CFA INSTITUTE THE STATE OF FINTECH IN 2017 Sviatoslav Rosov, PhD, CFA FINTECH – WHAT IS IT? • 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? 2 FINTECH – WHAT IS IT? • Three conceptual pillars: • Decentralisation • Disintermediation • Automation • Three technological pillars: • Marketplace Lending • Robo-advisors • Blockchain 3 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? 4 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. • Robo-advisors – no need for human financial advisors? 5 WHY AUTOMATION? • Can remove the need for human labour, or free up human capital for more productive tasks. • More efficient at serving large numbers of consumers. • Fintech that automates: • Robo-advice – more efficient way of providing simple diversified portfolios. • Smart contracts – execute automatically once pre-specified conditions are met. 6 STATE OF FINTECH Let’s get an update on the three fintech areas: 1. P2P lending 2. Blockchain 3. Robo-advisors 7 STATE OF PEER TO PEER LENDING • Increasingly looking like ordinary banking/ asset management. • New entrants typically not interested in selling directly to investors (exceptions – 1G firms like Lending Club and Prosper Marketplace). • Many source institutional funding to make loans: • P2Ps apply for bank loans arguing they are serving a near-prime customer base the banks don’t serve. • Some P2Ps are applying for banking licences (e.g. Zopa). Why? 8 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) • Graham Wellesley, founder of Wellesley & Co. says “P2P is a little bit of a red herring”, the business is more like an “…old-fashioned building society”. 9 P2P – WHAT NEXT? • Let’s look at one example – Ratesetter, one of the larger UK P2Ps. Offers investment ‘products’ that look like CIS. • Regulators: “If they look like banks why aren’t they regulated like banks?” 10 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. 11 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. • 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. 12 STATE OF BLOCKCHAIN • 2 years ago, Bitcoin’s design-issues caused industry to pivot towards alternatives based on underlying blockchain tech: • “Bitcoin bad, blockchain good” • The industry’s version of Bitcoin is the permissioned blockchain. • But… as commercialisation has stalled, another change in mood can be detected: • “Blockchain is boring, let’s look at Bitcoin again!” 13 PERMISSIONED BLOCKCHAINS • Same idea as Bitcoin, but only known users are allowed to participate in network. • Advantages: • Faster • Scalable • Conforms to regulation • Disadvantages: • Similar to difference between intranet (better for corporates) and intranet (bigger impact). 14 BLOCKCHAIN – WHAT’S NEXT? • The Australian Stock Exchange (ASX) – leading attempt at significant commercialisation. • ASX blockchain system is ready, will make final commercial decision by end of FY 2017. • The system would have (minimum) three nodes: • ASX • Reserve Bank of Australia, and • Australian Securities and Investments Commission (i.e. regtech): 15 BLOCKCHAIN – WHAT’S NEXT? • Blockchain benefits proportional to network effects – the more users the higher the benefits. • Past attempts to cooperate on sharing databases failed. • What will overcome cultural and competitive differences this time? • Regulatory environment: • Currently, regulators agree best approach is ‘do no harm’. How long will that last? 16 BLOCKCHAIN – WHAT’S NEXT? • SWIFT is working on its Global Payments Innovation project. • 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). 17 STATE OF ROBO ADVISORS • The UK Financial Conduct Authority (FCA) estimates 2/3 of retail financial products are purchased without advice. • Advice gap created by a ban on commission payments by producers to advisors selling funds (2012). • Retail clients don’t want to pay EUR 100s per hour for financial advice, advisors don’t want low-asset clients either! • To solve advice gap, FCA is pinning its hope on robo-advisors. Will it work? 18 ROBO ADVISORS – WHAT’S NEXT? • CFA Institute - 2016 Fintech Survey. 19 STATE OF ROBO ADVISORS • For independent robos, fees typically do not cover customer acquisition costs. • To solve this problem: • Robos are aiming to attract older/wealthier clients that are even more costly to acquire, but proportionally more profitable. • Others are working with/ selling out to incumbent managers with large client lists. 20 STATE OF ROBO ADVISORS • Wealthfront AUM $3 billion vs. Blackrock AUM $5 trillion. Chart source: US Census Bureau, TabbFORUM (TABB Group) 21 ROBO ADVISORS – WHAT’S NEXT? • ETF industry sees robos as promising distribution channel. Why? • Robo-advisors sell finite number of products (typically 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 option of ‘premium’ service – a human financial advisor. 22 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’? 23 HAS FINTECH DELIVERED? Most interesting fintech likely to be: 1. Payments technology • Apple Pay/ Android Pay • Open banking API regulations 2. Blockchain • Will anyone notice if markets/ settlement move to blockchain? 3. Robo-advice • How will it change incumbent business models? 24 CHALLENGES FOR FINTECH • Fintech is usually 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. • VC funds ‘disruption’, not ‘improvement’. • Most fintechs will ‘exit’ via sale to incumbents? 25 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. • We may also see increases in financial inclusion? 26 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. • Similar to countries bypassing telephone lines and going straight to 3G/4G mobile networks. 27 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 on a 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. 28 www.cfainstitute.org.