Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the rm may have a conict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certication and other important disclosures, see the Disclosure Appendix, or go to Analysts employed by non-US afliates are not registered/qualied as research analysts with FINRA in the U.S. The Goldman Sachs Group, Inc. November 17 , 2020 | 07:14PM CST Reinventing the Yuan for the Digital Age China is at the forefront of digital currency development and will likely be one of the rst countries to issue a sovereign digital currency (known as “DC/EP”). As a gradual replacement for physical cash, in the early stages DC/EP will facilitate small payments for consumables such as meals, groceries and transport, but over time will expand to larger and more complex, value-added services such as government subsidies and cross-border payments. Even in a cashless environment, DC/EP will be an attractive alternative to ntech platforms given its anonymity, the ability to operate outside of wireless networks, and interconnectivity among different payment methods. Successful adoption will ultimately require government promotion, which has the wherewithal to drive a rapid uptake. In ten years we expect DC/EP to reach 1 billion addressable users, Rmb1 .6tn in issuance, Rmb19tn in annual Total Payment Value and account for 15% of total consumption payments. Incorporating digital currency wallets into bank apps will level the playing eld in the Rmb 3tn revenue pool for retail nance by bringing consumers back to bank channels, thereby expanding their customer base and MAUs. This will likely slow the rate that banks have been ceding ground to ntech, and even reverse market share losses over the long-term if DC/EP gains in popularity. In the meantime, PAB and CMB will benet most from DC/EP as they are best placed to commercialize returning app users thanks to their leading retail franchises, premium client bases, superior ntech capability and strategic focus on retail nance. Yingqi Lin +86 21 2401-8691 Beijing Gao Hua Securities Company Limited Shuo Y ang, Ph.D. +86 10 6627-3054 Beijing Gao Hua Securities Company Limited Digital Currency Derek Su +852 2978-7436 Goldman Sachs (Asia) L.L.C. Equity Research For the exclusive use of MEGAN.RILEYGS a2810045d5314637bdba4864b34fcf51PM Summary: Digital Currency Reinventing the Yuan for the Digital Age 5 China at the forefront of digital currency development 7 Cash for the 21st Century 15 Petty cash payments and red packets to start 23 China already on the path to becoming cashless 32 Boost competition, level the playing eld for banks 43 Gateway to banks retail nance channels; CMB and PAB best placed to capitalize 54 Rmb 3tn revenue pool for retail nance by 2025, 9% CAGR 63 Appendix 73 Acronyms 75 References 76 Disclaimer for company logos 77 Disclosure Appendix 78 17 November 2020 2 Goldman Sachs China Financial Services Table of Contents We would like to thank Piyush Mubayi, Elsie Cheng and Thomas Wang for their contributions to this report. For the exclusive use of MEGAN.RILEYGS a2810045d5314637bdba4864b34fcf5117 November 2020 3 Goldman Sachs China Financial Services For the exclusive use of MEGAN.RILEYGS a2810045d5314637bdba4864b34fcf5120 FAQs on Digital Currency / Electronic Payment What is the PBOCs objective for DC/EP? A substitute for cash (M0). What is the PBOCs motivation to issue DC/EP? Address the challenges posed by other digital currencies (e.g. Libra), improve efficiency in the payment system, reduce the cost of cash. Will DC/EP be anonymous? Yes, for small transactions. Large payments may require ID verification. Will the PBOC distribute DC/EP to customers? No, commercial banks will circulate DC/EP to consumers after the PBOC distributes it to commercial banks. Will DC/EP disintermediate banks? No, DC/EP will not pay interest, caps can be set on wallets and commercial banks will be the 2nd pillar in the two-tier issuance system. Is DC/EP a cryptocurrency? No, the DC/EP system will be built on a centralized ledger, not a blockchain. Is DC/EP legal tender? Yes, it has the same legal status as Rmb cash. Will DC/EP expand the PBOCs balance sheet? Not likely as DC/EP can be converted from bank deposit reserves. Do users need a bank account to use DC/EP? No, unless replenishing a DC/EP wallet. Will DC/EP reduce banks balance sheet? Yes, if DC/EP is converted from deposits; No, if converted from cash. What will its main application be? Facilitate small payments for consumables (e.g. meals, groceries, transport). What is the “dual offline transfer? Payments can still be made without mobile internet access or network connectivity (e.g. subway, airline, mountainous area). Can DC/EP be used for government subsidies? Yes, real-time tracking can be used to monitor a transaction and it can be disabled once reaching the intended recipient. Will DC/EP pay interest? No, according to the PBOC. Will DC/EP charge fees? Unlikely, but the PBOC could charge a fee to enable a negative interest rate on DC/EP. Is DC/EP necessary in an already cashless society? Yes, still DC/EP has advantages over fintech: anonymity, dual-offline transfers, inclusion and interconnectivity among payment methods. Will banks be the only institutions operating DC/EP? Yes, as DC/EP is the digitalization of legal tender. However, fintech firms can add DC/EP as a payment method in their apps. Will take rates for consumption payments fall? No, take rates would be stable as DC/EP payments still need to use existing offline channels and infrastructure. What will be the impact on banks? Incorporating DC/EP wallets into bank apps will bring consumers back to bank channels, expanding their customer base and MAUs. When will DC/EP be launched? No timeline has been provided. Testing has already started in four cities and DC/EP will feature at the 2022 Beijing Winter Olympics. An official launch looks most likely in 2023. For the exclusive use of MEGAN.RILEYGS a2810045d5314637bdba4864b34fcf51PM Summary: Digital Currency Reinventing the Yuan for the Digital Age China at the forefront of digital currency development The Peoples Bank of China has already started testing a central bank digital currency, known as Digital Currency/Electronic Payment (DC/EP), while most other countries are in the early stages of research and development. Although no ofcial timeline has been announced, pilot testing recently commenced in four cities and digital currency will feature at the 2022 Winter Olympics in Beijing. If successful, China could be one of the rst countries to issue a sovereign digital currency. With DC/EP to eventually replace physical cash, it will embed similar characteristics such as anonymity, ofine payments, nancial inclusion, and ease of use. Cash for the 21st Century Chinas DC/EP system will feature (1) two-tier issuance, with the PBOC issuing digital currency for commercial banks to distribute and interface directly with customers; (2) controllable anonymity, with DC/EP wallets independent of bank accounts for smaller transactions; and (3) centralized processing instead of a distributed ledger, meaning DC/EP will not be a cryptocurrency. Converting household deposits to DC/EP wallets will not result in banking-sector disintermediation as the objective of DC/EP is to replace cash not deposits, DC/EP wallets will not be paid interest, and most transactions will be small. Petty cash payments and red packets to start In the early stages, DC/EP will primarily facilitate small payments for consumables such as meals, groceries and transport. However, as safety, security and functionality improve over time, applications will expand to larger and more complex, value-added services such as traceable government subsidies and cross-border payments. China already on the path to becoming cashless Use of cash at the point of sale and the M0 to M2 ratio in China is already among the lowest globally. Even in a cashless environment, DC/EP will have attractive features relative to current ntech offerings including anonymity, nancial inclusion, the ability to operate outside of wireless networks, and interconnectivity among different payment methods. Successful adoption will require promotion from the government, which has demonstrated the wherewithal to drive a rapid uptake. As the second pillar of the DC/EP system, commercial bank networks will likely be mobilized in this process. In ten years we expect DC/EP to reach 1 billion addressable users, Rmb1.6tn (US$240bn) in issuance, Rmb19tn (US$3tn) in annual T otal Payment Value (TPV) and Rmb162bn (US$24bn) in annual cost savings although our forecasts could differ from actual gures given limited details, including the timing of a public launch. While direct cost savings to the nancial system from replacing physical cash with digital currency will likely be small relative to bank earnings and GDP , DC/EP will reduce the invisible cost of cash and have a signicant impact on Chinas payment system. 17 November 2020 5 Goldman Sachs China Financial Services For the exclusive use of MEGAN.RILEYGS a2810045d5314637bdba4864b34fcf51Boost competition, level the playing eld for banks DC/EP will become the third pillar of Chinas payments system alongside banks and ntech, and in the process, increase competition. By 2029, we expect DC/EP to account for 15% of total consumption payments (TPV of Rmb128tn) as ntech market share tapers off (albeit still dominating the space) and usage of cash and physical bank cards shrink. Within the payment ecosystem, commercial banks will be clear beneciaries as they compete on a more level playing eld, third-party payment digital wallet issuers will face stiffer competition in the long term (but limited in the early stages), third-party payment acquirers will benet from higher volumes and increased demand for mobile payments, and software/hardware vendors will benet from R CMB and PAB best placed to capitalize Incorporating digital currency wallets into bank apps will bring consumers back to bank channels, expanding their customer base, MAUs and stickiness. A 10% increase in the bank app users would lift revenues by 2%-5%. PAB and CMB are best placed to commercialize returning app users given their leading retail franchises, premium client bases, superior ntech capability and strategic focus on retail nance. We reiterate our Buy ratings on CMB-H/A (A on the Conviction List) and PAB. Rmb 3tn revenue pool by 2025, ntech to continue capturing incremental market share We forecast a Rmb 3tn revenue pool for retail nance by 2025 (excluding mortgages) at 9% CAGR 20-25E as growth in payments and retail lending slows but wealth management and insurance agency remain brisk. Over the next ve years, we expect Fintech to grow revenues at almost double the rate of banks as they continue to capture incremental market share across the retail nance ecosystem. The DC/EP roll-out will likely slow the rate that banks cede ground to ntech, and even reverse over the long-term, albeit in a more competitive environment. 17 November 2020 6 Goldman Sachs China Financial Services For the exclusive use of MEGAN.RILEYGS a2810045d5314637bdba4864b34fcf51China at the forefront of digital currency development The Peoples Bank of China has already started testing a central bank digital currency, known as Digital Currency/Electronic Payment (DC/EP), while most other countries are in the early stages of research and development. Although no ofcial launch timeline has been announced, pilot testing recently commenced in four cities and digital currency will feature at the 2022 Winter Olympics in Beijing. If successful, China could be one of the rst countries to issue a sovereign digital currency. With DC/EP to eventually replace physical cash, it will embed similar characteristics such as anonymity, ofine payments, nancial inclusion, and ease of use. Pace of digital currency development accelerating globally Central banks have been researching Central Bank Digital Currency (CBDC) issuance since 2014-2015 following the melt up of cryptocurrencies (Exhibit 1). Facebooks Libra proposal (a decentralized blockchain) in mid-2019 increased the urgency of central banks to research and develop a CBDC given concern about the impact to monetary sovereignty. This year in particular has seen signicant progress: US Fed ofcials said in August 2020 that they have conducted in-house n experimentation of a “hypothetical digital currency oriented to central bank uses” through the Federal Reserve Boards Technology Lab in collaboration with MIT ; Pilot testing of Chinas DC/EP system recently commenced in four cities (Shenzhen, n Suzhou, Xiongan and Chengdu) and digital currency will feature at the Beijing Winter Olympics in 2022; The ECB said in May 2020 that they have set up a task force to examine the viability n of its own CBDC within the euro system; Swedens Riksbank begun testing its e-krona project this year, although it is yet to n provide any further updates. COVID has accelerated digital payment adoption as a CBDC can also (1) function as a sanitized substitution for cash, and (2) be used for direct subsidy payments to individuals by governments. In March 2020, the US economic stimulus package draft bill for the House n Democrats mentioned the creation of a “digital dollar” to aid individuals amid COVID, although this proposal was removed in a later version of the bill. An expert meeting hosted by Chinas National Development and Reform n Commission (NDRC, a macroeconomic management agency under the State Council) noted that Chinas CBDC development may be accelerated amid COVID and be used as a payment mechanism for special subsidies. 17 November 2020 7 Goldman Sachs China Financial Services Chief Asia Economist Andrew Tilton explains the impact of a digital currency on Chinas economy in his companion report “ Asia Economics Analyst: Chinas digital yuan and its macro implications For the exclusive use of MEGAN.RILEYGS a2810045d5314637bdba4864b34fcf51Exhibit 1: China is at the forefront of CBDC development, and although no timetable for a public launch has been provided, will likely be one of the rst central banks globally to issue a sovereign CBDC Source: PBOC, Caixin, Xinhua, CNBC, Reuters, Bloomberg, various central banks Exhibit 2: China and Sweden have started testing their CBDCs; other central banks are still in the R 2 = somewhat important; 3 = important; and 4 = very important. Sample of 66 central banks surveyed by BIS. Source: BIS Exhibit 5: The PBOC has been researching CBDC as early as 2014, on-the-ground testing has already started in four cities Source: PBOC, Caixin, Xinhua 17 November 2020 9 Goldman Sachs China Financial Services For the exclusive use of MEGAN.RILEYGS