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? 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. 5
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. 6
STATE OF PEER TO PEER LENDING Let’s get an update on the three fintech areas: 1. P2P lending 2. Robo-advisors 3. Blockchain 7
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 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) • Beginning to worry regulators. • 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. • Increasingly consensus is: • 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. • Risk of “regulatory arbitrage” by firms wanting to operate under light-touch P2P regulations while providing banking/ CIS products. 11
P2P – WHAT NEXT? Concern about investor protections in P2P sector highlighted in CFA Institute’s 2016 Fintech Survey: 12
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. 13
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 … 14
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 option of ‘premium’ service – a human financial advisor. 15
ROBO ADVISORS – WHAT’S NEXT? • Mass market robo-advice/ high-net-worth human advice intuition shared by CFA Institute members – 2016 Fintech Survey. 16
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’? 17
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!” • industry’s The version of 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 obligations. 18
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. 19
BLOCKCHAIN – WHAT’S NEXT? • The Australian Stock Exchange’s (ASX) attempts to move some functions onto 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. 20
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). 21
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? 22
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 or retaining intermediaries. • P2P – see above. 3. Automation • Robo-advice – is trying to shift towards older/ wealthier clients. • Blockchain – to be determined. 23
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