As China opens up, U.S. payment companies may want to back off

Western companies desperately want a chunk of China's vast domestic consumer payments market, though they may find themselves feeling lucky to be left out.

China has a history of bait-and-switch regulations and impenetrable local monopolies. The U.K.'s WorldFirst, which is reportedly close to becoming the first non-China-based company to operate a payments business in the country, may end up being the canary in the coal mine.

Qilai Shen/Bloomberg

The South China Morning Post, which is owned by Chinese e-commerce giant Alibaba, reports WorldFirst is about to receive a license, enabling it to start handling payments in Shanghai imminently. The newspaper also reports PayPal is in talks with Shanghai officials to support a local operation, though that deal appears to be further off than WorldFirst's.

Any outside company would appear to have access to a goldmine of consumer payments in China. It has a huge payments market, with about $27 trillion in yearly payments. The U.S. ACH volume in 2017 was about $46 trillion, the only payment market in the world that's larger than China.

If the U.K.-based WorldFirst gets its approval as expected, it would get a crucial head start on U.S. companies PayPal, American Express, Visa and Mastercard, which have long sought to set up shop in China.

American Express is trying to establish a local market in China through local provider Lianlian. This is a much more common way for western companies to open operations in China, where regulators have been more lenient toward collaborations.

Visa and Mastercard have long sought to open units in China, although the goalposts have been constantly in motion.

In an email, WorldFirst said it has completed the first step of an application for a third party payments license in China and is hopeful of a positive outcome, but would not comment further. Mastercard, American Express and Visa did not return requests for comment; PayPal declined to comment.

China has been a closed banking and financial services market for most of its history, but it has made several overtures in the past decade toward becoming more open, only to retreat. It made a substantial move in 2015, saying it would remove UnionPay's monopoly following pressure from the World Trade Organization, which contended China's government was not allowing adequate competition.

Visa and Mastercard made a push after the Chinese government's shift in 2015, but those efforts stalled. China's requirements were pretty stringent—it reportedly required a $160 million investment and a substantial local presence to operate in its payments market.

After a couple of years, Chinese government promised to clarify its requirements. Instead in 2017 China reportedly added "national security reviews" and measures that would add more than a year to the basic application progress.

With foreign companies effectively sidelined, the past three years have brought an explosion of e-commerce payments, where Alibaba's Alipay alone has nearly 500 million users — a substantially larger customer base than the entire U.S. population.

And since 2015, China's digital payment market has become more diverse. Apple Pay, which became available in China in 2016, has attracted a following for paying transit fare. Domestic cashless initiatives have had major success, creating more comfort with digital transactions.

As a result of this digital revolution, China has embarked on what it calls innovation-friendly policies, permitting outside majority investment in life insurance and investment brokerages. The South China Post lumps China's latest loosening of payment regulations in with these other reforms.

This spring, China's central bank issued yet another set of guidelines designed to be less stringent for outside payment companies, addressing domestic processing, local data storage and business continuity transparency. The big American payment companies quickly reapplied to build local operations.

But the same signs of retreat again exist, particularly for U.S. companies.

During Mastercard's latest earnings call, the card network said it has not gotten approval to establish a unit in China. It's also worth noting WorldFirst is a U.K. company, placing it outside of the U.S.'s trade war with China, a conflict that promises to put pressure on sellers that use Alipay and WeChat.

The Chinese government announced a retaliation to U.S. tariffs with tariffs of its own, and a warning that it will not support some of the trade agreements that had formed the basis for the latest "external payment provider" deregulations. That would return payments regulations to their earlier uncertainty, at least for U.S. companies. And the local data storage requirements from China's latest regulatory update in March may also lock out all but the largest outside companies because of the expense.

And if the market and regulatory softening holds, it's still a tall order for an outside company to enter a country where hundreds of millions of consumers have relationships with only three existing providers.

There are concerns China's local monopolies have reached a point of total saturation, so the government is opening a Chinese payments market that isn't truly open from a market perspective. Consider the reverse — almost all of UnionPay's volume in the U.S. comes from travelers or temporary residents — and not U.S.-based consumers, who are accustomed to thinking of Visa and Mastercard as the "card companies." And Alipay and WeChat Pay aren't even trying to form a U.S. domestic market.

"I am not convinced of the benefit of jumping into the Chinese payment market," said Sarah Grotta, director of the debit and alternative products advisory service at Mercator, noting the dominance of Alipay, WeChat Pay and UnionPay.

"Millions of merchants accept these payments through mobile point of sale using QR codes," Grotta said. "I would think it would be extremely difficult for a foreign payments company to disrupt the loyalty that users have for these domestic brands. The Chinese government will likely have significant control over the operation, which adds to the risk of entering that market."