Third-party payments: Regulation over customer reserves

Lately, the payment and settlement department of the People’s Bank of China (PBOC) issued the Notice on Work Concerning Cancellation of Renminbi Customer Reserve Accounts of Payment Institutions, which requires third-party payment institutions to cancel their renminbi customer reserve accounts by 14 January 2019. This will bring the time that payment institutions benefit from customer reserves to an end on the said day.

For the purpose of the notice, “customer reserves” are monetary funds actually received, as advance payments that will be used for final payments, by payment institutions for the purpose of processing payment transactions entrusted by customers.

A third-party payment transaction consists of two non-simultaneous steps. First, the customer originates the entrusted payment transaction and delivers the payment amount to the payment institution. Second, the payment institution forwards the amount to the payee. Evidently, there’s a time lag between these two steps. During this time lag, the sum is deposited in the reserve account held in the name of the payment institution and accrues interest income at a certain rate.

The ownership of the reserve and the interest income should be determined based on the civil legal relationship between the third-party payment company and the user. In the first step, as discussed above, the customer delivers the payment necessary to be made for purchase of goods or services from the merchant to the payment institution, which keeps the payment temporarily on the customer’s behalf; virtually, there is a contract of custody between the user and the third-party payment institution.

In the second step, where the payment institution forwards the payment to the merchant based on the mandate and specific payment order from the customer, there is a contractual relationship of entrustment between the two parties.

According to the provisions of the Contract Law, the deposited reserve, as the subject matter of the custody and entrustment arrangements, shall belong to the settlor, i.e., the user. Unless otherwise agreed between the parties, the legal fructus of the deposited reserve shall also belong to the owner of the original property from which they are derived, i.e., the customer.

As far as the legal fructus are concerned, Alipay and TenPay (the payment platform used by WeChat), which together account for about 90% of the total China market, specify on their related service agreements or user agreements that the fructus belong to the payment platforms. Specifically, the Alipay service agreement states that “the user shall have no right, title or interest in, or to any and all incomes (including without limitation, interest and any other fructus) from the payments received or paid by the payment company on the user’s behalf. In order to enable provision of better services, any and all incomes (including without limitation, interest and any other fructus) from the payments received or paid by the payment company on the user’s behalf shall belong to the payment company.” The WeChat payment user agreement also explicitly stipulates that the payment company is not obliged to pay any fructus to users.

In both cases, as permitted by law, the payment institutions use agreements that vest these incomes in themselves. For each specific user, the fructus are unmeaningful, as they are of small amounts with short repayment circles. However, for payment companies, many such small amounts make up a big value. Together, the fructus derived from payments of all customers represent a substantial income generating asset. As evidenced in the previous market cases, these incomes provide payment institutions with extraordinary bargaining power in business dealings with commercial banks and other business organizations.

Publicly available data show that as of the third quarter of 2016, 267 payment institutions had absorbed customer reserves of more than RMB460 billion (US$67.3 billion) in total. As of October 2018, the total reserves in the possession of the payment sector had risen to RMB1.17 trillion. Upon a previous special review on management of customer reserves by non-bank payment institutions, the PBOC recognises the following risks and concerns.

First, there is a risk that customer reserves are misappropriated by payment institutions. Second, some payment institutions illegally use customer reserves for purchasing wealth management products, or for some other investments of high risk. Third, payment institutions use reserve accounts maintained at various commercial banks to process cross-bank settlement transactions, a practice that is considered doing business beyond permitted scope, and more specifically, engaging in cross-bank settlement business of which only the PBOC or clearing houses are allowed to engage.

There are even payment institutions that provide channels for criminal activities such as money laundering by taking advantage of these accounts, raising concern that financial risks may spread across multiple systems. Fourth, the fact that customer reserves are deposited in a decentralised way, which is not conducive to unified management of funds by payment institutions, may give rise to liquidity risk.

Moreover, deviating from their main business of providing payment services, many payment institutions are seeking to earn interest income by expanding the size of their customer reserves. Going against the original intention with which the PBOC licensed this line of business, to a certain extent such activities cause disorder and chaos in the payment service market and undermine the market environment for fair competition.

The PBOC’s concern and regulation over the above-mentioned risks have been increasing. In January 2017, the PBOC issued the Notice on Implementing the Relevant Matters Concerning Centralised Depositing and Keeping of Customer Reserves of Payment Institutions, which states that, from 17 April 2017, payment institutions shall cause a specified percentage, about 20% on average for the first time, of customer reserves to be deposited in dedicated deposit accounts maintained with designated agencies.

On 29 June 2018, the PBOC issued a further notice that requires payment institutions to cause, in a progressive manner, up to 100% of the customer reserves to be deposited in the above-mentioned centralised way. On 29 November 2018, the payment and settlement department of the PBOC released the above-mentioned notice, requiring third-party payment institutions to cancel their RMB customer reserve accounts by 14 January 2019.

Aimed at strengthening regulation over payment institutions’ management of customer reserves, these regulations are expected to help payment institutions get back on track. Surely the life cycle of the third-party payment industry will reach the stage of maturity when it is able to operate sustainably and healthily without capitalizing on customers’ reserves.

Wu Jiejiang is a partner at Jingtian & Gongcheng