THE STATE OF FINTECH IN 2017 Sviatoslav Rosov, PhD, CFA FINTECH - - PowerPoint PPT Presentation

CFA INSTITUTE THE STATE OF FINTECH IN 2017

Sviatoslav Rosov, PhD, CFA

FINTECH – WHAT IS IT CONCEPTUALLY?

• Introduction of software into bricks-and-mortar business models.
• Can use experiences in other industry to predict future?
• Software typically enables:
• Accelerated industry development cycles  Increased

responsiveness to consumers.

• Greater efficiency in serving consumers  Fewer employees?
• Free services  New business models?

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FINTECH– WHAT IS IT?

• Three conceptual pillars:
• Decentralisation
• Disintermediation
• Automation
• Three technological pillars:
• Marketplace Lending
• Robo-advisors
• Blockchain

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WHY DECENTRALISATION?

• Decentralisation allows removal of single points of failure:
• No need for centralised record keeping (e.g. depositories)
• No need for centralised decision making (e.g. bank lending)
• More resilient to security attacks?
• Fintech that decentralises:
• Blockchain - can decentralise any activity.
• P2P lending – decentralises capital marketplace?

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WHY DISINTERMEDIATION

• No need for intermediaries to match forces of supply and demand.
• Removes the cost of the intermediary ecosystem  lower costs for

consumers or higher profits for producers?

• Fintech that disintermediates:
• P2P lending – brings savers and borrowers into direct contact.
• Blockchain – removes the need for CCPs, Brokers, Custodians,

Clearing Houses and CSDs.

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WHY AUTOMATION

• Can remove the need for (costly) human labour, or free up human

capital for more productive tasks.

• More efficient at serving large numbers of consumers.
• Easier to update service relative to re-training human capital.
• Fintech that automates:
• Robo-advice – more efficient way of providing simple diversified

portfolios.

• Smart contracts – execute automatically once pre-specified

conditions are met.

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STATE OF PEER TO PEER LENDING

Let’s get an update on the three fintech areas: 1. P2P lending 2. Robo-advisors 3. Blockchain

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STATE OF PEER TO PEER LENDING

• Increasingly looking like ordinary banking/ asset management.
• New entrants typically not interested in selling directly to investors

(only first-generation firms like Lending Club and Prosper Marketplace).

• Some P2Ps are starting banking services! (e.g. Zopa)
• The UK P2P market is (possibly) most mature in the world:
• GBP 3.3 billion lent in 2016
• GBP 8.7 billion lent to-date

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P2P – WHAT NEXT?

• Not enough retail lenders to sustain the growth rates demanded by

VC investment. Need ‘deposits’ to fund loan books.

• Adopting banking/ asset management techniques to survive/ grow:
• Bundled products (look like collective investment schemes!)
• Provision funds (look like deposit insurance)
• Redemption (look like deposits)
• Beginning to worry regulators.
• Graham Wellesley, founder of Wellesley & Co. says “P2P is a little bit
• f a red herring”, the business is more like an “…old-fashioned

building society”.

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P2P – WHAT NEXT?

• Let’s look at one example – Ratesetter, one of the larger UK P2Ps.

Offers investment ‘products’ that look like CIS.

• Increasingly consensus is:
• If they look like banks why aren’t they regulated like banks?

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P2P – WHAT NEXT?

After early enthusiasm driven by UK Treasury, the FCA has been casting a more critical eye at the industry:

• Innovative Finance ISA (tax-free investment vehicle) has been

delayed for a second year.

• FCA consulting on tougher rules after finding “inadequate

disclosures about risk and loan performance”.

• Firms “testing the boundaries” of what crowdfunding regulations

allow.

• Risk of “regulatory arbitrage” by firms wanting to operate under

light-touch P2P regulations while providing banking/ CIS products.

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P2P – WHAT NEXT?

Concern about investor protections in P2P sector highlighted in CFA Institute’s 2016 Fintech Survey:

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P2P – SIDE NOTE

In many ways, P2P in China is unrelated to rest of world:

• Scale - up to 75% of global P2P market (USD 100 billion). 20% of

consumer credit.

• Late-starter advantage with consumers moving from cash & no

investment opportunities to online payments & P2P + savings culture.

• No ‘incumbent’ intermediaries to displace. Mass comfort with ‘online

economy’. Integrated tech platforms.

• P2P are funded by individual investors, not institutional.
• To-date has been almost unregulated. Recent significant scams have led

to a looming regulatory wipe-out for majority of P2P firms.

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STATE OF ROBO ADVISORS

• Most are not making money – fees do not cover costs of attracting

new clients.

• Most robos racing to attract older/wealthier clients that dominate

asset wealth.

• Mostly use ETFs to construct diversified portfolios. ETF industry sees

Robos as promising distribution channel.

• Regulators see them as solution to ‘advice gap’.
• AUM trivial relative to incumbents serving baby boomer generation:
• Total robo-advisor AUM in 2020 predicted to be $8 trillion vs.

Blackrock AUM $5 trillion, but…

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ROBO ADVISORS – WHAT’S NEXT?

• Robo-advisors sell finite number of products (e.g. ETF

portfolios), not ‘investment advice’ in the broader sense.

• The underlying demand is for the latter.
• Future of robo advice – hybrid human/robo ‘lifestyle planning’?
• Betterment – the largest US robo has recently introduced the
• ption of ‘premium’ service – a human financial advisor.

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ROBO ADVISORS – WHAT’S NEXT?

• Mass market robo-advice/ high-net-worth human advice intuition

shared by CFA Institute members – 2016 Fintech Survey.

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ROBO ADVISORS – WHAT’S NEXT?

• Inevitably (?), basic financial advice (i.e. ETF diversification) will be

given away for free.

• What can you charge for?
• Lifestyle financial planning:
• Identifying goals and what is necessary to achieve them.
• Identifying psychological biases and how to overcome them.
• Considering personal circumstances.
• ’What if’ scenario planning.
• Asset managers are actually ‘life coaches’?

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STATE OF BLOCKCHAIN

• Over the last 18 months, as the realisation of Bitcoin design-problems

has increased, there has been a pivot towards:

• “Bitcoin bad, blockchain good”
• But recently you can detect another change in mood:
• “Blockchain disappointing, Bitcoin more promising after all!”
• The

industry’s version

• f

blockchain is the permissioned blockchain.

• These do not have the user anonymity of the Bitcoin Blockchain

and are more suitable for financial institutions with KYC/ AML

• bligations.

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PERMISSIONED BLOCKCHAINS

• Advantages:
• Faster - cryptographic problem does not need to be so strict since

users are trusted.

• Scalable – system design can be optimised for throughput.
• Conformability with regulation - pre-approved participants lower

issues with KYC/ AML.

• Disadvantages:
• You can compare public and private blockchains to the difference

between internet and intranet.

• Intranet is better for corporates and security, but it is the internet

that had a greater impact on the world.

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BLOCKCHAIN – WHAT’S NEXT?

• The Australian Stock Exchange’s (ASX) attempts to move some functions
• nto a blockchain is one of the most advanced commercialisation projects.

Why ASX?

• Australian equity market is less fragmented than other markets.
• ASX already clears in-house.
• ASX may lose its monopoly status in Australian clearing – motive?
• ASX has recently said its blockchain system is ready, and it will make a final

commercial decision by end of FY 2017.

• The system would have three nodes – ASX, Reserve Bank of Australia, and

the Australian Securities and Investments Commission (ASIC):

• The Reserve Bank and ASIC must agree to participate or project will be

cancelled.

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BLOCKCHAIN – WHAT’S NEXT?

• SWIFT is working on its Global Payments Innovation project –

making cross-border payments faster, more easily traced, and more consumer-friendly (potentially).

• Not using blockchain.
• SWIFT says blockchain is not ready and not necessary to

significantly improve cross-border transactions.

• One of the biggest original Blockchain ‘consortiums’ R3 now is

‘Blockchain-inspired’ consortium (i.e. does not use a blockchain).

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BLOCKCHAIN – WHAT’S NEXT?

• Sharing databases is nothing new, but benefits overwhelmed by

inability to cooperate to-date.

• What will overcome cultural and business model differences

this time?

• If blockchain allows capital and collateral provisions to be

reduced significantly, does that increase systemic risk?

• Regulatory environment
• Currently, regulators agree best approach is ‘do no harm’.

How long will that last?

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HAS FINTECH DELIVERED?

1. Decentralisation

• Blockchain – maybe
• P2P – hasn’t delivered with P2P firms increasingly resembling banks

(except in China?) 2. Disintermediation

• Blockchain – unlikely. Bitcoin and blockchain ecosystems reinventing
• r retaining intermediaries.
• P2P – see above.

3. Automation

• Robo-advice – is trying to shift towards older/ wealthier clients.
• Blockchain – to be determined.

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HAS FINTECH DELIVERED?

Most interesting fintech likely to be: 1. Payments technology

• Apple Pay/ Android Pay
• Open banking API regulations
• Blockchain? Bitcoin?

2. Blockchain

• Will anyone notice if markets/ settlement move to blockchain?

3. Robo-advice

• How will it change incumbent business models?

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CHALLENGES FOR FINTECH

1.

• Adoption. Pitched as addressing ‘millennial’ & ‘tech-savvy’ market.
• But millennials have relatively little wealth…
• Why bother? To influence early adopters…
• Start-up business model – growth now, profit later – risky.

2. Principles of finance haven’t changed in 2000+ years – risk management (credit risk, default risk).

• But risk management can only be improved by tech, not replaced.
• ‘Improvement’ doesn’t sound as good as ‘disruption’.
• VC doesn’t fund ‘improvement’.

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CHALLENGES FOR FINTECH

• As a result, we will likely see reinvention/ reform of existing

institutions rather than wholesale displacement:

• More efficient banking.
• Cheaper asset management.
• More efficient payments.
• Not insignificant improvements + improve financial inclusion?

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CHALLENGES FOR FINTECH

• Fintech may not be life-changing for developed world. The ‘West’ is

already ‘overbanked’ and any gains likely to be marginal.

• Developing world may see the biggest impact – low-hanging fruit of

financial inclusion potentially enormous.

• Example – Alibaba money-market fund went from zero to USD 90

billion AUM in 18 months…

• However, even in China fintech dwarfed (50x-100x plus) by

incumbent finance.

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ROLE FOR REGULATORS

• CFA Institute advocates in support of new technologies but not at

expense of:

• Market fairness
• Market integrity
• Investor protections
• Need to ensure new businesses that look like old business model but
• n an smartphone do not fall through regulatory cracks.
• Need to manage the entry of retail players mega-brands like Amazon/

Alibaba/ Facebook into financial services.

• Need to ensure regulations are technologically-agnostic.

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