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Jackson Mueller
Associate Director, Center for Financial Markets
Jackson Mueller is an associate director at the Milken Institute's Center for Financial Markets. He focuses on fintech, capital formation policy and financial markets education initiatives. Prior to joining the Institute, Mueller was an assistant vice president at the Securities Industry and Financial Markets Association (SIFMA), where he focused on...
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FinTech in Focus

By: Jackson Mueller
August 04, 2017
   
   

FinTech: Considerations on How to Enable a 21st Century Financial Services Ecosystem

Today, the Milken Institute Center for Financial Markets released a white paper that explores some of the reasons driving regulators’ interest in FinTech, the difficulties in adapting to and overseeing the digitally-driven changes occurring in the financial services industry, and whether a regulatory sandbox can truly address the challenges confronting regulators as they respond to FinTech. The report includes considerations for regulators and policymakers, based on numerous interviews and private roundtable discussions, as they begin or continue to chart their own paths in developing appropriate responses to the pervasive changes occurring within the financial sector.

The author would again like to thank all of the participants involved in the two private roundtable discussions the Milken Institute held in London, U.K., and Washington, D.C. in April covering regulatory efforts to foster financial innovation and regulatory sandboxes.

The Pulse of FinTech

KPMG released its second-quarter report measuring global venture capital investment in FinTech. According to the report, global investment in FinTech companies surpassed $8 billion across nearly 300 deals, with investment soaring to a four-quarter high. Even so, the report notes that the investment amounts were skewed as a result of the $3.6 billion buyout of Canada-based DH Corp. by Vista Equity Partners. Indeed, “This trend toward individual outlier financings affecting quarterly results is expected to continue on a relatively regular basis as large tech companies and FinTechs make big deals in the space, as part of growth and expansion plans.” Corporates are increasingly driving VC investment globally, with corporate participation in VC deals reaching 21 percent in the first half of this year, up from 17 percent in 2016. The report also discussed the continued valuation declines in late-stage deals and the continuing decline (five straight quarters) in seed and angel deal volume. Even so, RegTech remains on track for a record investment year, InsurTech hit a new peak in terms of total VC investment. Blockchain, however, needs to start showing value, according to the report, and move beyond the current focus on the technical capabilities of blockchain prototypes. The report also finds that focus is shifting beyond customer experience to leveraging FinTech to improve mid and back office functions, particularly in the U.S. and Europe.

Global VC Activity in FinTech (2010 – Q2’17)

global VC activity in fintech 
Source: KPMG

Reaching the Financially Excluded

The Institute for International Finance and the Center for Financial Inclusion at Accion released a report examining how partnerships between legacy financial services firms and FinTech firms have resulted in an expansion of financial access to the underserved. The report is particularly concerned “with the question of whether financial institution-fintech partnerships will increase the capacity—and interest—of financial service providers to cater to low-income customers.” To assess this question, the report examines 14 partnerships between traditional financial firms and FinTechs, as well as insights from a number of other individuals and institutions. In short, partnerships have led to new ways to leverage data, evaluate risk, and conduct relationships with the end user. The report specifically focuses on how partnerships have been able to address persistent inclusion problems of the past including, market access, the creation of new offerings for existing customers, data collection, management and use, and deepening customer engagement and product usage.

Strengths of Financial Institutions and FinTechs

strengths fin institutions 
Source, IIF and Accion

And speaking of financial inclusion, the World Bank Group, the International Telecommunication Union, and the Committee on Payments and Market Infrastructure, with the support of the Gates Foundation, have launched the Financial Inclusion Global Initiative. According to the press release, the three-year program will focus on China, Egypt, and Mexico, and provide support to each country's national authority to improve access through digital channels, while providing advanced research and policy recommendations covering the "security of information and communication technology (ICT) infrastructure and trust in digital financial services; digital IDs for financial services; and acceptance and use of e-payments by micro and small-scale merchants and their customers."

The State of Small Business Lending

Fundera–an online finance platform–recently released a survey of small business owners on the state of business lending in 2017. The top three reasons for seeking small business financing: working capital (49 percent), purchasing equipment (42 percent), and expansion (37 percent). As the report notes, “small businesses are borrowing in a more offensive, proactive way rather than the defensive, reactive way that many people assume of small businesses taking on debt.” In addition, small businesses still rely on brick and mortar bank branches with only 11 percent of respondents having sought funding through an online lender. Nevertheless, respondents noted their preference for applying through online channels, with nearly 60 percent of respondents applying for a business credit card online, while 16 percent applied online through an affiliate. Among some of the other results, nearly 60 percent of small business owners polled use their personal credit card for business expenses and nearly the same percentage of respondents do not check their business credit score.

Millennials

Yes, that avocado-loving generation is once again making a few headlines. For instance, and not surprisingly, college has left students with more questions than answers regarding personal finance, according to US Bank. In fact, as students progress through college they become increasingly concerned about their ability to save money, budgeting, credit scores, and saving for the future.

In a separate study by BMO Wealth Management, roughly one-third of Millennial men and women are concerned about their lack of financial literacy. Only 24 percent of Millennials surveyed demonstrated basic financial literacy, while eight percent showed a high-level of financial literacy. More than one-third of Millennials viewed carrying too much debt as their greatest concern. When it comes to wealth management, Millennials still prefer the personal touch, with more than half of respondents viewing "personal advice" and "advisor's knowledge and years of experience" as top qualities to look for in a financial advisor. Only 25 percent of respondents viewed the "use of innovative technology" as an important quality, while five percent of respondents said they preferred to use a robo-advisor. 

Some Headlines 

Bitcoin and the Blockchain: Team SegWit or Team Bitcoin Cash? Personally, I am more of a Team Jacob fan and we can further discuss my choice of terrible movies offline at a later date. Tuesday, August 1–the day when the Bitcoin network experienced a hard fork–the potential culmination of years of debate regarding Bitcoin’s scaling challenges (as well as possibilities). As a result of the fork, network capacity has increased by offering a blockchain with larger block sizes (8 MB versus 1 MB under the original Bitcoin network). Even so, it remains to be seen whether Bitcoin Cash will take off due to opposition from some miners and exchanges who support the original network (ex. Coinbase), which underwent a soft fork to activate a code change known as SegWit. The soft fork is meant to provide for greater transaction capacity. As of Wednesday morning, Bitcoin Cash was the third largest cryptocurrency by market cap.

In related news, blockchain technology and cryptocurrency related patent applications filed and published by the U.S. Patent and Trademark Office since the beginning of this year are up 90 percent compared to the same time period last year, according to a report. Lastly, the ongoing legal dispute between the U.S. Internal Revenue Service (IRS) and Coinbase continues. Despite efforts by the IRS to narrow its summons (see: FinTech in Focus from July 14), Coinbase responded that the summons remains “substantially overbroad” for a number of reasons. Chief among them is that the IRS “seeks the private financial records of 14,355 Coinbase account holders, without any indication that any of them (much less all of them) have done anything illegal or even engaged in any suspicious activity. Indeed, excluding transactions in which the account holder purchased bitcoin with U.S. dollars (because a purchase of bitcoin or other property is generally not a taxable event), approximately 40 percent of the accounts have an average of less than $20,000 of activity per year for the three year period." Coinbase added, "all that enforcement of this summons would accomplish is that it would permit the IRS – without a legitimate enforcement reason – to scour through the private financial records of millions of transactions by thousands of law abiding account holders that the IRS has no interest in auditing. Such a request by the IRS is manifestly overbroad on its face."

Payments: UniCredit began testing the first pan-European instant payment solution, known as R1, and is expected to roll out its service to customers in Italy and Germany beginning in November. Money transmission platform, TransferWise, has partnered with Apple Pay allowing users to send money internationally through the payment service. Meanwhile, Klarna, which recently received a full banking license from Sweden’s Financial Services Authority, launched Wavy–a free peer-to-peer payment service–allowing customers across 31 European markets to transfer cash and split bills with relative ease. According to Klarna's CEO: “There are no borders in an online context, why should there be in payments? Klarna was founded with the goal to make online payments safe, simple and smooth, Wavy is another step on that journey.” 

Robo: Have robo advisory start-ups lost the advantage? Even as the entrance of automated investment management platforms has resulted in some traditional platforms decreasing their advisory fees, a new report by S&P Global finds that standalone companies may be unable to win out. The report, as described in Financial Advisor, finds this to be “a troubling sign for the independent companies that have sprung up in the past few years, since top-tier institutions have demonstrated they can quickly build their own platforms and win customers. While the pioneers have undoubtedly made an impact, forcing the industry giants to offer lower-cost products and adopt digital models, it seems unlikely that the Davids can take on the Goliaths in [the] same way that, for instance, Amazon.com Inc. and Netflix Inc. did.”

Incumbent Moves: Goldman Sachs has partnered with Fidelity to provide loans to the “mass affluent”–customers largely in-between those catered to by Goldman’s online lending arm, Marcus, and its private wealth management group. Through a new online platform called GS Select, Goldman will offer securities-based loans between $75,000 and $25 million to the six million accounts that use Fidelity’s technology, according to the Wall Street Journal. Meanwhile, JPMorgan's trial of an artificial intelligence trading program, LOXM, is going so well that the company intends to launch the program in Asia and the U.S. in the fourth quarter. The announcement comes after successful trials across the bank's European equities algorithms business.

Online Finance: Lendio surpassed $500 million in small business loans originated through its online marketplace, which consists of 75 small business lenders in the U.S. and Canada. RateSetter surpassed the £2 billion milestone in loans originated through its platform. And CircleUp added lines of credit to its list of products allowing smaller consumer packaged goods companies to apply for $25,000 to $600,000 in credit to raise working capital. Lastly, former president of Prosper, Ron Suber, has joined Credible as executive vice-chairman.

Global Developments

U.S.: At the state-level, the State of Delaware has signed Blockchain legislation into law allowing Delaware corporations to store financial records using any electronic means, including Blockchain. For instance, embedded in the text of the legislation states the following: “Any records administered by or on behalf of the corporation in the regular course of its business, including its stock ledger, books of account and minute books, may be kept on, or by means of, or be in the form of, any information storage device, method, or one or more electronic networks or databases (including one or more distributed electronic networks or databases), provided that the records so kept can be converted into clearly legible paper form within a reasonable time.” Meanwhile, the State of Washington’s cryptocurrency exchange rules took effect and that has resulted in Poloniex and Bitfinex, both cryptocurrency exchanges, to move elsewhere.

The Treasury Department's Financial Crimes Enforcement Network (FinCEN) levied a $110 million civil penalty on BTC-e virtual currency exchange “for willfully violating U.S. anti-money laundering (AML) laws. Russian national Alexander Vinnik, one of the operators of BTC-e, was arrested in Greece this week, and FinCEN assessed a $12 million penalty against him for his role in the violations.” This is the second enforcement action by FinCEN against a virtual currency exchange and the first such action against a foreign-based money services businesses doing business in the U.S.

UK: Keep your eyes out for any FinTech agreement with regulatory officials in Malaysia after the soft launch of the UK Mega Tech diplomatic mission, which is meant to bolster digital ties between both countries. And keep those eyes open as HM Treasury is expected to release findings on the UK referral scheme in the next few days (or weeks). Meanwhile, the Financial Conduct Authority (FCA) has released answers to questions regarding robo advice. If you recall, the FCA set up its advice unit back in May 2016.

Canada: Payments Canada–the country's financial market infrastructure for payments–announced new rules to enhance automated funds transfers, or batch payments, that will take effect in the Fall of 2018. According to the press release, the changes “will enable new features like same-day payroll, expedited bill payments, faster settlement of invoices, the move away from paper and checks and more uniform service across the country in all time zones. These benefits are achieved with the introduction of a third time-of-day for financial institutions to exchange batch payments and new obligations to provide funds availability within two hours.” 

UAE: There has beena lot of FinTech-related activity in Abu Dhabi and Dubai over the past week. Abu Dhabi Global Market struck multiple FinTech agreements with the Australian Securities and Investments Commission, the Capital Markets Authority of Kenya, and authorities in Labuan, Malaysia. In Dubai, regulatory authorities there announced a regulatory framework for loan and investment-based crowdfunding platforms. Lastly, the financing arm of Dubai SME, the agency of the Dubai Economy mandated to help develop the small and medium enterprise (SME) sector, has concluded a deal with Beehive, the first and only regulated peer-to-peer finance platform, by acting as guarantor to a SME for a loan. The arrangement "marks the first such deal concluded under a partnership launched recently by [the financing arm of Dubai SME] and Beehive to enable SME owners to obtain loans for development and expansion at competitive rates through the Beehive Group Finance Platform." 

Australia: KPMG released a follow-up report to its previous report published in 2014 covering the FinTech opportunity for Sydney. According to the most recent report, the number of FinTech startups in Australia has risen from 100 in 2014 to nearly 600 today, with nearly 60 percent located in Sydney. To lead in Asia, key areas to focus on include payments, RegTech, blockchain, and increasing government support. Ten recommendations were also made in the report. They are: New South Wales (NSW) government must continue to work with the Committee of Sydney and the private sector to refresh the existing NSW Government Financial Services Strategy; foster alignment and coordination between the Commonwealth and NSW agencies; continue to promote and support FinTech hubs in Australia; support efforts by both public and private sectors to engage and collaborate on FinTech; build international pathways for Australia's FinTech sector; develop the skills and expertise needed for a digital economy and attract talent from abroad; facilitate cross-industry engagement to expedite enabling policy frameworks; engage policymakers and regulators to enhance the FinTech sector's development; work with the regulatory community and private sector to create better awareness of digital financial services; and engage the university sector and leverage research institutes to explore new business opportunities for commercialization.

Indonesia: Forbes, in a recent article, profiled the regulatory environment concerning peer-to-peer lending platforms with Aji Suleiman, executive director of public policy at Financial Technology Indonesia. Start-ups looking to operate in the peer-to-peer lending space must have $200,000 in capital before they can even be considered for an operating license, with loans capped at $150,000.

ChinaAccording to reports, blockchain associations in the country published a joint protocol covering the regulation of initial coin offerings (ICOs), known as the Guiyang ICO Consensus. The consensus also envisions a sandbox framework for ICO experimentation.

Singapore: Speaking of ICOs, the Monetary Authority of Singapore (MAS) clarified its approach to digital tokens the other day. According to the press release, “the offer or issue of digital tokens in Singapore will be regulated by MAS if the digital tokens constitute products regulated under the Securities and Futures Act.” MAS’ position of not regulating virtual currencies “is similar to that of most jurisdictions. However, MAS has observed that the function of digital tokens has evolved beyond just being a virtual currency. For example, digital tokens may represent ownership or a security interest over an issuer’s assets or property. Such tokens may therefore be considered an offer of shares or units in a collective investment scheme under the SFA. Digital tokens may also represent a debt owed by an issuer and be considered a debenture under the SFA.”

Hong Kong: The Hong Kong Monetary Authority (HKMA) and the Applied Science and Technology Research Institute held the FinTech Career Accelerator Scheme Induction Day on July 27, providing students with regulatory updates and technical workshops in preparation for FinTech internships. Under the Scheme, the students “will undertake internships for six months or one year to work on various FinTech projects at the participating banks and the HKMA.”

Korea: The Ministry of SMEs and Startups officially launched last week in Daejeon, South Korea. The Ministry announced that it will invest nearly $800 million in Korea Venture Investment Corp. to support start-ups and firms focused on the fourth industrial revolution.

India: Startupbootcamp FinTech and PwC released a report on the country’s FinTech ecosystem. The report finds that India "offers the highest expected return on investment on FinTech projects." On the regulatory environment, the report notes that corporates and institutions have been negatively impacted by the extensive regulatory requirements, yet young FinTech firms "suffer from a lack of regulations making for a very ambiguous situation overall." 

Regulatory Barriers for FinTech Innovation in India

 Regulatory Barriers Fintech Innov India


Source: PwC, Startupbootcamp FinTech

The National Payments Corporation of India, the umbrella organization for all retail payment systems in the country, received final authorization from the Reserve Bank of India "to function as the Bharat Bill Payment Central Unit and operate the Bharat Bill Payment System." According to the release, the initiative "will provide a major push to digital payments as it is a big step forward to formalizing the bill payment system in the country." Separately, the government is expected to introduce a new National Telecom Policy in the near future that is designed to reflect the rapid pace of innovation in the sector. 

Officials in Karnataka State will hold a seminar focused on blockchain technology and its use in the public sector. Lastly, keep an eye out for the unveiling of a national strategy for financial inclusion

Nigeria: The FinTech Association of Nigeria (FTAN) officially launched. According to reports, the principal object of FTAN “is to serve as a platform for the development of the financial technology industry in Nigeria and to be a forum for the exchange of ideas and dissemination of information by and between various stakeholders in the industry.”

Philippines: The country’s central bank is moving toward the adoption of artificial intelligence and RegTech. According to the central bank’s governor, “We are getting all kinds of unstructured data by way of complaints. It is very hard to evaluate unstructured data so here we are using chatbots or artificial intelligence” to collate consumer complaints filed with the Bank.

New Zealand: Jacqui Dean, minister of commerce and consumer affairs, discussed the benefits of "light touch" regulation when it comes to FinTech, during a panel discussion held last week. Dean referenced blockchain and robo advice in her comments.

 


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