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Mueller Jackson
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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Murphy Dan
Dan Murphy
Associate, FinTech Program, Center for Financial Markets
Capital Access and Europe and Finance and FinTech and U.S. Economy
Dan Murphy is an associate at the Milken Institute’s Center for Financial Markets. He focuses on FinTech and access to capital issues. Prior to joining the Institute, Murphy was a policy fellow at the Democratic Senatorial Campaign Committee.
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FinTech in Focus

By: Jackson Mueller and Dan Murphy
April 18, 2018
   
   

Disappointing Ledger Technology

Emerging technologies are often subject to what Gartner, a research and advisory firm, calls the “hype cycle”. As time moves forward from the initial moment of technological innovation, the expectations for a given technology rapidly rise, precipitously drop, and then modestly rise again before plateauing. In 2017, blockchain technology had already passed its peak of inflated expectations. In 2018, it may reach its nadir.

Two forces driving blockchain’s fall from grace have begun to crystallize. First, the unceremonious plunge in the value of cryptocurrencies has emboldened blockchain’s critics. Some of their arguments are quite convincing. Kai Stinchcombe’s critique of blockchain as both a technology and a “metaphor” should be required reading for blockchain enthusiasts. Stinchcombe is right that blockchain is not a “futuristic integrity wand” that you can wave at any problem to instill trust. He is also right to point out that many successful blockchain pilots feature a workaround that concentrates the ledger’s nodes in the hands of organizations already deemed trustworthy. Writing for FT Alphaville, Dan McCrum, points out that blockchain pitches often seem like “tokens in search of users as an end in itself.” In other words, blockchain is the proverbial hammer searching for a nail.

Second, the implementation of the General Data Protection Regulation (GDPR) in the European Union (EU) presents a legal obstacle to blockchain that it has not had to face before – consumer privacy protections. Under the GDPR, EU residents will have the right to demand that firms erase their personal data from their records. According to a paper by Michèle Finck, a senior researcher at the Max Planck Institute and Lecturer at Oxford, this requirement makes one of blockchain’s primary advantages, immutability, uniquely inconsistent with the law of the land. According to Dr. Finck, data that is encrypted or hashed (as on a public blockchain) qualifies as personal data under EU law.

This could spell trouble for blockchain. An individual block in a blockchain cannot be modified without invalidating all the subsequent blocks, meaning that complying with a request to delete data under the GDPR would call an entire blockchain’s validity into question. Proponents of the technology recognize this danger and have begun suggesting workarounds of their own. Coin Center, a cryptocurrency and blockchain-focused think tank, has suggested that the EU consider how it might better accommodate blockchain technology. Jerry Brito, Coin Center’s executive director, writes that “…GDPR presumes that there will be central intermediaries that can ‘erase’ information, but the world is trending toward ever more decentralized and immutable technologies.”

Perhaps, but if there is evidence to that effect, Mr. Stinchcombe’s argument demonstrates that there is also evidence to the contrary. Still, blockchain enthusiasts should look beyond 2018’s trough of disillusionment. One of the blockchain community’s leaders, Ethereum Founder Vitalik Buterin, is already taking this approach and suggests that enthusiasts modify their rhetoric. As blockchain technology continues to search for that elusive nail well-suited to its hammer, such pragmatism is a welcome addition.  

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Nudging Towards Creditworthiness

From the invention of the wheel to the “invention” of ice to preserve perishable foods, it’s often the seemingly obvious ideas that have the greatest impact. So it is in behavioral economics as well, where the most obvious intervention can nudge people toward more productive behavior. A recent paper by Tatiana Homonoff, Rourke OBrien, and Abigail Sussman is a perfect example of the efficacy of applying a simple nudge to improve the financial habits of borrowers. In a randomized control trial (RCT) using 400,000 student loan borrowers from Sallie Mae, the researchers found that a simple quarterly email made borrowers 65 percent more likely to log on to the Fannie Mae website to view their FICO score than borrowers in the control group, who did not receive an email. More encouraging still, after one year the rate of borrowers that were at least 30 days late on bill payments was 4 percent lower among those that had received a quarterly email. Is it low-tech? Sure, but sometimes the most impactful solutions are the ones already at our fingertips.

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Some Headlines

Crypto: If the above criticisms of blockchain have it all wrong, these folks may be onto something. The Wall Street Journal reports that despite the regulatory onslaught facing initial coin offerings (ICOs), a cohort of young firms are positioning themselves to be the Goldman Sachs of cryptocurrencies. One encouraging sign in the ICO space is that Hyperledger’s creator, the Sovrin Foundation, will raise money through an ICO this summer. Santander also announced a new blockchain initiative called “One Pay FX” this week, which hopes to compete with the likes of TransferWise. These continued investments lend some needed legitimacy in the space, at a challenging time.

Even so, challenges remain. Investors lost about $660 million last week after the firm behind a Vietnam-based ICO disappeared. In India, cryptocurrency exchange Coinsecure lost about $3 million of its users’ bitcoins. Finally, cryptocurrency exchange Kraken pulled out of Japan this week due to increased regulatory scrutiny. 

AltFi:  Bank partnerships were all the rage at this year’s LendIt FinTech conference in San Francisco, further solidifying a turn from online lenders’ pitchforks and torches to olive branches. On that note, Kabbage looks to be acquiring Orchard Platform Markets, a data provider that counts Vikram Pandit and John Mack as some of its investors. Not to be left out, Goldman Sachs announced the acquisition of personal finance app Clarity Money, which it plans to integrate into Marcus.

Elsewhere, Lending Club Founder Renaud Laplanche is seeking to take on the credit card industry. His new venture, Upgrade, will begin offering lines of credit and will eventually transition to supply borrowers with physical cards. Speaking of credit cards, former U.S. Trade Representative Michael Froman is being brought onboard at Mastercard as vice chairman and president of strategic growth.

Payments:  Two of America’s largest companies, Walmart and Amazon are falling all over themselves to acquire Flipkart, one of India’s hottest e-commerce firms. Walmart appears to have the upper hand for the moment, as it has reached deals with many of Flipkart’s shareholders. Still, Amazon has offered to pay Flipkart a $2 billion fee if the negotiations don’t proceed to Flipkart’s liking. One more global titan will have its say in this deal, however. SoftBank is Flipkart’s largest shareholder and is still pressing the advantage of having two potential suitors. 

In China, Ant Financial has been valued at an eye-popping $150 billion. We’re going to have more to say about FinTech valuations in the coming weeks, but for now, we refer you to a few interesting takeaways by the folks over at FT Alphaville (who have really outdone themselves over the past week).

RegTech: The Association for Financial Markets (AFME) in Europe and PwC published a report examining the impact of post-crisis regulation on banks' capital markets activities. According to the report, which analyzed data from 13 global banks representing 70 percent of global capital markets activities, the aggregate annual regulatory cost that applies to capital markets activities "is estimated to be approximately $37 billion," or nearly 40 percent of total capital markets-related expenses in 2016. "Regulation drove a 14 percentage point reduction in (pre-tax) capital markets return on equity (ROE) from 2010 to 2016 (from 17% to 3%) before banks’ mitigating actions via deleveraging, cost reductions or repricing. Following such actions, overall ROE (excluding one-off charges) recovered to 11% by 2016," according to the press release.

Challenger banks: Challenger banks continued to expand their operations both into new verticals and new geographies this week. Tandem, a U.K. based challenger bank, followed up its recent credit card launch with the launch of a fixed term savings account this week. Atom Bank, another U.K. challenger bank already offers a similar service. Meanwhile, in Berlin, N26 Founder Valentin Stalf announced that they would be expanding their operations to the U.S. by the end of 2018. N26 recently completed a $212 million funding round that included Tencent and Allianz and also plans to launch in the U.K. sometime this year. 

Global Developments 

Africa

Kenya: On April 10, Safaricom, Airtel, and Telkom Kenya rolled out mobile money interoperability across the country. Kenya now becomes the second country in Africa to introduce mobile money interoperability (behind Tanzania) and the 15th country worldwide.

Nigeria: MTN and Ecobank "have signed a Memorandum of Understanding (MoU) to put together expertise and advocate more patronage of digitalized financial services," according to The Guardian

Asia

A new report from McKinsey surveyed 17,000 urban banked respondents in 15 Asian markets and found that while bank branches “now account for only 12 to 21 percent of monthly transactions,” overall customer engagement has grown in both developed and emerging Asian nations, with smartphones driving growth in each case. That said, the study finds that “a significant percentage of customers in Asia still use the physical branch for transactions they consider complex.” The report also finds that 55 to 80 percent of customers in Asia "would consider opening an account with a branch-less digital-only bank; and those willing to bank digitally would be willing to shift between 35 to 40 percent of their total wallets to the digital account." Also of note, the penetration of non-bank payment solutions varies across Asia with nearly half of the population in Developed Asia using non-bank payment solutions compared to Emerging Asia, where penetration ranges from 5 to 15 percent.

Digital Channel Satisfaction has Significant Potential to Grow 

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China: Chairman of Ant Financial, Lucy Peng, is stepping down and being replaced by Eric Jing, the company's CEO. Separately, China's cabinet has approved plans to create a national financial database to protect against systemic risk, with the People’s Bank of China (PBOC) overseeing the effort. Meanwhile, volumes in China's peer-to-peer lending sector reached $30 billion in March, down nearly 25 percent year-over-year. Despite heightened regulatory risk and reduced volume, peer-to-peer lender Weidai Hangzhou Financial Service Co. is planning a $400 million IPO.

Speaking of databases, the Consultative Group to Assist the Poor (CGAP) published a blog post providing further detail on China’s efforts to launch Wanglian, a public clearing and settlement institution for online payments. “PBOC aims to launch Wanglian with a capacity of 120,000 transactions per second, almost 50 percent more than what even Alipay has reported handling, according to Caixin. By the same account, the central bank is promising lower operational costs to all third-party payments companies. If true, Wanglian may mean better outcomes to providers and users alike.” 

IndiaAccording to a report in The Business Standard, roughly 340 million post office savings account holders "will be able to avail a full-fledged digital banking service from May as the government has approved linking such accounts with that of India Post Payments Bank."

Separately, the Indian Private Equity and Venture Capital Association is currently working on a white paper, which will contain policy recommendations for regulators pertaining to challenges faced by startups and fund managers in the country.

According to a report in The Entrepreneur, the Reserve Bank of India, in its bi-monthly monetary policy paper, stated that “at present only certain payment system operators and their outsourcing partners store the payment system data either partly or completely in the country. In order to have unfettered access to all payment data for supervisory purposes, it has been decided that all payment system operators will ensure that data related to payment systems operated by them are stored only inside the country within a period of 6 months. Detailed instructions will be issued in this regard within one week.” 

Lastly, the International Monetary Fund (IMF) recently published its Fiscal Monitor report focused on the importance of broad-based growth in providing countries with opportunities to rebuild fiscal buffers and the role of technology in fostering digital governments. Importantly, the report highlight's the potential benefits and drawbacks of India's Aadhaar system. According to the IMF, "Depending on assumptions and how the reduction in leakage is expressed—that is, the reduction in total transfers or wrongful payments— estimated savings from digitalization range between 0.2 and 21 percent of cash transfers and 11 to 24 percent of wrongful payments." Similarly, "The costs of Aadhaar implementation have been contained. Between 2009 and 2017, the Unique Identification Authority of India—responsible for Aadhaar enrollment and authentication—reports cumulative expenditures of Rs 87.9 billion (about US$1.5 billion) including operation and management of all its stages. This implies a cost of US$1.25 per generated Aadhaar card. This compares favorably to the costs of other electronic identification systems of US$3 to US$6 (Gelb and Diofasi Metz 2018)." Beyond leakage concerns, the report also mentions that users are experiencing delays in being able to authenticate themselves due to lack of digital infrastructure in place. 

Indonesia: The country’s financial services regulator has granted operational permits to nearly 50 peer-to-peer lending businesses, up from around 30 permits as of January.

Philippines: The country's central bank is currently evaluating applications from 29 companies that are planning to set up virtual currency exchanges in the country,according to The Philippine Star. Bitcoin transaction volume in the Philippines has averaged $8.8 million per month in the first half of 2017–four times the $2 million average set in 2015. The number of applications is more than double what the central bank reported last year. 

Meanwhile, Central Bank Governor Nestor Espenilla, Jr. gave prepared remarks on navigating the digital frontier, including comments on the regulatory sandbox and how the central bank is able to cope with the rapid changes taking place.

Singapore: LATTICE80 announced the closure of its FinTech Hub in Singapore and replaced it with a Crypto Hub. According to a press release, "What is missing, despite massive interest, is a balanced ecosystem for Blockchain and crypto startups in the country. In my regular interactions with various founders and other important people in the industry, a demand for the expertise LATTICE80 brought to Fintech is evident."

David Hardoon, chief data officer at the Monetary Authority of Singapore (MAS), discussed open banking in an interview with the Business Mirror. The transition to open banking will be most successful provided it takes place without MAS mandating action, Hardoon said. 

Lastly, the Singapore FinTech Association established a marketplace lending committee. According to FinExtra, the core committee “is representative of senior crowdlenders in Singapore: Crowdo, Funding Societies, Minterest, New Union and Validus Capital.” 

Australia

IBM's Vice-President of Watson Financial Services, Marc Andrews, recently spoke with The Australian Financial Review about how most of the major banks in the country are piloting Watson technology to reduce compliance costs and overhaul efforts to detect financial crimes. "We're also seeing opportunities to collaborate and work with other banks to bring data together across banks to do things more effectively, whether it’s due diligence or managing alerts … an open banking scheme will help facilitate this and some of the initiatives from AUSTRAC are leaning towards this."

Speaking of open banking, several banking industry executives recently spoke at a summit on how open banking will improve lending standards and reduce fraudulent activity. Speaking at the summit, Australian Competition and Consumer Commission Chairman Rod Sims remarked that “if we continue to insulate our major banks from the consequences of their poor decisions, we risk stifling the cultural change many say is needed within our major banks to put the needs of their customers first. There is a, perhaps old fashioned view, that facing strong competition forces firms to increase their focus on customer outcomes. I think this holds for all sectors of economy, including the banking sector. Vigorous competition is a powerful mechanism for driving improved efficiency, and also for driving improved price and service offerings to customers.”

Meanwhile, the Australian Transaction Reports and Analysis Centre (AUSTRAC) released new guidelines aimed at digital currency exchange (DCE) providers. From April 3, DCE businesses are required to meet AML/CFT obligations. In addition, a “policy principles period” of six months will be in place, which means that "the AUSTRAC CEO can only take enforcement action if a DCE business fails to take ‘reasonable steps’ to comply."

EurAsia

Russia: Government officials have reportedly started legal proceedings to block the use of the Telegram messaging app in the country, according to the BBC. The company has refused to hand over encryption keys that would allow authorities to review messages relayed through the app.

Europe

French President Emmanuel Macron wants to take a look at the way European countries enforce banking and insurance capital rules, in an effort to boost lending. "We could modulate these rules for banks and insurance companies depending on the reality of the country and the economic cycle and that, when an economy recovers, we could guide banks’ targets - and that could be done by finance ministers and not only accounting and technical rules," Macron said, as reported by Reuters.

Meanwhile, Ana Botín, executive chairman of Santander, is unhappy with the EU's Second Payments Services Directive (PSD2) particularly as it relates to BigTech firms. According to Botín, as reported in the Financial Times, "We like competition, but what we like is fair competition.... The value of PSD2 is everyone knows how we’re using it, but anyone with data on, say, more than 50,000 customers should have the same rules."

Germany: Ford has won approval from the European Central Bank to establish a bank, Ford Credit Europe, in Germany in an effort to mitigate Brexit risk. Ford anticipates launching the bank in the second half of this year.

Ireland: The country's Chief Innovation Officer, Barry Lowry, spoke at a Cloud Expo Europe event in London on Ireland's eGovernment Strategy. “If we want the citizen to access government services through the devices of their choice, then the only way to do that is to create a joined up, digital experience. We can’t have individual departments with their own log-in systems and their own front-ends. We need to create one portal, where individuals can go in, verify themselves once and use that service.... So, instead of having separate silos of information that aren’t shared, we have proper joined up databases. A citizen should only need to change data once, and all the areas where it’s used should update automatically.”

Malta: The Financial Services Authority (MFSA) issued a consultation paper to the industry covering the 'Financial Instrument Test,' which was previously proposed in a discussion paper released in November 2017 on Initial Coin Offerings, virtual currencies, and related services providers. According to the regulator, "Having carefully considered the feedback received, the MFSA is considering the introduction of the Test as a mandatory requirement under the [Virtual Financial Assets Act (VFAA)], applicable both within the context of an Initial Coin Offering (‘ICO’) as well as during the intermediation of DLT assets, which may qualify as virtual financial assets."

Spain: According to El Economista, and as reported in Coin Telegraph, Spain's tax agency has sent information requests for customer data to 60 companies associated with cryptocurrencies.

U.K.: The Bank of England announced the first non-bank payment service provider (PSP), TransferWise, is now a direct participant in the U.K.’s Faster Payments system. The announcement comes almost a year after the Bank announced that PSPs were eligible to apply for a settlement account in the Bank's Real Time Gross Settlement (RTGS) System. "To safely enable access for non-bank PSPs to accounts in RTGS a new framework has been established. This framework consists of: supporting legislative change; a strengthened supervisory regime; and tailored operational arrangements in RTGS."

The U.K.'s Financial Conduct Authority (FCA) released its Business Plan 2018/19. Pages 20-33 of the report is where the “fun” begins. The FCA highlights cross-sector priorities related to firms' culture and governance; financial crime (fraud and scams) and anti-money laundering (AML); data security, resilience, and outsourcing; innovation, big data, technology, and competition; treatment of existing customers; long-term savings and pensions and intergenerational differences; and high-cost credit.

On AML issues: The FCA is "undertaking diagnostic work on money laundering and terrorist financing risks in the e-money sector," with findings expected to be published in Q2 2018/19. The FCA will also convene an international TechSprint later this year which will "bring together a range of experts to explore whether new technology can be used more effectively to fight financial crime."

On data security issues: "One area we are focusing on is outsourcing arrangements where the service provider supports many firms and so the impact of any disruption is magnified. Over 2018/19, we will increase our understanding of both outsourced services and core infrastructure provision across different sectors through several pieces of thematic and firm-specific work. This will include diagnosing how firms use third parties, their concentration in the market and the potential harm that results."

On innovation: The FCA "will undertake work that uses lessons we have learned since the sandbox was created in 2016. We aim to further reduce unnecessary barriers to entry for innovative firms." Over the next "few months" the FCA intends to work with interested regulators on a blueprint of the global sandbox. On RegTech, the FCA expects to publish a feedback statement on its Call for Input on machine executable regulatory reporting released earlier this year. The FCA is also conducting "several" experiments using advanced analytics including automated detection of unauthorized business activity on the internet through a variety of new technologies, testing advanced Natural Language Processing technologies and models to automate certain supervisory tasks, among others. On crowdfunding, proposed rules based on the FCA's post-implementation review will be published for public consultation in 2018. On cryptocurrencies: Not only will the FCA respond to the Treasury Committee's inquiry into cryptocurrencies, but the regulatory authority "will work with the Bank of England and the Treasury as part of a taskforce to develop thinking and publish a Discussion Paper later this year outlining our policy thinking on cryptocurrencies."

On issues related to the treatment of existing customers: retail banks and building societies must publish standardized, comparable information about personal and small businesses current account services beginning in August. 

Lastly, and we believe to be the first real indication of the value of FinTech agreements between two countries, Crowd2Fund will be one of the first, if not the first FinTech in the U.K. to use the FinTech bridge established between the U.K. and Australia to expand its platform and services to Australia. According to the press release, “Crowd2Fund are in the process of submitting their license application to the Australian regulator, have set up an office in Sydney, recruited local investors, and are modifying the platform to allow trading within Australia. Initial pre-launch activity includes collaborations with the Department of International Trade, with Crowd2Fund being invited to a number of events in Australia to promote the Fintech Bridge.”

Middle East

Kuwait: The country is expected to become the first Gulf Cooperation Council country to impose a tax on remittances by expatriates based on income level. Despite committee approval of the legislation, lawmakers remain deeply divided over the legislation and it’s unclear whether the bill will make it through the National Assembly.

Saudi Arabia: Google will set up five innovation hubs in the country, according to the Saudi Gazette. The hubs will focus on “combining the local talent in the production of prototypes, mobile applications and artificial intelligence.”

North America

U.S.: Recent meetings between the US-ASEAN Business Council delegation and ASEAN finance ministers and central bank governors touched on how to accelerate ASEAN economic integration through enabling digital financial services, among other topics discussed. “American financial services firms play an important role in contributing to Asean’s development, driving the modernisation of its financial services sector, finding innovative ways to transact and protect the financial system, facilitating investment into the region, and broadening the number of people in Southeast Asia who participate in and benefit from financial services,” said Alexander Feldman, president & CEO of the US-ASEAN Business Council, as reported in the Borneo Bulletin.

Meanwhile, the U.S. Department of Commerce is holding two FinTech trade mission events in Hong Kong and Mexico. On May 7-9, the U.S. Commercial Service in Hong Kong is hosting a Fintech & RegTech mission for U.S. companies interested in exploring opportunities in Asia’s most dynamic financial services hub. The mission will occur in conjunction with the Global Fintech & Blockchain Summit and will include optional spin-off programs to Shenzhen, China or Taipei, Taiwan. In Mexico, the U.S. Commercial Service in Mexico City is planning a FinTech, Payments, and Banking Technologies event on May 16– 17. The event will assist U.S. FinTechs to enter or increase their presence in the Mexican market.

Separately, the 2017 Securities and Exchange Commission (SEC) Government-Business Forum on Small Business Capital Formation released its final report based on discussions that took place in Austin, Texas back in November. Crowdfund Insider provides a breakdown of the top recommendations included in the report.

The SEC also obtained a court order "freezing more than $27 million in trading proceeds from allegedly illegal distributions and sales of restricted shares of Longfin Corp. stock involving the company, its CEO, and three other affiliated individuals." 

According to the complaint, “shortly after Longfin began trading on NASDAQ and announced the acquisition of a purported cryptocurrency business, its stock price rose dramatically and its market capitalization exceeded $3 billion. The SEC alleges that Amro Izzelden ‘Andy’ Altahawi, Dorababu Penumarthi, and Suresh Tammineedi then illegally sold large blocks of their restricted Longfin shares to the public while the stock price was highly elevated. Through their sales, Altahawi, Penumarthi, and Tammineedi collectively reaped more than $27 million in profits.” The Wall Street Journal recently published an article related to the SEC action and how “lax” IPO rules and lack of due diligence on the part of the SEC contributed to Longfin’s dramatic rise and fall. In the article, William Galvin, Massachusetts secretary of the commonwealth, commented that if the SEC is “going to rubber stamp even the minimum requirements…it opens the door to scams and fraud…. What you’re opening the door for here is a lot of unaccredited investors getting caught up in the buzz of the moment and victimized.”

Lastly, we can expect further underreporting of gains from cryptocurrency investments to the Internal Revenue Service this tax season, according to various reports. And, on the topic of cryptocurrency, New York’s Attorney General, Eric Schneiderman, launched an inquiry into cryptocurrency exchanges. As stated in the press release, “Today, New York Attorney General Eric T. Schneiderman launched the Virtual Markets Integrity Initiative, a fact-finding inquiry into the policies and practices of platforms used by consumers to trade virtual or ‘crypto’ currencies like bitcoin and ether. As part of a broader effort to protect cryptocurrency investors and consumers, the Attorney General’s office sent letters to thirteen major virtual currency trading platforms requesting key information on their operations, internal controls, and safeguards to protect customer assets.”


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