FinTech in Focus
A new report by Broadridge focuses on how capital markets firms are seeking new technologies (artificial intelligence, cloud computing, and distributed ledger technology) to drive shareholder value. Since the financial crisis, capital markets firms have shed $40 billion in costs. However, as the report notes, “after 10 years of change, the industry has yet to reach a sustainable growth model, and investment analysts believe it will remain difficult for capital markets firms to beat their cost of equity capital over the next five years.” In a survey of 69 executives at capital markets firms, respondents (not surprisingly) indicated that regulatory compliance and legacy technology were the two biggest operational pain points. Technology-related priorities over the next two years include efforts to streamline/update/simplify certain processes and leverage new technologies. The industry must overcome three primary challenges in order to streamline and simplify: the inability of the largest banks to agree on their top priorities—the lack of an available next-generation, multi-tenant global technology platform, and the high cost of on-boarding institutions onto such a platform once it's created.
Functional Preference for an Industry-Wide Utility
Getting Close, Real Close
A report by Forbes Insights focuses on the importance of hyper-accurate location data for insurance underwriting and pricing. As the report notes, "the current industry standard methods for determining a location—whether by zip code or street segment data—often substitutes an estimated location for the actual location. In many cases, the gap between the estimated and actual location is small enough to be insignificant, but where it’s not, there’s room for error—and that error can be costly." The report references two studies conducted by Perr&Knight and Pitney Bowes which found that five percent of homeowner policies and as much as 10 percent of auto policies could be priced incorrectly due to imprecise location data. Efforts to improve location data within the industry have been slow to catch on for the following reasons: Carriers don't realize the opportunity for better location data, the lack of awareness, the challenges in switching out vendors and dealing with pricing disruption from a more accurate system, and concerns regarding opening up Pandora’s box and the time it may take for firms to search all areas where data elements can be improved or considered.
JOBS Act and IPOs: Information Uncertainty
A new report from three professors from Stanford University, the University of North Carolina, and the University of Pennsylvania compares initial public offerings (IPOs) of emerging growth companies (EGCs) with non-EGC (NEGC) firms. The report finds greater volatility and underpricing for shares of EGCs than NEGCs after an IPO. More specifically: “In terms of economic magnitudes, we find the difference in underpricing between the average EGC and NEGC firm on the day of the IPO (30 days after the IPO) is $9.97 ($18.18) million dollars, which translates to an economically significant 7.09 percent (12.93 percent) of IPO proceeds.”
The professors constructed two indexes based on the number of JOBS Act provisions that each EGC firm applies. According to the findings, “the indexes are significantly associated with the larger underpricing and higher post-IPO volatility for EGC firms. In addition, we find that inclusion of the indexes eliminates the larger underpricing and higher post-IPO volatility for EGC firms. These findings are evidence of a direct link between the provisions of the Act and greater information uncertainty of EGC firms, and that the greater information uncertainty is not attributable to potential intertemporal changes in market conditions that affect all EGC firms similarly. Findings from additional analyses support the inference that the greater information uncertainty of EGC firms is associated with the JOBS Act rather than intertemporal changes in market conditions.”
And speaking of IPOs, the U.S. Treasury released its second report covering the Administration's core principles of financial regulation. The report covers ways to streamline and reduce the burdens of capital market regulation. Among the recommendations put forward by Treasury include efforts to increase the number of public companies in the U.S. The recommendations also touched on crowdfunding and the private marketplace.
The U.S. Securities and Exchange (SEC) Commission chairman Jay Clayton also raised concern about the dearth of IPOs. In prepared testimony before the House Financial Services Committee, Clayton stated that this dynamic “will lead to fewer opportunities for Main Street investors to invest directly in high-quality companies. To be clear, it is not fewer opportunities to invest in IPOs themselves that troubles me. But without IPOs of growing companies, we have a shrinking and generally more mature portfolio of public companies. This is a significant concern. A shrinking proportion of public companies, particularly smaller and medium-sized companies, has costs beyond investment choices, including that there will be less publicly available information about the operations and performance of companies that are important to our economy."
Non-Cash Transactions Grow, Yet Cash Remains King
A new report from Capgemini and BNP Paribas finds that global non-cash transaction volumes “showed the highest growth of the past decade” with volumes increasing more than 11 percent between 2014-2015 to reach 433.1 billion transactions. The report estimates that global non-cash transactions “will increase at a CAGR of 10.9 percent from 2015-2020, with developing economies growing at 19.6 percent. E- and m-payments are expected to take a significant 32 percent share of the total global non-cash transactions volumes,” with a CAGR of 10.5 percent during 2015-2020. However, the use of cash continues to prevail, especially for low-value transactions. The reasons include demographics, the anonymity of cash transactions, lack of modernized payment infrastructures, lack of access to banking systems in emerging markets. The report also finds that while the share of cash in total payment volumes is declining in the majority of countries, “cash in circulation (CIC) remained stable or increased slightly over the past five years,” with the CIC to GDP ratio "increasing at a higher pace globally except in Denmark, the UK, Sweden, Canada, and South Africa.” That said, non-cash transaction volumes in mature markets saw a growth rate of 6.8 percent in 2015 while emerging markets witnessed a growth rate of 21.6 percent during the same period.
Number of Worldwide Non-Cash Transactions (Billion), by Region, 2015-2020E
Source: Capgemini, BNP Paribas
How to Move Out of Your Parents Basement
Have your parents refinance their house to provide you with enough cash to out-compete all-cash buyers for a home in a hot housing market. That’s right, you heard me. Millennials are now asking their parents to refinance their home to support their kid’s ability to buy a home. My god… what have we gotten ourselves into? The truly amazing thing about all of this is that as we’re asking our parents to put up gargantuan sums of money (because they have not spent enough on us to begin with) to get us to the American Dream, my generation apparently has no idea how to hammer a nail, mop a floor, use a tape measure, or EVEN pick out a paint color. I mean, come on people….
Incumbents Doing Things:
On the investment and acquisition front, UK-based insurer Aviva took a majority stake in robo-investment startup Wealthify. Navient acquired student loan refinance platform Earnest for $155 million (Earnest was previously valued at $375 million in 2015), JPMorgan, and Temasek led a $100 million investment in California-based payments firm Bill.com, and SoftBank led a $93 million investment in Pittsburgh-based artificial intelligence company Petuum Inc. Lastly, BlackRock is reported to be in talks for a stake in a FinTech company, while Singapore-based DBS Bank is hunting for a robo-adviser.
Regarding innovation offices, KAS BANK—a Netherlands-based company providing wholesale securities services—has set up a FinTech innovation division focused on “transforming the governance technologies available to UK pension schemes,” according to a report. Mastercard, which recently extended its partnership with PayPal, set up its second innovation office in the Asia-Pacific region with the establishment of Mastercard Labs in India. The office will focus on digital payments, data solutions, financial inclusion, alternative payments, and safety and security.
On the payments front, Singapore’s OCBC Bank is incorporating Apple's Siri, allowing the bank's SME customers to initiate fund transfers to business associates' OCBC Bank accounts and make account balance inquiries.According to the Bank, “The volume of e-payments between OCBC Bank business accounts performed via Velocity@ocbc saw 33 percent growth from July 2015 to July 2017; inquiries relating to business account balances via the business mobile banking app, OCBC Business Mobile Banking app, has increased by 110 percent since June last year.”
But wait, there’s more. Several financial institutions, including HSBC, BNP Paribas, ING, and Finastra have teamed up "to create an online marketplace to drive transparency and efficiency in the syndicated loan market. Underpinned by Corda, R3’s distributed ledger technology (DLT) based platform, Fusion LenderComm exposes real-time credit agreement, accrual balances, position information, and detailed transaction data to lenders, directly from agent bank loan servicing platforms."
Crypto: While debate continues over whether the Segwit2x hard fork should be implemented, Coinbase and Bitfinex provided a bit more clarity on the issue, but no firm stance as to whether they support or oppose. According to Coinbase, "Customers with bitcoin balances stored on Coinbase at the time of the fork will have access to bitcoin on both blockchains. There is no action required from customers and bitcoin can be securely stored on Coinbase before, during, and after the fork.... In the coming weeks—nearer to the date of the fork—we will provide a more detailed plan for how Coinbase will approach naming the two Bitcoin blockchains." Separately, Bitfinex made it clear that the company “does not intend to advocate for or against any particular hard fork. Miners have the prerogative to commit their hashing power to whatever projects they choose, including alternative and incompatible protocol implementations. However, our first obligation is to our customers, who often demand tokens on each chain in the event of a hard fork that lacks clear community consensus. At this time, we do not believe that there is sufficient consensus to identify a clear winner in the Segwit2x hard fork. Accordingly, our customers will have access to tokens on both chains.” The company further noted that “the lack of strong two-way replay protection in Segwit2x means that we must take steps to protect customer funds. At the moment of the fork, all deposits and withdrawals for both BTC and B2X will be halted until we are able to: 1. ‘taint’ our customers’ bitcoins to ensure withdrawals cannot be replayed on both chains; and, 2. ensure that we can properly credit deposits in the event a transaction is replayed on both chains. We expect this process to require at least 24 hours, and potentially significantly longer. If the event happens, announcements will be made throughout the process to keep everyone up to date."
EU: The European Central Bank (ECB) is exploring ways to regulate decentralized currencies. The ECB argues that virtual currencies are too volatile to be considered a “good” currency, and are primarily speculative at this point.
EU member states signed a declaration that will move forward the implementation of a digital identification system. The digital IDs would enable users to access new online public and private services.
Meanwhile, Brussels regulators raided European bank associations in Poland and the Netherlands. The raid was part of an antitrust crackdown after concerns were raised regarding access to bank account information by competing services. “The Commission has concerns that the companies involved and/or the associations representing them may have engaged in anti-competitive practices in breach of EU antitrust rules that prohibit cartels and restrictive business practices and/or abuse of dominant market positions,” according to a European Commission press release.
Africa: According to a recent poll, only 20 percent of the adult population in Africa use formal or semi-formal financial services. While overall penetration is low in Africa, 95 percent of Nigerians, 94 percent of South Africans, and 90 percent of Kenyans stated that they had at least one bank account. Separately, countries in common markets for Eastern and Southern Africa will abolish roaming and termination charges on mobile calls. This is an effort by the 19 member block of countries to bring down the cost of cell phone calls, as Africans currently pay 25 percent of their monthly income on cellular call expenses.
Luxembourg: The Luxembourg Bankers’ Association has created a FinTech Map of the nation’s start-ups to drive collaboration with the banking community. The map provides basic information about legally present FinTech firms.
Philippines: A recent report was released on the state of the Phillippines’ FinTech development. The report includes 60 start-ups primarily concentrated in mobile payments and wallets, and alternative finance. The market is currently valued at $5.49 million, but saw annualized growth of 19 percent year-on-year.
India: The Reserve Bank of India will allow interoperabilityamong ‘know your customer’ compliant prepaid payment instruments within six months of revised master directions that are set to be released this week. The directive will allow mobile payment systems to accept payments directly from other applications and is a key step in developing the country’s digital payments market.
Mastercard has agreed to partner with the government of Andhra Pradesh to help increase opportunities for local businesses through the use of payment technologies. This partnership is part of the government’s efforts to make Andhra Pradesh a cashless society. The government of Andrah Pradesh is also seeking to utilize blockchain to increase transparency in the property market. The government has partnered with ChromaWay to build a blockchain solution, in hopes of reducing corruption and increasing the security of information.
Following the retirement of Arundhati Bhattacharya, Rajnish Kumar is now the chairman of the State Bank of India (SBI). Mr. Kumar joined the SBI board in May 2015 and will serve as chairman for the next three years.
Indonesia: Venture capital investment in Indonesia has rapidly increased over the last three years. In 2015, $31 million was invested. In 2015, the country saw $631 million in investment. That pales in comparison to 2017 where, as of September, investment has already reached $3 billion. The reasons for this influx include a growing middle class, increasing ubiquity of cell phones, and growing internet use.
UK: The Financial Conduct Authority briefed the EU Justice Sub-Committee for its inquiry into the implications of Brexit on consumer protection rights. Chris Woolard, executive director of strategy for the Financial Conduct Authority, gave oral evidence.
The Bank of England published an update on its FinTech Accelerator program. The bank currently has four firms in its accelerator program, and its portfolio includes firms focused on distributive ledger technology, big data analysis, regulatory technology, and artificial intelligence. According to the report, the accelerator has enabled greater understanding of the FinTech ecosystem, and in particular, has enabled the bank to better understand distributed ledger technology’s potential applications.
The Financial Conduct Authority (FCA) published guidanceon conduct for robo-advisers. The FCA’s advice included considering minimum contributions, affordability, risk, and volatility of products, access, and flexibility. The advisory community responded by stating that they are a data-driven business and will continue to incorporate customer feedback into their offerings but do not see any specific changes resulting from the FCA’s input.
UK Faster Payments is seeking expressions of interest from vendors for the “renewal and management” of its backend infrastructure. Faster Payments is seeking improvements in response to a recent review by the Payment Systems Regulator, which set out new guidelines for central payment systems infrastructure. The contract will last 10 years and the winner will be selected by mid-2018.
Lastly, lending across UK peer-to-peer platforms is at least 20 percent higher than in 2016.
UAE: Abu Dhabi’s Financial Services Regulatory Authority (FSRA) released guidance on ICOs and virtual currencies. The FSRA stated that ICOs have transformed capital formation options and that regulatory frameworks need to evolve to incorporation this innovation. The FSRA further encouraged companies pursuing an ICO to work directly with the FSRA to ensure the appropriate regulatory treatment of their offering.
The Dubai land registrar has revealed plans for a new system that would record all local real estate contracts on a blockchain. The project is part of a broader plan to secure all government documents on blockchain by 2020.
Germany: The German Savings Bank Finance Group announced it would launch a mobile payment product in 2018. S-Payment developed the product, and it is currently in pilot.
In response to Brexit, banks are increasing their office space in Germany. Goldman Sachs has recently agreed to lease 10,000 square meters of office space in the Marienturm building in Frankfurt. Morgan Stanley has stated that it expects its staff in Frankfurt to double, for instance.
Taiwan: The chairman of Taiwan’s Financial Supervisory Commission indicated that he is hesitant to develop “heavy-handed” approaches to digital currency regulation. The island views distributive ledger technology as a major potential growth industry and is seeking to formalize financial innovation through the proposed Financial Innovation Experimentation Act.
Australia: The Australian government is asking for a final round of industry feedback on the framework standards for the development of an opt-in national digital identity. The consultation has lasted roughly a year and will move out of its beta phase at the end of 2017.
Singapore: The Overseas Chinese Banking Corp, Singapore’s second-largest lender, announced a strategic partnership with StarHub, the city-state’s second largest telecom company. The two companies intend to invest $4.4 million into researching artificial intelligence and the internet of things. This partnership will last one year.
Singapore’s central bank has successfully developed three new blockchain prototypes for interbank payments and settlements. The Monetary Authority of Singapore revealed that this phase of the blockchain program, Project Ubin, has allowed for transaction netting while protecting the privacy of each transaction. This could be a major step in implementing cross-border blockchain-based interactions between central banks. The full report will be published during Singapore’s FinTech Week.
Singapore’s deputy prime minister stated that the central bank is monitoring the development of cryptocurrencies and ICO fundraising. The deputy prime minister further stated that the Monetary Authority of Singapore is working on regulatory frameworks to address the risks of virtual currency transactions.
According to the Director of Payment Systems Policy at the Bank of Thailand, Naphongthaway Phothiki, Singapore and Thailand are discussing connecting their national digital payment systems–Singapore’s PayNow and Thailand’s PromptPay. The effort is part of both countries push to reduce the use of cash.
Canada: The Ontario Securities Commission (OSC) released its annual report which provides further details into the OSC's efforts to support FinTech firms.
According to the document, 38 FinTech companies have received support from the OSC's LaunchPad (Canada's version of a regulatory sandbox). OSC Chair and CEO Maureen Jensen also noted that the OSC created two new advisory committees this year, one of which focuses on FinTech. For 2018, the OSC will place more focus and investment towards delivering responsive regulation including identifying opportunities to reduce regulatory burden while maintaining appropriate investor protections, and working with FinTech businesses to support innovation, promote capital formation, and regulatory compliance.
More importantly, R3, Payments Canada, the Bank of Canada, and others released a formal white papersummarizing Project Jasper. The Project was launched back in March 2016, and the report focuses on efforts by participating organizations to explore the use of distributed ledger technology (DLT) for wholesale interbank payments settlement. According to the report, “the analysis thus far is suggestive that DLT platforms that employ a ‘proof-of-work’ consensus protocol, as was built in Phase 1, do not deliver the necessary settlement finality and low operational risk expected of core settlement systems. Phase 2, however, built a distributed ledger system that employed an alternative consensus model on the basis of a ‘notary node’ that could deliver improvements in regard to settlement finality, scalability, and privacy.”
U.S.: Regulators and government officials were active over the past week. The Federal Housing Finance Agency (FHFA) director, Melvin Watt, testified before the House Financial Services Committee. According to Watt, the agency “is continuing to make progress” on its alternative credit score project. The FHFA is also expected to release a request for input this fall. That said, the agency "has received overwhelming feedback from the industry that it would be a serious mistake to change credit scoring models before the Enterprises implement the Single Security in mid-2019. Consequently, even if FHFA announced a decision immediately about alternative credit score models, the changes would not go into effect before 2019. This is a realistic implementation timeline that takes into account operational challenges and the timing of other system changes being made by the mortgage industry.”
For those who may have missed it, acting Comptroller of the Office of the Comptroller of the Currency (OCC), Keith Noreika, spoke to Wharton professor Richard Herringabout the OCC’s views on FinTech. Noreika touched on the latest litigation regarding the OCC’s FinTech charter efforts, regulatory sandboxes, and regulatory coordination, banking and commerce, Fed oversight of bank holding companies, third-party partnerships, along with other topics.
Speaking of the OCC, at the same time the Consumer Financial Protection Bureau (CFPB) released final rules applicable to short-term, small-dollar lenders, Noreika announced that the OCC rescinded guidance related to deposit advance products. “The final rule regarding short-term, small-dollar loans submitted to the Federal Register by the Consumer Financial Protection Bureau necessitates revisiting the OCC guidance. The OCC may consider issuing new guidance in the future. The continuation of the OCC’s guidance would subject national banks and federal savings associations to potentially inconsistent regulatory direction and undue burden as they prepare to implement the requirements of the CFPB’s final rule,” Noreika stated.