Optimism Tempered with Caution

A version of this post also appeared in the June 2011 issue of Paybefore Legal.

The People’s Republic of China has ventured carefully in the area of payment cards. Its first step was launching its national bankcard network, UnionPay, in 2002. From that beginning, the Chinese bankcard industry has grown rapidly. According to UnionPay, by the end of 2006, there were 1.175 billion bankcards: 1.119 billion debit cards and 56 million credit cards.

In the last five years, closed-loop prepaid cards, especially store and phone cards, also have been booming in China. A recent Mercator report, Prepaid Cards in China 2010, indicated overall sales of closed-loop prepaid cards exceeded $200 billion. For example, a category of cards known as payroll and benefit cards, exceeded US$58 billion in sales. These are not the payroll cards we are accustomed to in the United States, but are essentially closed-loop gift cards given at important holidays, replacing traditional gifts of groceries or cash.

According to the Mercator report, open-loop prepaid cards account for less than 0.01 percent of all prepaid cards in China, primarily due to government concerns about confusion between debit, credit and prepaid. In fact, banks have been forbidden from issuing prepaid cards since 2006.

But, change is coming. For the first time, China has issued regulations that permit nonbanks to issue open-loop prepaid cards, subject to stringent licensing requirements. These new regulations, which appear to be somewhat similar to U.S. money transmitter licensing laws, are summarized below.

The New Measures

In June 2010, China’s central bank, the People’s Bank of China, issued the Administrative Measures for Payment Services of Non-Financial Institutions (Measures). The Measures came into effect on Sept. 1, 2010, followed by implementing rules issued in December 2010 (Implementing Rules).

The new law requires administrative approval before a non-financial institution may conduct prepaid card business. This approval includes a significant capital investment requirement. An entity interested in operating at the national level needs to have a minimum registered capital of RMB 100 million (approximately US$15.3 million). An entity that limits its operation to a single province needs to have a minimum registered capital of RMB 30 million (US$4.6 million).

Definition of Prepaid Cards. According to the Measures, prepaid cards refer to the advanced value (i.e., funds paid in advance) for cards issued for the purpose of purchasing goods or services outside the issuer, which use technologies, including magnetic stripes and chips, in the form of a card or a password.
For the purpose of the Measures, prepaid cards do not include:

  • Prepaid cards that are only used for distributing social security;
  • Prepaid cards that are only used for taking public transport;
  • Prepaid cards that are only used for paying telecommunication expenses such as phone bills; and
  • Prepaid cards with the issuer and the designated merchant being the same legal person.

Requirements for Receiving a License. Applicants must satisfy the following conditions to apply for a Payment Business License to conduct prepaid card business and other payment services as regulated by the Measures:

  • The applicant needs to be a limited liability company or stock limited company established in China and cannot be a financial institution;
  • It needs to have the minimum registered capital provided in the Measures;
  • The capital contributors also need to meet the requirement provided in the Measures;
  • It must have more than five senior management personnel familiar with the payment business;
  • It must have implemented antimoney- laundering measures that comply with certain requirements;
  • Its payment business facilities need to meet certain requirements;
  • The applicant must have a sound organizational structure, internal control system and risk management measures;
  • The applicant must have necessary business offices and safety precautions; and
  • The applicant and senior management personnel thereof must have no record of punishment for committing any illegal criminal activities by abusing the payment business or handling payment business for illegal criminal activities for the last three years.

Scope of Business Activity. The Measures regulate non-financial institutions that provide all or part of the following transfer services of
monetary capital as an intermediary between payees and payers:

  • Online payment;
  • Issuance and acceptance of prepaid cards;
  • Bankcard acceptance; and
  • Other payment services as specified by the People’s Bank of China.

Powers of Licensed Entities. After being licensed, the non-financial institution will be able to provide all of the payment services listed above.

Limited to Companies Established in China. The Measures only regulate entities established within China. The People’s Bank of China has promised to promulgate additional regulations regarding foreign-invested payment institutions, including their business scope and the qualifications and investment ratio of foreign investors.

Companies Licensed under the Current Scheme. Two hundred-sixty domestic companies have applied for the license, and the People’s Bank of China announced on May 26 that the first 27 licenses have been issued.

Why Now?

Why has China’s central bank chosen this time to issue the new Measures? Certainly, China must recognize the cost savings accrued by replacing paper checks with prepaid cards. In addition, China likely issued this regulation to prevent market failures in a rapidly
developing industry.

According to the news, payments through the Internet, phones and mobile phones reached nearly RMB 374 billion (approximately US$57.4 billion) for the fourth quarter of 2010. In total, third-party payment transactions (transactions paid or settled through third-party processors or issuers) amounted to RMB 1.1 trillion (US$169 billion) in 2010, a 95 percent increase over 2009.

It’s those third-party issuers, many of which have apparently created regional or local proprietary payment networks, that generate particular concern.

At the same time, issues and risks are rising, such as the threat of money laundering, security of servers and unfair competition. When commenting on the promulgation of the Measures, the People’s Bank of China said that such issues cannot be resolved by the market itself and need to be addressed by the new regulations.

Prospects for Bank-Issued Prepaid Cards

China banned bank-issued prepaid cards in the Circular of China Banking Regulatory Commission Concerning Prohibiting Banks and Commercial Institutions from Distributing Co-Brand Stored-Value Cards (Circular),  issued by the China Banking Regulatory Commission on Aug. 1, 2006.5 According to the Circular, banks and commercial institutions may not issue anonymous co-branded stored value cards with sales tax invoices. Such products brought risks to banks and were banned to maintain a “sound financial order.”

In an article published in 2007, industry analysts argued that the real reason these bank-issued cards were banned was to prevent corruption, since prepaid cards were anonymous and did not require registration. According to the article, officials were worried these untraceable cards could be used as anonymous gift cards to give bribes.

Some speculate that if the rules on bank-issued prepaid cards are ever loosened, the government will place strict Know Your Customer obligations on the issuers. At this point, it’s still not clear whether or not this ban will be reversed in the near future. Instead, it appears banks are taking other steps to enter the prepaid market. For example, recently Bank of China and UnionPay established a joint venture called Bank of China Expresspay Commerce Limited Company. It issues UnionPaymarked stored value cards, which can be used wherever UnionPay cards are accepted.

According to the China First Business Daily on Nov. 11, 2010, one or two banks recently have issued prepaid cards with the UnionPay logo. For example, China Everbright Bank issues a prepaid card called the Sunlight Travel Prepaid Card. The card, with a fixed prepaid value of up to RMB 1,000, currently is issued in Guangdong. (Whether such cards are legitimate is questionable in light of the 2006 Circular.) In the meantime, with the new Measures, nonbanks can start expanding their prepaid business in China.