payment service providers and online insurers rapidly penetrated into people’s daily lives in the absence of efficient supervision. A wave of collapses in the P2P sector is estimated to put several hundred billions of yuan of investors’ money at risk as many of the operators are found to have illegally raised funds from savers while re-lending them to cash-hungry businesses at high interest rates. The People’s Bank of China (PBOC) is also conducting a thorough inspection of online payment firms across the nation to uproot irregularities. Players including Ant Financial Services, Union Mobile Financial Technology and Gopay have been fined.

A stepped-up regulation is a boon for banks as fintech companies, once perceived as a headwind to the lenders, will have to consolidate their ties with the established and licensed financial institutions to survive the crackdown. “They developed financial technologies, only to find that they are not allowed to offer financial services,” said Ngai. “By the end of the day, big banks will come out and buy them over to boost their digitalization drive.” Chinese banks have become increasingly aware of the significance of developing digital banking as the economy moves towards a cashless society spurred by the widespread use of mobile payments among residents, the South China Morning Post reports.

China surpassed North America in attracting venture capital for the first time in the second quarter, helped by a record USD14 billion fundraising round by Alibaba Group Holding affiliate Ant Financial Services. Start-ups in China accounted for 47% of the world’s VC funding in the three months ended June, compared with a combined 35% for the U.S. and Canada, according to a report by Crunchbase, which tracks and compiles fundraising data.

The surge in China fundraising in the second quarter could be attributed to Ant Financial, which raised about USD14 billion last month. Investors, including Singapore’s GIC and Temasek Holdings, Warburg Pincus, Canada Pension Plan Investment Board and Silver Lake, took part in the fundraising, while existing shareholders supported a yuan-denominated tranche. The financing brought Ant Financial’s valuation to more than USD150 billion, which is roughly double Uber Technologies’ valuation. Excluding Ant Financial, China’s start-ups raised just slightly more than they did in the first quarter, taking up 36% of the global total, according to Crunchbase.

China has seen a surge in the number of start-ups in recent years as the government vowed to do more to implement an innovation-driven development strategy to make the country more competitive and transform itself from the factory floor of the world into a global innovation powerhouse. Venture capitalists poured billions into areas from artificial intelligence to blockchain, lured by the prospect of backing the next Alibaba, Tencent Holdings or Baidu, while start-up founders aspired to become billionaires like Jack Ma or Pony Ma, the South China Morning Post reports.

The threshold at which people pay personal income tax is expected to be lifted to CNY5,000 a month from the current CNY3,500, according to a draft amendment to the Individual Income Tax Law, as the National People’s Congress (NPC) – China’s legislature – is revising the personal income tax code in a sweeping overhaul of the tax system. Specific personal income tax changes aim to reduce taxpayers’ burdens and boost consumption. The draft was submitted to the NPC Standing Committee’s bimonthly session for its first discussion on June 26. A draft revision usually receives three readings before adoption.

According to the draft amendment, the previous method of taxing monthly income will be replaced with a new calculation that focuses on taxing annual income. “The new method will be fairer and more reasonable for those whose monthly salary vary,” said Zhang Bin, an expert from the National Academy of Economic Strategy of the Chinese Academy of Social Sciences. If the revisions are adopted, those whose monthly salary ranges from CNY5,000 to CNY20,000 will see their tax cut by more than 50% and those whose monthly salary ranges from CNY20,000 to CNY80,000 will see their tax cut by 10% to 50%. The amendment defines resident individuals and non-resident individuals as two types of taxpayers. In addition, the length of time used to distinguish between the two groups will be adjusted to 183 days from the previous 365 days.
The move is expected to increase residents’ income and enhance consumption power because it reduces the tax burden for individual taxpayers, especially people of low to medium income, Finance Minister Liu Kun wrote in the draft.

The revision is the biggest tax overhaul in over two decades. China’s income tax rates for individuals, comprising seven brackets with rates ranging from 3% to 45% of income, are expected to be adjusted. For the first time, items deductible for personal tax will include such expenses as the cost of children’s education, medical fees for major illnesses, interest on housing loans, and housing rent. The government will set specific rates for tax deductions in each category once the draft amendment is approved by the NPC Standing Committee. For the first time, taxation will cover four income categories – salaries, remuneration for personal services, authors’ remuneration and royalties. Yan Yuejin, Research Director at E-house China’s R&D Institute, said deductible real estate items are expected to benefit a wide group of residents who either rent or hope to purchase a home.

In 2017, China’s total tax revenue rose by 10.7% year-on-year to CNY14.4 trillion, and tax revenue from individuals went up by 18.6% year-on-year to CNY1.2 trillion, the China Daily reports.

A rising tide of corporate debt defaults is sparking some concern that another banking crisis may be just around the corner. More than 20 Chinese firms have failed to meet bond or loan repayments so far this year, many of them the victims of monetary tightening as Beijing tries to ward off financial risks by reducing borrowing levels. With bonds worth about CNY20 trillion due to expire within the next year, and tighter liquidity making it difficult for indebted companies to access new financing, there are fears the number of defaults could start to spiral.

“Investors are getting skittish about the defaults, fearing that more will come in the next few months,” said Wang Feng, Chairman of Ye Lang Capital, a financial services company based in Shanghai. “The financial regulators are standing firm in deleveraging the economy, and it is certain that dozens of debt-ridden corporate borrowers grappling with the cash squeeze will have difficulties in repaying loans.” Nonetheless, some analysts and business executives contend that any panic at this stage is premature. Gao Ting, head of China strategy at UBS Securities, said the defaults only represented a small portion of the country’s corporate debt market, which is valued at USD2.8 trillion. “No high risks have been seen yet,” he said. “The defaults are not likely to have an impact on the overall market.”

According to data provider Wind Information, 12 listed companies have defaulted on repayments for 20 bonds worth a combined CNY16 billion in 2018, including a CNY2 billion bill sold by a principal unit of asset buyer CEFC China Energy. As the central bank keeps tightening liquidity, it is likely that some of the corporate borrowers, unable to access new financing, will fail to repay the principals and interest.

China’s debts at the end of last year’s second quarter represented 268% of the country’s economic output, according JP Morgan. It was not until March 2014 that China’s bond market saw its first default when Shanghai Chaori Solar Energy Science & Technology failed to make an interest payment. Prior to that, the authorities would step in to bail out struggling corporate borrowers with cash injections or restructuring plans to ensure repayments would be made, the South China Morning Post reports. S&P Global Ratings said in January that China is likely to see its first bond default by a local government this year as the deleveraging efforts by Beijing continue.

Two foreign ratings agencies — Fitch Ratings and S&P Global Ratings — have announced that they plan to launch their own companies in China, amid the further opening-up of the financial sector as they target the huge potential of the world’s third largest bond market. Fitch sold its 49% equity interest in China Lianhe Credit Rating Co to Singapore’s sovereign wealth fund GIC in January, after jointly running the business since April 2007.

China has mapped out a national financial development plan, setting the goal of building a modern financial system by 2020 and preventing systemic risks. The plan was jointly drawn up by nine ministry-level bodies led by the People’s Bank of China (PBOC), the central bank. The release of the five-year development plan (2016-20) for the financial sector has been delayed by almost two years, due to the restructuring of the nation’s top financial regulatory framework and the fast-changing global financial environment. Compared with the draft version proposed in August 2016, specific sections on further financial opening-up measures were added in the final version.

The plan also clarifies the duty of the Financial Stability and Development Committee under the State Council, which was launched last November. Monetary policy targets will be further optimized, with more emphasis to be put on maintaining price stability The interest rate will gradually replace M2, the broad measure of money supply, as the key factor for monetary policy implementation. The newly-established Committee will supervise financial regulatory departments as well as local governments, which will be held accountable for financial risks. The regulation of “shadow banking” business will be strengthened through greater supervision and wider coverage of the regulation, while irregular financial activities such as illegal fundraising will be combated, media reports said. Prevention of financial risks will continue to be the policy priority in the coming years.

Chen Wenhui, Vice Chairman of the China Banking and Insurance Regulatory Commission (CBIRC), said at a forum at Tsinghua University that China is stepping up efforts to roll out detailed opening-up measures, including easing restrictions on foreign investment and expanding the business scope of foreign-funded banks. Zhu Min, former Deputy Managing Director of the International Monetary Fund (IMF), said that “a modern supervision and regulation system can only be established with an open market”, the China Daily reports.

An example of the opening of the financial sector is the green light given to S&P Global to set up a ratings business in China, a market closed to foreign players for two decades. So far, foreign rating agencies have had to work with a Chinese partner, and S&P had a partnership with Shanghai Brilliance Credit Rating & Investors Service Co. German Chancellor Angela Merkel, on a visit to Beijing last week, said she welcomed recent announcements that China would further open its financial sector to foreign participation, adding that she hoped “concrete progress” could be made on an investment treaty between China and the EU to show both sides’ commitment to free trade.

Foreign investment in China-listed stocks is also expected to rise in the near future. For years, foreign ownership of China’s A shares, or renminbi-denominated equities traded on the stock exchanges in the Chinese mainland, has been static around 2% or less, despite the fact that China’s stock market, whose capitalization is over USD8.5 trillion, is the world’s second largest. Foreign participation was also minimal in the Chinese bond market, the world’s third-largest valued at USD8 trillion as of April. But this will change as Chinese stocks and bonds are poised to be included in major global indices and Chinese regulators intend to further open up the markets by loosening controls on two-way capital flows.