Securities/Insurance Big tech players ’ advance into the financial industry: Partnerships and conflicts
Overweight (Maintain) Big tech players’ advance into the financial industry: From partners to competitors Industry Report Big tech companies such as NAVER (035420 KS/Buy/TP: W230,000/CP: W158,000) and September 25, 2019 Kakao (035720 KS/Buy/TP: W177,000/CP: W136,500) are accelerating their entries into the financial industry. We believe the rapid convergence of financial services and online platforms is not a fad but a new reality. Indeed, digitalization has long been underway in financial products and services, which are well-suited to online platforms Mirae Asset Daewoo Co., Ltd. due to their intangible nature. Notably, f inancial products and services are also commodity-like, with a huge existing market. [Securities/Insurance ] For the traditional financial industry, which faces slowing growth amid intensifying
Gil -won Jeong competition, the presence of big tech companies represents both an opportunity and a +822 -3774 -1675 threat. [email protected] So far, big tech companies and financial institutions have functioned as business
partners, shoring up each other’s weaknesses. Generally speaking, financial
institutions have traditionally been responsible for all of the factors (i.e., capital, products, sales channels, and labor) required to offer products and services within a strict regulatory framework. Now, thanks to cross-industry partnerships, they can share some of that burden with tech companies.
The risks inherent to the financial industry have historically hampered tech companies’ activities in the area (with the exception of payment services); meanwhile, one of the major challenges for financial institutions is channel diversification from offline to online. Against this backdrop, we believe that cross-industry partnerships can yield mutual benefits. However, any disturbance in the balance of power/ benefits can easily turn partners into competitors. We believe WeBank, launched by Tencent (0700 HK/CP : HK$328.40) as China's first digital bank, makes a good case for cross-industry cooperation. Meanwhile, MYbank, an offshoot of Alibaba (BABA US/CP: US$175.00), is a good example of how conflicting interests can turn former partners into competitors.
Valuations to hinge on returns and inherent risks Under a Korean government initiative called MyData , financial institutions’ customers will soon be able to grant third-party access to select personal data in order to receive financial services (asset management, financial product recommendations, etc.). We view this as an irreversible shift that will have a huge impact on the markets for simple-structure and/or high-fee financial products.
In this report, we aim to provide a basic framework for understanding big tech’s move into the financial industry, including the potential impact on different financ ial segments. Cooperation-conflict matrix
ⒹⒹⒹ Big tech firms become competitors Ⓒ Platforms > Financial institutions High - Balance of power tilts toward online - Online platforms directly enter the platforms financial services market by establishing - Financial institutions increasingly rely on financial subsidiaries online platforms, losing bargaining power - Disagreements surface over revenue sharing and level of cooperation
Conflict level
ⒶⒶⒶ No need for cooperation Ⓑ Mutually beneficial relationship
- Separate markets - Access to new sales channels (for financial institutions) and risk-sharing (for platforms) - In many cases, joint ventures are established Low
Cost savings Growth (customers, sales channels, etc.) New business model Need for cooperation
Source: Mirae Asset Daewoo Research
September 25, 2019 Securities/Insurance
C O N T E N T S
I. From partners to competitors 3 Environmental factors: Low interest rates + digitalization 5 Growing need for partnerships 10
II. Conditions for cooperation and conflict 17 Cooperation-conflict matrix 17 Regulatory changes ‰ Greater need for cooperation 22
III. Other issues 25 Firms with simple, commodity-like product lineups to be more affected 25 Valuation 27
Mirae Asset Daewoo Research 2 September 25, 2019 Securities/Insurance
I. From partners to competitors
Big tech companies such as NAVER and Kakao are accelerating their entries into the financial industry. Having already made significant strides in the payment sector based on their strong online platforms, big tech players are currently working on extending their reach by selling financial products and establishing financial subsidiaries.
We believe the rapid convergence of financial services and online platforms is not a fad but a new reality. Indeed, digitalization has long been underway in financial products and services, which are well-suited to online platforms due to their intangible nature. Notably, financial products and services are also commodity-like, with a huge existing market.
For the financial industry, which faces slowing growth amid intensifying competition, the presence of big tech companies represents both an opportunity and a threat.
So far, big tech companies and financial institutions have functioned as business partners, shoring up each other’s weaknesses. Generally speaking, financial institutions have traditionally been responsible for all of the factors (i.e., capital, products, sales channels, and labor) required to offer products and services within a strict regulatory framework. Now, thanks to cross-industry partnerships, they can share some of that burden with tech companies.
The risks inherent to the financial industry have historically hampered tech companies’ activities in the area (with the exception of payment services); meanwhile, one of the major challenges for financial institutions is channel diversification from offline to online. Against this backdrop, we believe that cross-industry partnerships can yield mutual benefits. However, any disturbance in the balance of power/benefits can easily turn partners into competitors.
But given that big tech and financial institutions are not typical competitors operating under the same set of regulatory or license requirements, we believe investors need a new framework for understanding the market dynamics that are currently taking shape.
A common mistake when interpreting new trends is to extrapolate successful overseas cases to the domestic market, disregarding differences in regulatory conditions, market maturity, and participants’ needs.
The purpose of this report is to help prevent such mistakes and provide a basic framework for understanding the advance of big tech into the financial industry ahead of a series of key events, such as the spin-off of NAVER Pay (to form NAVER Financial) and KakaoBank’s IPO.
Table 1. Big tech’s advance into the financial market: Korea Services Company Asset Future plans Money transfer Payments Credit card management/ Lending insurance - Acquisition of Baro Investment & Securities by KakaoPay (2019) Kakao KakaoPay KakaoPay - - KakaoBank - Launch of insurance services by KakaoPay (2019) - Launch of credit card service s by Kakao Bank (1H 20) - Launch of offline payment service (3Q 19) NAVER NAVER Pay NAVER Pay - - - - Spin-off of NAVER Pay to establish NAVER Financial (November 20 19) Samsung Samsung Pay* Samsung Pay - Samsung Pay - Electronics
LG - LG Pay - - -
Big 3 telcos K Bank SK Pay** K Bank K Bank K Bank (SKT, KT, LGU+) Notes: * Overseas money transfers only; ** SK Pay was launched by combining 11Pay and T Pay (July 2019) Source: IBK Economic Research Institute, press reports, Mirae Asset Daewoo Research
Mirae Asset Daewoo Research 3 September 25, 2019 Securities/Insurance
Table 2. Big tech’s advance into the financial market: Overseas Services
Company Money Asset Lending Recently launched services/future plans Payments Credit card Insurance transfer management Personal SME
- Established a healthcare company in partnership Amazon - ○ ○ - △ - ○ with JP Morgan and Berkshire Hathaway (US) - Plans to launch insurance service
Alibaba ○ ○ - ○ ○ ○ ○ (China)
Tencent ○ ○ - ○ ○ ○ ○ (China)
Apple - Launched Apple Card in partnership with ○ ○ ○ - - - - (US) Goldman Sachs (August 2019)
Google ○ ○ - - - ○ ○ (US)
- Launched e-wallet service based on messaging Facebook platform WhatsApp in the UK (June 2019) ○ ○ - - - - ○ (US) - Libra, a virtual currency project, is scheduled to be launched in 1H20
M-Pesa ○ ○ - - - ○ - (Kenya)
- Received approval for MercadoPago, a payment Mercado Libre - ○ - ○ △ - ○ service provider, in Brazil (November 2018) (Argentina) - Plans to launch insurance service
Notes: ○ currently available; △ to be launched Source: IBK Economic Research Institute, BIS, press reports, Mirae Asset Daewoo Research
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Environmental factors: Low interest rates + digitalization
Low interest rates increase need for financial market changes
ROE, which indicates the efficiency of capital and the growth of shareholder value, can be expressed as follows:
ROE = ROA (P) × Leverage (Q)
ROA has been on a secular downtrend. While this is partly a result of intense competition, we believe the more fundamental cause is narrowing spreads amid falling interest rates. As interest rates have dropped from over 6% to 2%, margins (e.g., NIM, spreads on annuity insurance products, commission fees, management fees, etc.) have declined. Meanwhile, fees paid to brokers/agents (financial institutions) have also fallen.
For example, the decline in interest rates has led to a fall in margins on customer deposits from over 5% to nearly 0%; customer deposits of over W20tr now yield almost no margins for securities firms.
Interest rate movements are not a variable that financial institutions can control. Although they may consider trying to offset the negative impact of falling interest rates by taking on more risk, they face limitations in doing so due to stricter capital regulations.
Figure 1. Deteriorating business environment
Source: Mirae Asset Daewoo Research
With prices trending down, any rise in ROE will inevitably hinge on quantitative growth. The problem is that organic growth is also slowing down.
Between 2001 and 2008 (before the onset of the global financial crisis), financial debts expanded at a CAGR of 8.2%, and net profit at a CAGR of 16.6%. Since then, however, the growth rates have significantly slowed to 5.8% and 7.5%, respectively.
With economic growth weakening, financial institutions have seen organic asset growth lose steam, giving rise to a zero-sum competitive environment.
Against this backdrop, large banks (holding companies) have been seeking to diversify their product and business portfolios, shifting away from a deposit-dominated mix. As a result, they have sharply increased their acquisitions of securities and insurance firms; a significant number of top-tier securities firms and mid-range insurers have recently found themselves under new ownership.
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Figure 2. Margins on customer deposits Figure 3. Mutual fund fees
(%) (bps) 8.0 Margins on customer deposits 120 3Y KTB yield 100 6.0 80
4.0 60
40 2.0 20
0.0 0 06 08 10 12 14 16 18 03 06 09 12 15 18
Source: KSFC, Mirae Asset Daewoo Research Source: KOFIA, Mirae Asset Daewoo Research
Figure 4. Bank NIM Figure 5. Insurer ROA
(%) (%) 3.2 3.0 Life Non-life
2.4 2.4
1.8 1.6 1.2
0.8 0.6
0.0 0.0 00 02 04 06 08 10 12 14 16 18 01 03 05 07 09 11 13 15 17
Source: FISIS, Mirae Asset Daewoo Research Source: FISIS, Mirae Asset Daewoo Research
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With the period of fierce market competition and portfolio changes drawing to an end, financial firms are now focusing on reducing their SG&A expenses.
For financial firms, a high proportion of expenses are tied to the maintenance of offline sales channels. Accordingly, financial firms are likely to continue their efforts to shift toward low-cost, high-efficiency sales channels from traditional offline channels that incur high fixed costs (e.g., labor, rent).
Figure 6. Global banking ROE movements: Improving cost efficiency offsets the impact of narrower margins and increased risk costs
(%) 9.6 1.5 1.6 0 0.1 0.6 8.6 0.6
2014ROE ROE2014 MarginRisk Risk costs cost Cost efficiency Taxes FinesFines/ and Capital2016 ROE ROE2016 othersother Western 4.2 -1.3 2.4 -0.4 -0.5 -0.4 -0.3 3.7 Europe
EEMEA 12.6 -3.7 2.0 2.1 0.1 -0.6 -0.2 12.3
Source: McKinsey, Mirae Asset Daewoo Research
Figure 7. No. of bank branches in the US and Europe
Source: McKinsey, Mirae Asset Daewoo Research
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Digitalization: Channel diversification aimed at improving ROIC
Conventional financial firms face the need to diversify sales channels from an ROIC perspective. To raise ROIC, it is essential to allocate invested capital effectively.
For securities firms, invested capital mostly refers to the equity capital needed to mitigate risks that can arise in the course of ordinary business, such as creating credit, risk-taking on behalf of investors, and brokering/managing marketable securities. In contrast, the amount of borrowed capital is insignificant for most securities firms, and is mostly used for managing sales channels and human capital (customer assets are not technically liabilities). Although firms issue subordinate bonds, the amount is negligible.
( ) = ( ) + ( )
Based on the above formula, a rise in ROIC requires an increase in net operating revenue.
In the past, when the financial market was less mature, financial firms could attract more customers and boost profits by increasing labor input at offline branches. Under the conventional brokerage business model, offline sales channels were the main source of profits, while the importance of capital power was marginal.
Due to falling interest rates and intensifying competition, however, it appears the traditional business models (NIS for banks, brokerage fees for securities firms) are no longer effective at boosting net operating revenue. Of note, the high cost of offline branch management (which accounts for the majority of SG&A expenses) weighs heavily on ROIC.
Against this backdrop, capital efficiency improvement is increasingly coming into focus. Indeed, trading (non-commission) income has already exceeded commission income at securities firms, which offer a variety of financial products.
Figure 8. Securities firms’ profit structure: Commission income vs. trading (non-commission) income
Commission income Non-commission income Other 100%
80%
60%
40%
20%
0% FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18
Source: FISIS, Mirae Asset Daewoo Research
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Amid growing calls for capital efficiency improvement, we believe financial firms need to adopt a two-track strategy, offering 1) high-risk, high-return products along with 2) low- priced, quick return-oriented products.
This should inevitably lead to sales channel diversification. The distribution of high-risk, high-return products requires sales channels targeting high-net-worth customers, whereas the sale of low-priced, quick return-oriented products demands a channel that incurs exceptionally low marginal costs (i.e., online).
Indeed, financial products and services are well-suited to online trading. When the online securities trading system was introduced 20 years ago, it brought about fundamental changes in the existing fee-based profit structure, ultimately driving changes in the industry’s competitive landscape.
Notably, the percentage of new brokerage accounts opened via non-face-to-face verification increased to nearly 70% just two years after this verification method was introduced.
Figure 9. No. of brokerage accounts opened via non-face-to-face verification
('000) 800 Monthly Cumulative
600
400 Expansion to non-monetary institutions (2/26/16)
200
0 Dec. 2015Jan. 2016 Feb. Mar. Apr. May Jun. Jul. Aug. Sep. Oct. Nov. Dec. 2016
Source: FSC, Mirae Asset Daewoo Research
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Growing need for partnerships
It is common for cross-industry partnerships to integrate different elements of production (e.g., capital, labor, channels, and technology) according to each side’s strengths. We believe big tech firms (online channels) and financial institutions (capital strength and risk management capabilities) have functioned well as business partners, shoring up each other’s weaknesses.
Table 3. Integration of financial firms’ capital strength and risk management capabilities and big tech firms ’ channels Capital Risk Channels Expertise Data analysis Innovation strength management
Financial ● ● - - institutions ● -
Big tech ▲ ● - - ● ●
Fintech - ▲ - - ▲ ●
Source : Mirae Asset Daewoo Research
Risk perspective: Restrictions on big tech firms
We believe the potential entry of fintech and big tech firms into the brokerage space should be approached from two angles. First, it should be viewed in the context of the fundamental role of the financial industry (allocation of economic resources and provision of credit). The second context to consider is the services provided by the industry. The former entails taking risks on the book, while the latter does not. For this reason, most fintech and big tech firms are currently focusing on risk-free service businesses.
Broadly, financial firms’ revenues come from either core banking functions (lending, trading, etc.), which entail risk taking, or fee-based businesses (brokerage, transactions/payments, insurance, etc.).
Figure 10. Global banking industry’s profitability structure (McKinsey)
Source: McKinsey, Mirae Asset Daewoo Research
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The ongoing contraction of the lending business and expansion of the payment business can also be witnessed in the recent trends of the “Fintech100” firms selected by KPMG.
Figure 11. Fintech100 firms’ operating profit by segment
(%) 35 2016 2017 2018 30 25 20 15 10 5 0
Source: Mirae Asset Daewoo Research
For example, the peer-to-peer (P2P) lending industry is facing numerous challenges. In the world’s largest P2P lending markets (China, the UK, and the US), the industry has been experiencing a significant decline in margins and increase in losses since 2016.
In China (which accounts for nearly half of the global P2P market), in particular, the competitive market structure is being reshaped due to the sharp increase in failed P2P firms; the number of P2P firms, which once exceeded 3,000, has declined more than 50%.
In response to growing P2P-related problems, including losses and fraud, financial regulators have introduced measures such as bans on new online lending platforms, tighter lending limits, and freezing of assets. To protect individual investors, regulators have also banned Chinese P2P platforms from providing direct/indirect guarantees on loans or guarantees on investment principals/returns. In additional to these regulations, the introduction of tighter lending limits has led to a marked slowdown in P2P market growth.
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Figure 12. P2P lending market volume Figure 13. China’s P2P lending market size
(US$mn) 240,905
32,414
6,068
549
380 368 338 233 190 169
CHN US UK AUS JPN KOR FRA DEU NZL CAN
Source: BIS, Mirae Asset Daewoo Research Note: BIS Quarterly Review , Sep. 2018: Fintech credit markets around the world: Size, drivers and policy issues Source: BIS, Mirae Asset Daewoo Research
Figure 15. No. of companies entering or exiting the Chinese Figure 14. P2P lending profitability (%) P2P lending market
Note: BIS Quarterly Review, September 2018, Fintech credit markets around the world: size, drivers and policy issues Source: BIS, Mirae Asset Daewoo Research
Figure 16. LendingClub share price Figure 17. Qudian share price
(US$) (US$) 160 40
120 30
80 20
40 10
0 0 7/14 7/15 7/16 7/17 7/18 7/19 7/17 1/18 7/18 1/19 7/19
Source: Bloomberg, Mirae Asset Daewoo Research Source: Bloomberg, Mirae Asset Daewoo Research
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The series of setbacks that some domestic fintech firms and KakaoPay have experienced while breaking into the brokerage market can also be understood from this perspective.
And we believe that these players will likely continue to face obstacles in expanding into the pure brokerage market, due to current capital regulations.
As current capital regulations (net capital ratio, or NCR) measure risk levels based on the absolute cost of a business license, limited capital can be a huge hurdle to business expansion. Fixed (illiquid) assets that increase on top-line growth are fully deducted from the net operating capital calculation.
In addition, firms can only provide margin lending within their equity capital, suggesting restrictions on leverage. Simply put, firms with low capital face considerable limitations in terms of the scope of businesses they can operate. Even if these firms enter the market, competition will likely be confined to very limited areas.
Figure 18. NCR structure
Source: FSS, Mirae Asset Daewoo Research
Since the global financial crisis in 2008, brokerage firms have made significant changes to their revenue mix. Firms have been improving their profit structures to defend against deteriorating margins on risk-free services, including brokerage. Large-scale capital-raising efforts and M&As have driven an overhaul of the competitive landscape. Furthermore, revenue sources are evolving, with the investment and trading businesses—both of which involve risk—coming into greater focus.
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Unlike bank customers, brokerage firm clients generally have a clear purpose. The utility of investment products offered by brokerage firms ultimately lies not in convenience but in higher returns, which, in turn, are determined by capital power, deal sourcing, and asset management capabilities—competitive strengths that cannot easily be substituted.
As such, even if fintech and big tech companies enter the brokerage business, we believe that top-tier firms would face only limited margin deterioration. However, the entries of fintech and big tech companies could pose a threat to firms with heavy reliance on financial services, with the extent of the threat varying depending on levels of exposure to risk-free CMAs and online brokerage.
Figure 19. Securities sector’s profit structure trend
Brokerage Wealth management IB Interest income Product income Other 100%
80%
60%
40%
20%
0%
-20% FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18
Source: FISIS, Mirae Asset Daewoo Research
Mirae Asset Daewoo Research 14 September 25, 2019 Securities/Insurance
Channel perspective: Restrictions on financial institutions
In all competitive markets, the greatest concern for participants is striking a balance between top line and profitability. In the financial industry, scale is particularly important, which forces firms to remain committed to sales channel expansion (vs. a single-minded focus on margins).
Figure 20. Profitability-volume matrix
Specialization High Oligopolistic - Focus on high-net-worth clients markets/products - Highly specialized offline channels (currently not viable due to intense competition)
Profitability Digitalizaton Markets/products with - Online channels low barriers to entry - Simple stand-alone products that do Low not carry high misselling risks
Volume
Source: Mirae Asset Daewoo Research
From a game theory perspective, for an oligopolistic market with high barriers to entry, moderate, balanced competition is generally ideal for profitability. When one firm disturbs the balance by seeking market share gains, other players follow suit, leading to industry- wide margin deterioration.
Notably, the domestic non-life insurance market has recently seen intense competition on volume. Since 2017, second-tier insurers have pursued aggressive expansion in the general agency channel, leading to intensifying competition. As such, top-tier firms have also shifted their strategic focus from profits to volume, giving rise to a game of chicken. In order for normalization to take place, second-tier insurers must slow down their growth efforts, but to do so before achieving economies of scale would prove damaging.
As the financial industry matures, margin growth is increasingly being driven by offline channels and specialization, while volume growth is increasingly being driven by new channels.
Figure 21. Insurance market’s maturity and channel utilization
Accelerating separation of product Sales development and distribution channel utilization India, Poland, China, Turkey, Brazil France, Spain, Italy US, UK, Germany, Netherlands
IFA/broker IFA/broker
IFA/broker
Bancassurance Licensed agent Bancassurance
Bancassurance
Licensed agent Licensed agent Licensed agent
Other Other Other Other
Emerging Developing Mature I Mature II
Insurance market maturity
Source: Deloitte, Mirae Asset Daewoo Research
Mirae Asset Daewoo Research 15 September 25, 2019 Securities/Insurance
Changes in US fund sales channels deserve attention. In 2008-18, the contributions of independent financial advisors (IFAs) and discount brokers steadily climbed from 24% to 26% and from 10% to 16%, respectively.
Figure 22. Online-only fund volume and share trends
(Wbn) (%) 12,000 Online-only fund volume (L) 6.0 Contribution of public offering funds (R)
9,000 4.5
6,000 3.0
3,000 1.5
0 0.0 07 09 11 13 15 17 7/19 Source: KOFIA, Mirae Asset Daewoo Research
Figure 23. Major fund purchase channels in the US
Full-service brokers IFAs Banks/savings institutions Insurance/other Mutual fund providers (direct) Discount brokers 100%
80%
60%
40%
20%
0% 08 09 10 11 12 13 14 15 16 17 18
Source: ICI, Mirae Asset Daewoo Research
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II. Conditions for cooperation and conflict
Cooperation-conflict matrix
The following matrix illustrates how the dynamics between financial institutions and big tech players evolve according to their need for cooperation and the extent of any conflicts.
- Quadrant A: There is no need for cooperation, as big tech firms and financial institutions operate in separate markets without any shared interests.
- Quadrant B: The need for cooperation increases, as: 1) the risks inherent to the financial industry hamper tech companies’ activities in the area; and 2) one of the major challenges for financial institutions is channel diversification from offline to online.
- Quadrant C: Conflicts between online platforms and financial institutions begin to surface when the market, having grown to a certain size, starts to settle.
- Quadrant D: Mounting conflicts result in reduced cooperation, until former partnerships dissolve into competition or even a zero-sum game.
Currently, the market is in phase B, which benefits both big tech players, which need to limit exposure to the risks inherent to the traditional financial business, and financial institutions, which seek to secure new channels to drive top- and bottom-line growth.
Figure 24. Cooperation-conflict matrix
ⒹⒹⒹ Big tech firms become competitors Ⓒ Platforms > Financial institutions High - Balance of power tilts toward online - Online platforms directly enter the platforms financial services market by establishing - Financial institutions increasingly rely on financial subsidiaries online platforms, losing bargaining power - Disagreements surface over revenue sharing and level of cooperation
Conflict level
ⒶⒶⒶ No need for cooperation Ⓑ Mutually beneficial relationship
- Separate markets - Access to new sales channels (for financial institutions) and risk-sharing (for platforms) - In many cases, joint ventures are established Low
Cost savings Growth (customers, sales channels, etc.) New business model Need for cooperation
Source: Mirae Asset Daewoo Research
Generally speaking, a big tech company looking to start a lending business could choose one of the following paths: 1) directly extending loans; 2) establishing a banking subsidiary; 3) relying on small P2P providers; or 4) building partnerships with existing banks.
The first three options involve significant obstacles. Directly extending loans requires a license and would weigh on the firm’s capital base. (A lack of expertise would be another hindrance.) Establishing a banking subsidiary would create exposure to financial industry risks. And working with small P2P providers could give rise to reputational risks. Thus, we believe that building partnerships with banks is the most sensible option. In phase B of the matrix above, both tech companies and financial institutions have much to gain from cooperation.
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WeBank: A model for cooperation
WeBank, an online-only bank established by Tencent in 2015, leads its peers in terms of revenue and margins. The firm’s assets and loans expanded 169% and 151% YoY in 2018, respectively. In 2018, WeBank recorded ROE of nearly 30%, NIM of 3.89%, and an NPL ratio of 0.51%, levels unheard of in the traditional banking industry.
WeBank’s performance is extraordinary when compared to MYbank, the no. 2 online bank in China. Indeed, MYbank’s revenue and ROE figures are half those of WeBank.
WeBank has opted to partner with banks, rather than directly extend loans on its own, in order to reduce credit risks. Specifically, 20% of each WeBank loan is funded internally, while 80% is funded by a partner bank. 50 banks participate in this joint lending model, including many small/medium-sized and regional banks that have ample lending capacity but small sales channels.
WeBank was able to build cooperative relationships with traditional banks not only by acting as a loan broker, but also by offering risk management tools (including credit assessment based on big data collected through its WeChat platform and AI technologies). Through WeBank, banks have been able to broaden their reach beyond the highly competitive, secured loan market to reach out to new customers.
WeBank is unique among banks in that it does not rely solely on NIM, with commissions from partner banks accounting for 44% of total revenue. Valuations of financial institutions can vary widely according to their levels of exposure to risk-based fee income and risk-free brokerage commissions. For WeBank, recent fundraising events and independent credit evaluations have indicated a 10x P/B valuation.
Figure 25. WeBank’s cooperative banking model
Source: Press materials, Mirae Asset Daewoo Research
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Table 4. Financials of Chinese online-only banks (RMBmn, %) WeBank MYbank XW Bank Balance sheet Assets 220,037 95,864 36,157 - Loans 119,817 47,689 25,716 Shareholders’ equity 11,940 5,365 3,172 Debts 208,096 90,499 32,986 - Deposits 154,478 42,979 13,638 Income statement Operating income 10,030 6,284 1,335 Fee income 4,424 1,635 - Interest income 5,520 4,623 - Other income 90 25 - Net profit 2,474 671 368 NIM 3.89 5.41 3.31 NPLs 0.51 1.30 0.11 ROE 26.1 13.4 12.3 Note: As of December 31, 2018 Source: Respective companies, Mirae Asset Daewoo Research
Figure 26. WeBank’s loans and deposits Figure 27. WeBank’s fee income and ROE
(RMBbn) (RMBmn) (%) 180 Loans 6,000 Net commission income (L) 40 Deposits ROE (R) 150 4,500 25 120
90 3,000 10
60 1,500 -5 30
0 0 -20 FY15 FY16 FY17 FY18 FY15 FY16 FY17 FY18
Source: WeBank, Mirae Asset Daewoo Research Source: WeBank, Mirae Asset Daewoo Research
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MYbank: Conflicting interests
As the market progresses, however, conflicts will inevitably escalate. Generally speaking, in the initial stage of cooperation, the primary concern for market participants is growing the size of the pie. When the pie cannot expand further, the focus shifts to securing a bigger slice.
As financial institutions’ reliance on online platforms increases, big tech firms will gain more bargaining power. Indeed, in the future, we will likely see a plethora of financial institutions (including banks) scrambling to gain access to the handful of dominant platforms controlled by big tech players. Simply put, financial institutions are likely to become reduced to easily substitutable suppliers.
Quadrant D of
Although MYbank was launched in 2015, Alibaba first launched lending services in 2007. Initially, Alibaba served as a loan broker, providing Aliloan services to small businesses through commercial banks such as Industrial and Commercial Bank of China (601398 CH/CP: RMB5.49). For companies lacking loan collateral or sufficiently high credit ratings, Alibaba assigned alternative credit scores based on their sales and other transaction information culled from the Alibaba platform.
Loans grew quickly, but the Alibaba-bank partnership did not last long. The e-commerce giant demanded excessively high fees, and banks applied strict lending rules to manage risks. Alibaba switched to direct lending in 2011, and went on to obtain an internet-only bank license in 2015.
As their partnerships with Alibaba came to an end, traditional banks decided to open their own online shopping malls. Indeed, by working with Alibaba, their eyes were opened to the importance of big data (obtained through e-commerce) and customer access through online channels.
Figure 28. Aliloan structure
Source: Woori Finance Research Institute, Mirae Asset Daewoo Research
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MYbank offers services mostly to small businesses. In China, large companies have greater access to financial services than in G20 countries, but small businesses are virtually isolated from such services. As commercial banks seek to broaden their customer bases, their competition with MYbank will likely intensify.
Figure 29. % of businesses engaging in loan/credit transactions
(%) 100 China G20 MICs EAP L-MICs 80 Other L-MICs
60
40
20
0 Total Large firms Mid-sized firms Small firms
Note: MICs are developing economies; L-MICs are developing economies with adult populations of more than 20mn. Source: WBG Enterprise Surveys 2012 -16, Mirae Asset Daewoo Research
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Regulatory changes ‰‰‰ Greater need for cooperation
Financial data: Regulatory shift from protection to utilization
Open banking allows banks to share consumer-permissioned data with third parties or other banks.
Figure 30. Concept of open banking
Source: Deloitte, Mirae Asset Daewoo Research
One of the key links between financial institutions and big tech players is financial data. Previously, financial data was viewed as something to be protected. However, we note a growing shift from protection to utilization. Indeed, developed countries are implementing various regulatory changes to introduce competition and innovation in financial data utilization and financial settlements. Such changes are aimed at increasing access to and openness in financial data.
In particular, the EU, the UK, and Japan are introducing policies to allow fintech firms to access settlement networks and data.
Last year, the EU implemented the Payment Services Directive 2 (PSD2), under which third parties, in addition to financial institutions, are allowed access to consumer-permissioned data.
Under PSD2, there are two types of open banking service providers: payment initiation service providers (PISPs) and account information service providers (AISP). PISPs are authorized to initiate payments into or out of a user’s account, and AISPs are authorized to retrieve account data (balances, transaction history, etc.) provided by banks and financial institutions. As such, open banking will allow third parties (including fintech firms) to access customers’ accounts and provide various financial services, including payments.
The UK introduced open banking in January 2018, allowing banks to provide account information to third parties through an application programming interface (API) with the consent of the customers.
Meanwhile, Japan has mandated banks to adopt an open API through revisions to its banking law (May 2017). In Japan, cash remains the prevalent form of payment, and the government has a long-term goal of doubling cashless transactions within 10 years.
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Table 5. PSD2 overview PISP AISP
A service provider that receives/sends payment information required for transactions from/to A service provider that provides account information in Definition banks and initiates payments at the request of the an integrated format payer
Access to payment system Access to the account information
Scope The same level of information (required for (openness) The same level of information (user account and initiation/execution of payment/settlement) that a payment/settlement) that a user sees when he/she user provides when he/she directly initiates a directly accesses his/her account online payment/settlement
Source: FSC, Mirae Asset Daewoo Research
Figure 31. PISP Figure 32. AISP
Source: Accenture, Mirae Asset Daewoo Research Source: Accenture, Mirae Asset Daewoo Research
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MyData initiative
In July 2018, the Financial Services Commission (FSC) announced its MyData initiative.
MyData will give consumers the legal right to demand the transfer of information from financial institutions to authorized third parties, and require financial institutions to develop/disclose their API details to ensure safe and efficient data transmission (similar to the PSD2 system in Europe). The initiative should also help support the systematic management of personal credit information, and enable the provision of various personal data-based services such as asset management and credit management. Some fintech firms can already access customer account information through screen scraping, but access is limited and incomplete.
MyData pilot projects were carried out in finance and telecommunications last year, and eight sectors (medical, financial, retail, etc.) were selected this year.
The FSC and the Korea Financial Telecommunications and Clearings Institute (KFTC) plan to establish an open banking system and launch open banking services in December, as part of their efforts to introduce innovation and openness in financial settlements.
The full-scale introduction of MyData in the financial sector will require revisions to relevant laws. A bill to revise the Personal Information Protection Act, the Credit Information Act, and the Information and Communications Network Act was proposed in November 2018, but has not yet been passed by the National Assembly.
For consumers, MyData means greater convenience, as it will allow them to easily manage all of their financial data and assets without having to constantly access separate financial accounts.
For financial institutions, MyData will provide opportunities to utilize financial data to offer customized products and asset management services based on individual consumption patterns and preferences. With financial data integration, data utilization will increase full swing.
Comparing/analyzing financial products has long been difficult for consumers, given the difficulty of standardization, the overly complex product structures, and the overabundance of suppliers in the market. MyData can easily clear up such problems by facilitating the provision of more sophisticated financial services. Such services could include recommending loans with more favorable terms, or recommending credit cards best suited to individual needs based on an analysis of personal credit status and consumption patterns.
Once tech giants become MyData service providers, the utilization of data directly collected and safeguarded by financial institutions should decrease sharply.
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III. Other issues
Firms with simple, commodity-like product lineups to be more affected
In many industries, platforms have eliminated or significantly decreased intermediary costs associated with the distribution process. This suggests that financial firms with high exposure to products/services that can be simplified are likely to face increased price competition with platforms. Indeed, instead of assuming risks, platforms can encroach on traditional sales channels by acting as a distributor for certain financial products or as a customer touch point for new account openings. On the other hand, we see opportunities for financial firms to save on distribution costs by working with platforms.
If financial platforms become prevalent, which sectors will be affected most significantly? We think products that are simple in structure (bank products) and involve high commissions (insurance products) are well-suited to online platforms.
The bank and insurance businesses are based on a relatively simple model under which deposits or insurance premiums are received and returned according to predetermined conditions (e.g., interest rates, maturity, etc.). Meanwhile, securities firms operate under a more complicated model involving higher-risk products and various services (e.g., brokerage, management, structuring, pooling, etc.).
For the bank and insurance businesses, competitiveness hinges on channels, rather than products. Due to the simple structures of their products and their high dependence on existing channels, demand for new channels is high.
In particular, the insurance sector incurs high channel costs. For protection-type policies, commissions paid to sales agents can be as high as 1,600% of the monthly premium, which is equivalent to more than 15% of the total premiums paid over a 10-year term (based on present value). For reference, the commission rate is equivalent to more than 1.5% on an annualized basis, which is far higher than the rates associated with equity funds (less than 0.8%). And notably, higher prices on products sold through sales agents would give rise to only modest margin improvements. As such, if a cheaper replacement channel becomes available, insurers would be highly incentivized to move over. Moreover, once IFRS 17 is implemented, insurers will be forced to shift their focus to profitability from volume competition.
In our view, bank deposits and annuities are unlikely to be offered via platforms due to their low marketability in the current low interest environment. On the other hand, we believe loans and protection-type insurance products, which are in popular demand, are well-suited to platforms.
We believe complex products with high intrinsic risk levels, such as derivatives-linked securities (DLS), will remain better suited to offline channels, unless they undergo significant modifications.
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Figure 33. Banking business overview
Source: Mirae Asset Daewoo Research
Figure 34. Insurance business overview
Source: Mirae Asset Daewoo Research
Figure 35. Brokerage business model
Brokerage firms Markets Customers Diversified product portfolio
Products
Banks Loans Investment Brokerage Deposits Investment - Credit products - Stocks, bonds - Wrap, trusts, banks --Secured - ETF, ETN Collateral Asset funds --Corp. finance --Derivatives, --CMAs, RPs managers Management Cash flow - Letters of prime Other dealers --ELS, DLS brokerage commitment Financing --Bancassurance, firms Outsourcing Retail clients
Trading Capital strength Underwriting Risk management Structuring + Sales channels Pooling Consulting
Source: Mirae Asset Daewoo Research
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Valuation
Given a series of key upcoming events, such as the spin-off of NAVER Pay (to form NAVER Financial) and KakaoBank’s IPO in 2019, it is time to start mulling the valuations of tech players’ financial subsidiaries.
We believe it is important to determine which valuation base to use —a traditional financial sector valuation model or a premium to the internet sector valuation. The former puts an emphasis on risky profits, while the latter focuses on customer base growth.
For example, WeBank, albeit still unlisted, receives high valuations (around 10x P/B), thanks to not only its ample growth potential, but also its unique profit structure. As a loan “connector,” WeBank receives fees from banks, which account for around 40% of its total revenue. And because the company is able to generate a high ROE while minimizing lending-related credit risks, it enjoys a high valuation premium.
Table 6. WeBank financial summary (RMBmn, %) FY15 FY16 FY17 FY18 Balance sheet Assets 9,621 51,995 81,704 220,037 Loans 3,862 30,777 47,706 119,817 Equity 3,000 6,875 7,044 11,940 Liabilities 7,194 45,292 73,372 208,096 Deposits 145 3,297 5,336 154,478 Income statement Net operating revenue 226 2,449 6,748 10,030 Net commissions received 27 562 2,274 4,424 Net interest income 195 1,835 4,396 5,520 Other income 4 52 78 90 Net profit -584 401 1,448 2,474 NIM - - 7.03 3.89 NPL 0.12 0.32 0.64 0.51 ROE - 8.1 20.8 26.1 Data: WeBank, Mirae Asset Daewoo Research
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Another case to consider is MarketAxess, which operates a leading fixed-income electronic trading platform. The firm delivers high ROE (20-30%) and, like WeBank, utilizes a brokerage/”connector” model to help mitigate risks.
As shown in
To sum up, valuations of big tech firms’ financial services operations will vary depending on whether they choose to simply pursue the risk-free brokerage model or engage in all-out competition with traditional financial firms.
Figure 36. MarketAxess: Share performance vs. fixed-income Figure 37. MarketAxess: ROE vs. P/B transactions made via the platform
(US$) (bn) (x) (%) 500 Share price (L) 200 25 ROE (R) 35 Platform transaction volume (R) P/B (L)
400 160 20 30
300 120 15 25
200 80 10 20
100 40 5 15
0 0 0 10 14 15 16 17 18 19 14 15 16 17 18 19
Source: Company data, Bloomberg, Mirae Asset Daewoo Research Source: Company data, Bloomberg, Mirae Asset Daewoo Research
Figure 38. US financial sector average P/B by segment
(x) 20 Average P/B
15
10
5 5.14 3.12 3.70 1.43 1.95 2.28 1.91 1.60 0 1.07 1.16 0.84 0.35 0.92 0.69 1.28
-5
Source: Bloomberg, Mirae Asset Daewoo Research
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APPENDIX 1
Important Disclosures & Disclaimers
Stock Ratings Industry Ratings Buy : Relative performance of 20% or greater Overweight : Fundamentals are favorable or improving Trading Buy : Relative performance of 10% or greater, but with volatility Neutral : Fundamentals are steady without any material changes Hold : Relative performance of -10% and 10% Underweight : Fundamentals are unfavorable or worsening Sell : Relative performance of -10% Ratings and Target Price History (Share price ( ─), Target price (▬), Not covered ( ■), Buy ( ▲), Trading Buy ( ■), Hold ( ●), Sell ( ◆)) * Our investment rating is a guide to the relative return of the stock versus the market over the next 12 months. * Although it is not part of the official ratings at Mirae Asset Daewoo Co., Ltd., we may call a trading opportunity in case there is a technical or short-term material development. * The target price was determined by the research analyst through valuation methods discussed in this report, in part based on the analyst’s estimate of future earnings. * The achievement of the target price may be impeded by risks related to the subject securities and companies, as well as general market and economic conditions.
Equity Ratings Distribution & Investment Banking Services Buy Trading Buy Hold Sell Equity Ratings Distribution 83.14% 8.72% 8.14% 0.00% Investment Banking Services 77.78% 11.11% 11.11% 0.00% * Based on recommendations in the last 12-months (as of June 30, 2019)
Analyst Certification The research analysts who prepared this report (the “Analysts”) are registered with the Korea Financial Investment Association and are subject to Korean securities regulations. They are neither registered as research analysts in any other jurisdiction nor subject to the laws or regulations thereof. Each Analyst responsible for the preparation of this report certifies that (i) all views expressed in this report accurately reflect the personal views of the Analyst about any and all of the issuers and securities named in this report and (ii) no part of the compensation of the Analyst was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report. Mirae Asset Daewoo Co., Ltd. (“Mirae Asset Daewoo”) policy prohibits its Analysts and members of their households from owning securities of any company in the Analyst’s area of coverage, and the Analysts do not serve as an officer, director or advisory board member of the subject companies. Except as otherwise specified herein, the Analysts have not received any compensation or any other benefits from the subject companies in the past 12 months and have not been promised the same in connection with this report. Like all employees of Mirae Asset Daewoo, the Analysts receive compensation that is determined by overall firm profitability, which includes revenues from, among other business units, the institutional equities, investment banking, proprietary trading and private client division. At the time of publication of this report, the Analysts do not know or have reason to know of any actual, material conflict of interest of the Analyst or Mirae Asset Daewoo except as otherwise stated herein.
Disclaimers This report was prepared by Mirae Asset Daewoo, a broker-dealer registered in the Republic of Korea and a member of the Korea Exchange. Information and opinions contained herein have been compiled in good faith and from sources believed to be reliable, but such information has not been independently verified and Mirae Asset Daewoo makes no guarantee, representation or warranty, express or implied, as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein or of any translation into English from the Korean language. In case of an English translation of a report prepared in the Korean language, the original Korean language report may have been made available to investors in advance of this report. The intended recipients of this report are sophisticated institutional investors who have substantial knowledge of the local business environment, its common practices, laws and accounting principles and no person whose receipt or use of this report would violate any laws or regulations or subject Mirae Asset Daewoo or any of its affiliates to registration or licensing requirements in any jurisdiction shall receive or make any use hereof. This report is for general information purposes only and it is not and shall not be construed as an offer or a solicitation of an offer to effect transactions in any securities or other financial instruments. The report does not constitute investment advice to any person and such person shall not be treated as a client of Mirae Asset Daewoo by virtue of receiving this report. This report does not take into account the particular investment objectives, financial situations, or needs of individual clients. The report is not to be relied upon in substitution for the exercise of independent judgment. Information and opinions contained herein are as of the date hereof and are subject to change without notice. The price and value of the investments referred to in this report and the income from them may depreciate or appreciate, and investors may incur losses on investments. Past performance is not a guide to future performance. Future returns are not guaranteed, and a loss of original capital may occur. Mirae Asset Daewoo, its affiliates and their directors, officers, employees and agents do not accept any liability for any loss arising out of the use hereof. Mirae Asset Daewoo may have issued other reports that are inconsistent with, and reach different conclusions from, the opinions presented in this report. The reports may reflect different assumptions, views and analytical methods of the analysts who prepared them. Mirae Asset Daewoo may make investment decisions that are inconsistent with the opinions and views expressed in this research report. Mirae Asset Daewoo, its affiliates and their directors, officers, employees and agents may have long or short positions in any of the subject securities at any time and may make a purchase or sale, or offer to make a purchase or sale, of any such securities or other financial instruments from time to time in the open market or otherwise, in each case either as principals or agents. Mirae Asset Daewoo and its affiliates may have had, or may be expecting to enter into, business relationships with the subject companies to provide investment banking, market-making or other financial services as are permitted under applicable laws and regulations. No part of this document may be copied or reproduced in any manner or form or redistributed or published, in whole or in part, without the prior written consent of Mirae Asset Daewoo.
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