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Daniel Gorfine
Adjunct Fellow; Vice President, External Affairs and Associate General Counsel, OnDeck
Capital Access and Capital Markets and Demographics and FinTech and Global Economy and Public Policy
Daniel Gorfine is an adjunct fellow at the Milken Institute and vice president, external affairs and associate general counsel at OnDeck, a technology-based company focused on transforming small business lending.
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Q&A with Sam Hodges of Funding Circle on the latest FinTech trends

By: Daniel Gorfine
October 08, 2014
   
   

LeadershipSpotlightOneLineCenter

By Daniel Gorfine

The development of financial technologies is driving profound shifts in financial markets and services. From new digital payment systems and the use of digital or electronic currencies to the use of data analytics and the creation of online investment and finance platforms, the “Internet of Finance” is here to stay.

This is the first in a series of leadership profiles that takes the pulse of FinTech: where we are and where we are likely to go when it comes to responsible development.

I recently spoke with Sam Hodges, co-founder and U.S. managing director of Funding Circle, an online marketplace lender with operations in the U.S. and UK. Sam has explored how the existing regulatory system affects banking, and, with Funding Circle’s cross-Atlantic operations, observed first-hand differences between U.S. and UK policy frameworks applying to online lenders. Here’s our conversation.

1. Daniel Gorfine: According to Accenture, global FinTech investment has tripled over the past five years from $928 million to $2.97 billion, and is expected to rise to $6-$8 billion by 2018. What has changed to drive this increased interest in FinTech?

Sam Hodges: There is a confluence of factors:
1) A set of enabling innovations in data infrastructure, security, and web technologies make it possible to redesign various parts of the financial ecosystem in a very cost effective way.
2) Demographic and consumer shifts mean that an increasingly large share of consumers, small businesses, institutional investors, etc., are comfortable moving money through the internet. Early innovators like PayPal have paved the way for the current wave of innovators, who are taking on evermore ambitious projects.
3) The financial crisis of 2007-2008, and the regulation and compliance changes that followed, left many banks and other traditional financial services providers reeling –and contracting. This means a perfect storm for entrepreneurs who are providing services that offer end-users greater speed, safety, returns and transparency, and building businesses that can get to scale quickly and demonstrate tremendous network effects.

2. DG: At CFM, we define FinTech through four key verticals: digital payment systems, digital and electronic currencies, online investment and finance platforms, and big data and related analytics focused on financial markets and services. Which FinTech verticals are you most bullish on and why?

SH: I’m most bullish on marketplace lending because these platforms offer a disruptive way to deliver finance. Marketplace lenders directly connect capital from a wide range of (oftentimes non-traditional) investors with high quality borrowers, all in a transparent and efficient marketplace. This opens up the capital markets for borrowers who aren’t well-served by existing lenders, and presents a compelling risk-adjusted return for investors seeking yield.

Sam Hodges2

3. DG: As technology, technologists, and computer and data scientists increasingly enter the realm of traditional financial markets and services, what do you see as the largest barriers or hurdles for FinTech to overcome?

SH: The “walled garden” manner in which most traditional financial institutions have built up their technology infrastructure is the largest barrier I see. These Frankenstein and proprietary systems make it very difficult to build and sell new systems to existing players. Financial technology companies that have been and will be the most successful are the ones that deliver an end-to-end service, rather than selling a system for an established player’s use.

4. DG: What do policymakers and regulators need to understand about the FinTech industry and potential related risks in order to foster its responsible development?

SH: The current regulatory frameworks that govern financial services companies are opaque, fragmented, and difficult to navigate. They discourage innovation and protect incumbents. This is despite the best efforts of many of the civil servants who work very hard to make sure these rules are well-understood and followed.

Consumer and investor protection are critical, but I think we need to a see a shift to more principles-based v. rules-based systems, particularly since many narrowly-written rules can’t foresee technological change (the ’40 Act very clearly didn’t anticipate the internet, and that’s a big problem). Additionally, there should be a “graduation path” for emerging financial services businesses such that regulatory and compliance requirements step up as a business gains more scale and presents more risk to the system and to consumers and/or investors.

5. DG: Funding Circle is in a unique position, operating in both the U.S. and the UK, and so has the opportunity to observe how regulators in both countries have responded to financial innovation, such as the development of online lending platforms. How would you compare and contrast the two regimes, and are there lessons each could learn from the other?

SH: The biggest difference is that the UK has a much more “principles-based” system of regulation than we have here in the U.S. When Funding Circle was first founded in the UK, there was very little specific regulation for this type of business; instead, we followed basic principles laid out by the UK’s treasury and securities regulatory groups, and that allowed us to build the business quickly – serving thousands of small businesses. In the U.S., there are narrow (and oftentimes overlapping) rules that govern almost every aspect of what we do – from how we originate loans, to how we form capital from investors, to how we solicit borrowers and investors.

6. DG: In five to 10 years, what do you see as the most dramatic changes in financial markets and services brought about by FinTech innovation?

SH: Looking at this ten years out, I anticipate the following changes:

1) Consumers’ interactions with bank branches will be minimal. Banks will play an important role in aggregating deposits and providing other “protected” financial services, but they will leverage a host of non-bank partners (including businesses like Funding Circle) in order to offer a more complete menu of options for their customers.

2) Consumers will rarely use cash. Cash currency will be used in a small fraction of transactions (and many consumers in large cities will never use cash), and most consumers will use a variety of credit and payment applications to make purchases.

3) Fewer layers of intermediation in the capital markets. The level of “value capture” from the traditional financial ecosystem will decrease and shift value to those financial services companies who most effectively use data and technology infrastructure to create great, transparent, and efficient customer experiences. Returns to these central players will be very high.

Stay tuned for the next Leadership Spotlight.

Learn more about Center for Financial Market’s newest program, FinTech: 21st Century Market & Policy Developments.