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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 18, 2017
   
   

The Financing Environment for U.S. Startups

The Federal Reserve Bank of New York released its first survey covering the financing environment for U.S. start-ups. According to some of the findings, 63 percent of start-up applicants sought $100,000 or less in financing, yet nearly 70 percent of applicants received less than the amount they sought. The most commonly cited reason behind the financing shortfall: insufficient credit history. Of note, medium or high credit risk start-ups "reported applying to online lenders at comparable rates to small banks, regardless of their age." That said, nearly 30 percent of start-ups are discouraged and did not apply—twice the share of mature nonapplicants.

Reasons for Credit Denial by Age and Credit Risk

% of applicants with a financing shortfall

 FiF reasons for credit denial

 

Source: Federal Reserve Bank of New York

 

Taxation and the Peer-to-Peer Economy

A working paper published by the International Monetary Fund (IMF) explores the various taxation issues related to the peer-to-peer economy. While the new platforms in the peer-to-peer space differ from existing structures, “the tax behavior of individuals operating in this new economy are very familiar.” However, the IMF finds that a definitive approach to taxation in the peer-to-peer space “is not immediately obvious,” particularly if seeking to use peer-to-peer platforms to withhold direct taxes. As the report explains: “If an individual’s entire income were earned on a single platform, platforms could withhold income taxes (as for employees) after deducting an estimate for costs—or if individuals provided a record of expenses to the platform. However, as anecdotal evidence suggests, sellers earn small amounts of income through multiple P2P activities—or are engaged in the same activity across multiple platforms—platforms do not have complete information on sellers’ total income and costs and therefore cannot perform such withholding. Without the full income and cost profile for sellers, anything more than a blunt withholding instrument on gross income earned through that platform—either as a final tax or a prepayment—is currently difficult for the platform to administer.” 

Some Headlines 

Online Finance: PayPal acquired Swift Financial for an undisclosed amount. According to the press release, "While PayPal Working Capital provides access to capital based exclusively on proprietary insights, Swift’s technology will allow us to assess supplemental information to more fully understand the strength of a business and provide access to complementary financing products to meet the needs of small and mid-sized businesses." RateSetter is close to finally receiving full authorization from the UK Financial Conduct Authority. The last of the large peer-to-peer lenders in the UK to receive authorization, RateSetter has had to delay the launch of its Innovate Finance ISA until it receives approval.

Payments: WhatsApp is reportedly adding a UPI enabled payments feature, while Venmo rolled out QR codes for its mobile app. More importantly, SWIFT announced "that it will provide U.S. institutions with a gateway to The Clearing House's real-time payments (RTP) platform," which is expected to be made commercially available next year. The Clearing House is a member of the Fed’s Faster Payments Task Force and, together with FIS, submitted a joint proposal for evaluation of its RTP system to the Fed last year. Amazon and FlipKart, meanwhile, are battling it out in India after Amazon launched a digital wallet service and FlipKart received $2.5 billion in funding from SoftBank Group.

Lastly, move over avocado toast and buying into the American Dream, millennials are “penny poking” each other. [Author’s note: God help us all!]

Bitcoin and the Blockchain: Coinbase secured a $100 million Series D financing round–the largest traditional funding round for a public blockchain or cryptocurrency startup, according to Coindesk. Overstock may part ways with its blockchain business after the online retailer reported a $10 million pretax loss in the second quarter. Microsoft announced that the company has developed a system called Confidential Consortium (CoCo) Framework in an effort to solve for speed and privacy issues concerning distributed ledger systems. Separately, the Bitfury Group is making further inroads into the healthcare industry after partnering with Insilico Medicine, while the Illinois Blockchain Initiative partnered with Hashed Health–a blockchain healthcare company–to "explore opportunities to improve the efficiency and accuracy of the medical credentialing process in Illinois." Lastly, the Ethereum network recorded roughly 410,000 transactions over 24 hours–a record beyond any other blockchain, according to reports.

Data Access and Privacy: LinkedIn lost its court battle with hiQ Labs over third-party access to public profiles on LinkedIn–a decision that could have far reaching effects. At the Supreme Court, big time Silicon Valley companies have filed a brief urging the Court to make it more difficult for government officials to gain access to sensitive phone data. Meanwhile, a closely watched legal battle regarding violations to the Fair Credit Reporting Act due to inaccurate data being published by Spokeo Inc. was allowed to move forward. The case was previously on remand from the U.S. Supreme Court.

Global Developments

U.S.: For those of you looking for the most recent equivalent to Leo Tolstoy’s War and Peace, look no further than the Securities Exchange Commission’s (SEC) recent report covering access to capital and market liquidity. From the signing of the Dodd-Frank Act back in 2010 through 2016, capital formation totaled $20.2 trillion–$8.8 trillion from registered securities offerings while the rest ($11.4 trillion) came from unregistered offerings. The SEC did not find primary market security issuance to have fallen as a result of Dodd-Frank and found no evidence suggesting that liquidity has deteriorated as a result of the regulatory reforms put in place. With regards to regulation crowdfunding, between May 16 and December 31, 2016 "there were 163 unique offerings by 156 issuers (including 7 issuers that filed for more than one crowdfunding offering). Of those, 28 offerings reported meeting their target amount on Form C-U as of December 31, 2016." In addition, of the offerings that were reported to have raised at least the target amount, "the median (average) amount reported raised was... approximately $171,000 ($290,000)." The SEC also noted that small, pre-revenue firms are beginning to tap into equity crowdfunding as a method of raising capital.

And given all of what's going on in the initial coin offering (ICO) space, the SEC was bound to start applying more pressure. Last week, the Commission announced the temporary suspension of trading in securities of the CIAO Group "because of questions regarding the accuracy of assertions by CIAO in press releases to investors concerning, among other things, the activities of the company with respect to business plans in the telecommunications industry and plans for an Initial Coin Offering or ICO."

Meanwhile, the OCC’'s Office of Innovation is exploring the creation of something similar to a regulatory sandbox, without calling it a sandbox. Speaking at an American Bar Association event, OCC senior deputy comptroller and chief counsel, Amy Friend, stated: “I don't think that's the way sandboxes really work but we've been calling them 'pilots' and we're working on what we would be comfortable with.” She added, “We view bank-run pilots as a way to gather information useful to us as a way to share our perspective with banks that may be engaging in some type of innovation before they get too far down the road. So we're looking at … bank-fintech partnerships in the piloting program.”

Mexico: As discussions concerning the North American Free Trade Agreement (NAFTA) begin, Vanessa Rubio, the undersecretary at Mexico’s finance ministry, stated that while it is uncertain as to what the final text will look like covering financial services, discussions will at the very least focus on new services, “above all about the fintech industry.” What’s even more interesting about these discussions–the tech industry has nearly the same number of lobbying firms advocating on its behalf during the NAFTA discussions as the transport sector. Still, tech is a ways away from matching the number of firms representing agricultural interests. 

UK: David Davis, the secretary of state for exiting the European Union, provided an update on the status of Brexit discussions from negotiations that took place in July. According to Davis, those discussions focused, in particular, on citizens' rights. According to Davis, the next round of talks, to take place this month, will “consider the issues of mutual recognition of professional qualifications and economic rights which by agreement were not discussed in the July round.” The government also unveiled the first in a series of position papers on Brexit.

Meanwhile, could Estonia’s e-residency effort provide British businesses with a loophole to continue operating as is across the EU? According to one report, more than 1,200 British individuals have become e-residents so far and there has been a noticeable spike in the number of applications submitted from the UK since Brexit.

As part of its efforts to comply with the EU's General Data Protection Regulation, the UK Department for Digital, Culture, Media, and Sport released a statement of intent regarding planned reforms under a new data protection bill. The proposal will allow for improved data access and enhanced data portability, and overall will strengthen the oversight of the Information Commissioner's office.

And speaking of data, new figures show that the UK referral scheme may not be working as well as it should. According to the data provided, only 230 out of 8,100 firms referred to alternative financing platforms obtained finance, with an average loan size of £16,000. The findings prompted former business secretary and Lib Dem Vince Cable to slam the process and state that the big banks "seem to have succeeded in restricting competition to niche credit providers."

On the RegTech front, the Financial Conduct Authority (FCA) published a report, New Technologies and Anti-Money Laundering (AML) Compliance. The report provides a review of new technologies with potential application to AML, the views from tech leaders around AML and compliance, and the views on the FCA's approach to new technologies in AML compliance. According to the report, of the technologies considered during the review across the AML lifecycle, "the most highly regarded by respondents were those related to data analytics, machine learning and [natural language processing (NLP)] all of which were considered to have potential for transforming almost every part of the AML compliance lifecycle." As for views on the FCA, respondents noted that the FCA could provide updated guidance to reflect new technologies in the space and facilitate further industry-wide discussions on AML compliance and relevant new technologies. "Many of these issues, particularly around new regulations or guidance, are not specific to the FCA but reflective of a global trend whereby lawmakers and regulators struggle to keep pace with new technologies," the report stated. 

Russia: Russia's central securities depository and Waves Platform "have started to develop a blockchain platform to support digital assets." The first prototype will be unveiled in the first half of 2018.

Ukraine: National Bank of Ukraine (NBU) governor Oleg Churly published comments on the status of Bitcoin in the country. According to Churly, the NBU will address the issue at the next meeting of the Financial Stability Council in late August.

Norway: Roughly 20 banks, tech companies, and academics have launched an effort to create a fintech hub in Bergen, Norway.

UAE: Abu Dhabi Global Market (ADGM) the International Financial Center in Abu Dhabi and the UAE Exchange entered into a joint partnership "to support, develop and promote the fintech ecosystem in Abu Dhabi and the United Arab Emirates." The partnership will also test new fintech solutions through ADGM's Regulatory Laboratory covering remittances, foreign exchange, and other payments products and services. And speaking of the regulatory laboratory, ADGM closed the application process to be included in the Lab’s second cohort. According to the release, the Lab “attracted 22 local and international fintech startups and innovators, doubling the number of applications as compared to its first cohort.”

Bahrain: The country’s central bank announced debt-based crowdfunding regulations for conventional and sharia compliant markets. According to the announcement, equity crowdfunding regulations are likely to be released “later this month.” 

France: The country is partnering with Germany in an effort to stamp out efforts by technology companies, particularly U.S. technology firms, avoiding paying taxes. A draft digital taxation plan is likely to be submitted by the next EU Council meeting in mid-September.

China: The People's Bank of China (PBOC) is making additional moves to regulate fintech. In a report released last week, the PBOC is considering whether to expand its risk assessment to include online finance models including peer-to-peer lending and crowdfunding. Meanwhile, the PBOC is now requiring third-party payment companies to direct payments through a new clearing house by June 2018, in a move that could impact Alipay and Tencent's market power.

Thailand: One of the country's largest commercial banks, KBank, has teamed up with IBM to launch "a new enterprise Letter of Guarantee network based on IBM Blockchain." According to the release, Letters of Guarantee are expected to eclipse $40 billion in 2017, with roughly one-quarter issued by KBank.

Iran: The central bank is expected to release a regulatory framework covering fintech in the coming weeks, according to reports. The Office of Payment Systems hosted a private session last week and focus is likely to be on payments providers and streamlining the licensing process. 

India: The Securities and Exchange Board of India is close to finalizing regulations pertaining to crowdfunding, according to reports. Meanwhile, the Digital Payments Security Alliance, a forum composed of traditional banks, payment banks, mobile wallet companies, and the IT ministry, will hold its first meeting in September to discuss the opportunities and challenges in the digital payments ecosystem.

Australia: Labor Senator Sam Dastyari and Liberal Senator Jane Hume have launched the 'Parliamentary Friends of Blockchain' group to "provide a forum for Members and Senators to meet and interact with relevant stakeholders on matters relating to the future of Blockchain."

Indonesia: Indonesian President Joko Widodo signed an e-commerce roadmap, which is expected to be unveiled later this year and will provide guidance on the development of the country's digital economy. The signing occurred three days before Luhut Panjaitan, minister for economic affairs, met with Singapore's Minister of Trade and Industry to discuss collaboration on efforts to foster a digital economy, among other issues. 

Canada: In case you missed it, the Bank of Canada released a staff working paper titled, FinTech: Is this time different? The paper explores the risks and opportunities fintech presents to central banks and assesses when central banks should become concerned about developments in fintech. According to the report, “The main theme of our conclusions is that fintech is more likely to bring change by creating new financial intermediation applications rather than by changing the ones that exist today. Therefore, at this moment the best response of central banks is to monitor fintech to form a view on its risks and opportunities, by providing access to the infrastructures central banks control and to encourage the testing of new business models with the new technology.” The report also rejects the views that permissionless distributed ledger systems will replace high-value payment systems, and that fintech firms are driving the unbundling of banking services.

The government of Ontaria released a report on modernizing financial services regulations that contains a number of fintech-specific recommendations, including: the creation of a “new, flexible and innovative financial services and pension regulator,” the development of a pilot program centered on a fintech start-up regulatory grace period run by the Financial Services Regulatory Authority, a review of licensing requirements for financial services professions, the harmonization of provincial and federal regulators, and an online resource for financial services regulations. 

Taiwan: The Financial Supervisory Commission (FSC) has reportedly lifted a ban on the use of robo advisory services for securities trading. Several financial firms have already received approval from the FSC and the relaxed rules will allow firms to apply the service to mutual funds in the beginning, with expansion to exchange traded funds and other products at a later date.

Philippines: Finance Secretary Carlos Dominguez III praised the "substantial inroads" made by the Association of Southeast Asian Nations (ASEAN) "in laying the foundations for a seamless regional financial system to support the goal of a regional economic community." Citing agreements that have allowed for greater foreign equity investment in the ASEAN, Dominguez remarked that Filipinos "now enjoy greater access to financial services, including products and alternative financing mechanisms not yet available to the domestic market." 

Meanwhile, the central bank has issued stringent guidelines applied to money services businesses covering formal written procedures and internal control standards, document retention, and maintenance.

Singapore: As part of the SMEs Go Digital initiative launched back in April, the Infocomm Media Development Authority has signed seven memoranda of intent with various financial institutions and telecommunications firms in an effort to help small and medium-sized enterprises expand their digital capabilities. 


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