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Working out of a cramped 600-square-foot apartment in Beijing’s Chaoyang central business district, Jack Wang leads a team of ten customer service representatives for Qishi Club Co., an online toy seller. Each month his company racks up more than 150,000 yuan ($24,000) in sales from Alibaba Group Holding’s e-commerce platform, Taobao.com, which is the eBay of China.

In the past Wang would withdraw all of the funds from Alipay, the group’s payment service, and put the money in his bank, where he can earn interest ranging from 35 basis points on demand deposits to a maximum of 3.3 percent on a one-year term deposit. Since early this year, however, he has been transferring the revenue to Yu’e Bao, Alibaba’s new money market fund. The arrangement is simple, requiring just a click on Taobao’s site, and lucrative. In mid-May, Yu’e Bao was paying an interest rate of 5 percent on accounts that offer instant liquidity: Wang can make withdrawals from the fund at any time without penalty.

“Of course, we stop pulling out money and putting them into banks and instead keep all of our cash flow in Yu’e Bao,” Wang tells Institutional Investor. “On average, we keep anywhere from 300,000 yuan to 500,000 yuan on Alibaba’s platform — money that we used to keep in banks.”

Wang is not alone. At the end of April, Yu’e Bao (pronounced “yu-eh bow”) boasted an astonishing 554 billion yuan, or almost $90 billion, in assets. It also had 81 million investors, more than the combined total of all other Chinese asset managers. Considering that Alibaba launched the money fund only in June 2013, that makes it the fastest-growing mutual fund of all time, anywhere. Yu’e Bao now accounts for just over a third of China’s 1.46 trillion-yuan money market fund business, a burgeoning segment that makes up 31 percent of the country’s asset management industry. Only three U.S. money market funds — Vanguard Prime ($129.8 billion), Fidelity Cash Reserves ($116.1 billion) and JPMorgan Prime ($108.2 billion) — are larger, and they’ve been around for decades.

The fund’s rise underscores Alibaba’s tremendous innovation and potential for growth, which are expected to generate strong demand for the company’s shares. In May, Alibaba filed for an initial public offering on the New York Stock Exchange that analysts estimate could raise as much as $20 billion.

Yu’e Bao, which means “savings balance treasure,” poses a stark challenge to competitors in China’s banking and asset management industries, and to the country’s regulators. Banks have long dominated the country’s financial scene, taking advantage of tight restrictions on interest rates to capture low-cost deposits from hundreds of millions of savers and provide cheap loans to state-owned enterprises. Regulators have begun moving gingerly to free up interest rates, regarding this as crucial to shifting the economy toward greater domestic consumption and away from investment-led growth. Yu’e Bao’s meteoric rise demonstrates the potential for new entrants to break up existing relationships and seize market share in a shifting landscape. Such disruption, however, can pose threats to financial stability, as anyone who experienced U.S. interest rate liberalization in the 1970s and the subsequent savings and loan crisis can attest.

“The explosive rise of Yu’e Bao surprised everyone, including Alibaba, which is proving to be a potential disintermediator for the entire financial industry,” says Peter Alexander, founder and managing director of Z-Ben Advisors, an investment management consulting firm based in Shanghai. Other e-commerce companies, including search engine Baidu.com and Internet service provider Tencent Holdings, have entered the money market fray with similar offerings in recent months, but so far none has gained the kind of traction enjoyed by Yu’e Bao. Traditional asset management companies, whose fortunes have languished because of the five-year bear market for Chinese equities, have ramped up their own money market fund offerings. Nevertheless, Alexander says, “no one more than Alibaba at this point has the ability to disrupt the entire financial industry in China — and in the process help drive financial reforms.”

The banks aren’t taking the challenge lying down. They have lobbied the People’s Bank of China to begin regulating online money market funds. Central bank governor Zhou Xiaochuan has indicated that authorities are considering closer supervision of the money funds, but he has insisted that they don’t want to stifle innovation. “Financial business on the Internet is a new thing,” and regulators need to adapt to it, Zhou told journalists recently. “But in general, financial policy supports the application of technology, so it needs to follow the footsteps of time and technology.”

ALIBABA’S VAST SCALE AND STUNNING GROWTH hint at the potential of e-commerce companies to dramatically change the face of finance in China.

Founded in 1999 by former English teacher and tour guide Jack Ma out of his apartment in Hangzhou, an ancient city about a two-hour drive from Shanghai, Alibaba has grown to become China’s leading Internet company, with revenue topping $7.5 billion in 2013. The group’s Taobao platform plays host to some 7 million online merchants, such as Wang’s Qishi Club, and sold more than 1 trillion yuan worth of products to more than 500 million registered buyers last year. The cash flow generated by that commerce has fueled Yu’e Bao’s rise.

Alibaba executives declined requests for interviews, citing the quiet period before the company’s IPO. But a spokeswoman for Shanghai-based Tianhong Asset Management Co., which manages the fund, says executives are optimistic about the prospects for growth.

“Yu’e Bao is the leading innovation in finance in China,” Tianhong’s Ding Xuemei tells II. “Internet finance is a powerful tool that can break legacy barriers. It isn’t just a financial tool created by e-commerce companies or a digital tool created by financial companies. It is a joint innovation that is the result of champions coming together from e-commerce and finance. Together we win over the customer by serving their needs.”

Ding declines to discuss in detail how the firm manages the money market fund, saying only that it invests primarily in China’s interbank market. According to analysts who know the company well, Tianhong has been able to negotiate annualized interest rates as high as 8 percent from various banks, allowing it to offer returns of 6 percent or more to depositors in Yu’e Bao. In effect, Alibaba is getting the banks to fund their most potent rival.

Chris Powers, an associate at Z-Ben Advisors, estimates that fully 92 percent of Yu’e Bao’s funds are parked in negotiable deposits with smaller Chinese banks. He says most of the Big Five state-owned banks — Industrial and Commercial Bank of China, China Construction Bank, Agricultural Bank of China, Bank of China and Bank of Communications — have refused to take deposits from Tianhong for competitive reasons.

“When you come in to meet smaller banks with 500 billion yuan, you can negotiate the deposit rates you desire,” Powers says.

Founded by a group of corporate investors in 2004, Tianhong labored in the backwaters of China’s asset management industry for nearly a decade before teaming up with Alibaba last year. It manages 14 other mutual funds, but they collectively have only 13 billion yuan in assets. The firm had moved to bolster its management with an eye to revving up growth before teaming up with Alibaba, though. In May 2011 it hired Guo Shuqiang, head of institutional business at China Asset Management Co., to run Tianhong as general manager.

Sources say Alibaba’s Ma initially approached four leading asset managers about launching a money market fund but was turned down; they apparently didn’t feel it was worth the trouble to cooperate with the e-commerce giant. Ma ultimately chose Tianhong because it was willing to cooperate — and to consider selling a majority stake. In October, Alibaba spent 1.1 billion yuan to acquire 51 percent of the firm.

Formally named the Tianhong Zenglibao Money Management Fund, Yu’e Bao launched in June 2013 and is sold exclusively on Alibaba’s Alipay payments service. The company could hardly have chosen a better time to get into the business.

Chinese banks typically scramble for deposits at the end of a quarter to meet their mandated loan-to-deposit ratios, and the central bank has historically supplied ample liquidity. But last June the PBOC demurred, apparently seeking to send a signal to banks to contain the growth of lending. The one-week Shanghai interbank offered rate, or Shibor, shot up as high as 13 percent. Similar liquidity squeezes drove Shibor up to 8.84 percent in December and to 5.36 percent in February.

Yu’e Bao was able to take advantage of the liquidity shortfall, earning high returns on the interbank market and offering high rates to depositors. In January it advertised rates as high as 6.58 percent. The money fund’s rates have eased recently, but even at 5 percent in mid-May, they’ve been well above the 3.3 percent maximum that banks are allowed to pay on one-year term deposits. Those yields have proved effective: Yu’e Bao had attracted 184 billion yuan of investor funds by the end of December; three months later the total had nearly tripled, to 540 billion.

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