Fintech

Between finance and technology: global trends and best practices to leverage fintech and digital payments as a driver for development – Material for the Discussion

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Date: 19 December 2018

Type: Other

Topic: Credit

In the first 6 months of 2018 global investments in FinTech – across Venture Capital, Private Equity and Strategic Acquisitions – were exceptional and driven by two massive deals: the $10 billion acquisition of the e-commerce payment company WorldPay by the US merchant acquirer Vantiv and the $14 billion VC funding raised by Ant Financial, Alibaba’s digital payments company. This record half-year has seen $58 billion raised worldwide, in over 800 deals, a growth of more than two and a half times compared to the prior year.
In this evolving landscape growth is driven especially by the payment segment. In 2017, investments in this area increased by 30% and it’s expected that, by 2020, digital transactions will make up nearly 20% of global retail transactions value.
Many observers and insiders made catastrophic predictions about the impact of FinTech on the traditional financial industry: in 2015 Francisco Gonzalez, President and C.E.O of Spanish banking giant BBVA, foresaw that half of the world banks would be wiped out by the digital transformation brought by the FinTech revolution. Three years later, this vision appears far too pessimistic: banks, to speak metaphorically, intend to use all the means to avoid ending up as taxicabs in this “uberization” of finance.
Such a disruptive change inevitably affects all those entities gravitating around the financial sector and presents critical challenges for financial institutions and regulators, as much as for the customers and final users. On one hand, banks and traditional financial firms are struggling to maintain their role as privileged intermediaries, while regulators face the arduous task of designing a legal framework that keeps up with the technological change and the liquid nature of the FinTech sector. On the other hand, consumers and users, who seem to have everything to gain from financial innovation, should be concerned of their data and money’s security. The extent to which FinTech is going to shape our lives and permanently change the way we think about money, for better or worse, will be determined by our ability to identify and address these challenges properly.
This document wants to highlight and spark a discussion among global top experts, leading practitioners and key decision makers on the main trends in the fintech sectors in general and payments in particular.

1.Partnerships between Banks and Fintech Companies

A common adagio says: if you can’t beat them, join them. Financial institutions struggle to keep up with the innovation led by FinTech companies. At the same time, FinTech companies’ growth will require increasing capital injections. For this reason, Financial Institutions and FinTech companies are working together to provide innovative financial services to their customers. According to the World Retail Report 2017, 91% of financial institutions and 75% of FinTech companies expect to cooperate in the foreseeable future, putting an end to the fictitious dichotomy between banking and non-banking sector. Financial firms are heavily increasing their investments in the FinTech industry, hundreds of bank-FinTech partnerships have taken place in the last year, through innovation programs, incubators, accelerators as well as acquisitions.
Since September 2017, four banks, namely JPMorgan, BNP Parisbas, Credit Suisse and Toronto Dominion made their first FinTech acquisition.
The most active acquirer in the industry is BBVA, that is attempting to supplement its traditional banking operations with fintech products and pioneered open banking, with the launch of the API Market program. The initiative will allow companies, startups and developers to build new products and services by accessing and integrating costumer’s banking data into their applications. Furthermore, the Spanish bank acquired the big data company Madiva, online bank Holvi Payment and the digital payment startup Openpay in the last year, with a total investment close to $1 billion.
In the same period the Merchant Banking Division of Goldman Sachs acquired a majority stake in Financelt, a POS lending startup, and is reportedly close to acquiring Clarity Money, which analyzes the financial situation of users and help them to better manage their bank accounts.
The two trends, of rapid transformation and banks-fintech partnership, are particularly visible in the payment segment. In 2016 core payment revenues represented 20% to 25% of global banking revenues, or $800 billions. It’s therefore natural for major investment banks to try and carve out a place for themselves in the payments ecosystem either by developing partnerships with the new players or by exploiting the so-called “network effect”. Zelle, for instance, is a US-based digital payment service launched by a large group of banks, including Bank of America, JPMorganChase and Wells Fargo, to compete with tech and fintech giants.
In the payment segment cooperation between the banking sector and new financial firms is particularly profitable: banks can count on the market infrastructure, a solid customer base and well-known brands, while payment companies are driving innovation. Goldman Sachs, for instance, is one of the largest shareholder in Circle Pay, a P2P platform that allows to send money rapidly through a blockchain solution. In the UK, Circle’s basic infrastructure was built by Barclays, marking a new forward-looking partnership.
What market infrastructure, ecosystem elements, policies and regulation can support the incubation and growth of dynamic FinTech companies before they can partner with financial institutions? What policy and environment would facilitate these partnerships and acquisitions? Furthermore, how can regulation change in order to favor investments in innovation and encourage banks to attract and retain technology-dedicated employees, in a way that they can compete with “Tech Giants”? What policies are necessary to retrain human capital in banks and make it more technology oriented? And finally, how can financial innovation, blockchain in particular, be used to increase the banks’ profitability, rather than reduce costs only? What policies and business attitude can facilitate the growth of digital payments and the adoption of new technologies in this segment?

2.Tech Giants and digital payments.

While Banks are partnering with fintech players or join forces to advance in the payment segment, Tech Giants don’t wait on the sideline. The success of payment apps like Apple Pay, Google Pay and Facebook Messenger is a clear indication of this trend. These companies are committed to become a disruptive force in the industry and, despite entry barriers, are gaining market share. How is the payments landscape going to look like in 2030? A big debate is floating around the world on how these giants should be taxed. Tim Cook stated that Apple should pay taxes in California where value is created and its R&D sits. How about consumer data? Aren’t data one of the most valuable assets in our society? How should policy makers view Tech Giants in their role of financial intermediaries and / or fintech providers?

3. Digital Payments and Financial Inclusion.

According to the Gates Foundation’s Financial Services for the Poor Initiative “the most effective way to significantly expand poor people’s access to formal financial services is through digital means”. Digital technologies are enabling the creation of cheaper, faster, safer and increasingly ubiquitous tools to tackle deep-rooted development challenges. Digital payments play a prominent role in the democratization of finance: between 2011 and 2014 they allowed 700 million people in the developing world gain access to formal financial services.
A 2016 report by McKinsey Global Institute revealed that digital financial services could add $3.7 trillions to the GDP of emerging economies by 2025. This additional GDP could create up to 95 million new jobs across all sectors of the economy. An additional $2.1 trillion of loans to individuals and small businesses could be made sustainable, while governments could gain $110 billion per year by reducing leakage in public spending and tax collection. Although the effects of this revolution seem more pronounced in developing countries, digital payments are driving financial inclusion and economic growth also in developed economies, particularly among women and young people.
Within financial inclusion, there are four aspects we would like to debate:

(a) Social and economic development: How can digital payments drive the transition towards a more equal society, in terms of economic and social opportunities in Western Countries? Is it legitimate to expect a great benefit deriving from digital payments in a country like Italy, where the job market is plagued by one of the largest shadow economies in the OECD?

(b) Privacy and security of data: in return for faster and more efficient payment transfers, users must be willing to share their personal data with an increasing number of providers. In this respect, banks and fintech companies are expecting a large amount of losses resulting from cyber attacks such as phishing, DDoS, data breaches and identity thefts, therefore cybersecurity is essential to face serious threats and to prevent massive damages, both from an economic as well as a reputational point of view. Bank executives are aware of the extent of the threat: 65% of the managers surveyed in 2017 said that cybersecurity is their number one concern in payments. How can FinTech companies be able to provide proper defensive systems against cyber attacks and manage data sharing and ownership properly? What policies regulators can enact in order to defend the security of customers data? And will these instruments be sufficient? Is the European cybersecurity package, adopted within the Digital Single Market strategy, enough to address the current threats?

(c) How to narrow the “cash divide”? Within mature markets there’s a significant divide on digital payments penetration: in the face of almost cashless economies (like Sweden or Finland), where the adoption of digital payment has been incredibly quick, there are some “cash loyalists” (Italy, Spain and Japan above all) were cash has proven more resilient. Countries such as France and the United Kingdom are considered to be “in transition”. Given the powerful advantages brought by digital payments, how can Italy narrow the divide?

(d) Technology as a mean to financial education and planning. A whole segment of apps is spreading around the world focused on making savings easier by analyzing income and spending patterns and making educated recommendation, offering piggy bank services (eg Digit and Prism), lower people income volatility and/or extending a more personalized cyclical and short-term lending (eg Even). How fast do we expect the adoption of these services in Europe? Do we foresee the raise of a European / Pan-European champion in this area?

4. Disintermediation Risk.

In Europe, following the approval of the PSD2 directive, Third Party Providers, when authorized, can access customers bank accounts and carry out transactions for them. Moreover, new digital tools, technologies, and capabilities are disintegrating the value chain that gave banks their dominating position. According to a survey conducted by Accenture, by 2020 23% of consumers in North America will give up their mobile banking app for a digital wallet that fits their payments information in one place and 64% of consumers plan to use a mobile wallet. The direct relationship between banks and customers could be strongly downsized. Even if the highly regulated environment where banks operate provides customers the assurance that their personal data and their assets are being protected, there’s no guarantee that the competitive advantage of reputation and trust will hold for long: consumers could give priority to efficiency and comfort rather than security. How can banks maintain a grip on their customers without missing out on new opportunities offered by technology? How can fintech companies grow on a standalone basis? What services can we foresee from a rapid adoption of PSD2? What would be the impact in Europe in terms of job and value creation?

5. Fintech and Regulation.

FinTech regulation is an issue that is being tackled differently in the various jurisdictions and it involves an active dialogue by regulators, governments and industry players. Regulators around the world are pursuing initiatives to sustain FinTech development and create a breeding ground for startups. Countries like United Kingdom, The Netherlands, Singapore and Hong Kong have implemented specific measures, for example “sandboxes”, with the aim to develop a safe environment in which financial firms and tech companies can collaborate and innovate. At the same time, in many countries, including the United States, Fintech regulation is underdeveloped and many asked for a smarter regulation to compete globally. In this respect, what are the best practices and initiatives for a Country that wants to foster financial technology development, without leaving room for moral hazard? And will an integrated approach to regulation at supranational level be necessary in order to avoid regulatory arbitrage among jurisdictions?

6. RegTech

Technology offers the possibility to comply with legal requirements and improve the overall transparency of the financial industry. RegTech, made of those firms that are using enabling technologies such as big data and blockchain in order to support financial intermediaries in complying with regulatory requirements, is the fastest growing area of FinTech. Global RegTech investments have doubled in 2017, with nearly 44% of total capital invested raised in the fourth quarter of the year and, according to CB Insights, the market for RegTech solutions will grow to around $120 billion by 2020.
Within the context of RegTech, the served segments of cross-borders payments and money laundering deserve particular attention. As highlighted by Brookings, FinTech and RegTech offer tremendous promises for broadening and strengthening the global financial system. According to the United Nations Office for Drugs and Crime (“UNODC”), the amount of money laundered annually is between 2% and 5% of global GDP, or between $800 billion and $2 trillion, with much of that being used to fund trafficking and terrorism. This huge amount of money is moving throughout the global banking network, thanks to an old and outdated global fund transfer technology. Payments are handled by multiple intermediaries, most of which are unaware of the identity of the others. RegTech provides a plethora of solutions to this issue: technology can eliminate cross-border payments risk enabling direct, point-to-point settlement of cross-border payments. What infrastructures and policies should be adopted to accelerate the diffusion of technologies to mitigate the risks of terrorist financing and money-laundering?

7. Digital Payments and Development (SMEs):

Last July Mastercard and Strands, a financial services software provider, announced their partnership, aimed at creating an integrated platform of digital cash management specifically designed to meet the needs of Small and Medium Enterprises.
SMEs are an important part of the economic fabric, but they often have trouble in finding financial solutions tailored to their requirements. In Italy SMEs account for 68% of GDP and 78% of employment. Dedicated digital services would for sure provide a powerful tool for development as well as a rewarding product. What are the key trends at play? How can a rapid implementation of PSD2 help?

8. M&A: moving towards payments industry consolidation.

In order to exploit economies of scale, enhance efficiency and take strategic initiatives for the whole sector, several companies are merging, creating new financial behemoths. Suffice to say that in Europe, from January to September 2017, M&A deals in payments have been made for a total value exceeding 40 billions and it is estimated that in the last few years they accounted for a quarter of the overall value creation in the field of digital payments. Among the most significant deals, it’s worth mentioning at least these three acquisitions, the largest in terms of value: British-based Worldpay was acquired by the American Vantiv for a record breaking $12 billion deal, creating the transatlantic giant Worldpay. Danish firm Nets was acquired by US firm Hellman & Friedman; British firm Paysafe was acquired by a consortium of The Blackstone Group and CVC Capital Partners, two leading American private equity companies. We notice that private equity funds are playing a crucial role in the current phase of European payments industry consolidation. How much longer is this trend going to last? How will the global payment landscape look like in 2030?

9. Asset Management.

Also asset management is experiencing a rapid evolution. Global competition, low interest rates and ETF “explosion” are bringing huge pressure on margins. In August 2018 Fidelity announced the first zero-fees benchmark fund, doubling down in September with two additional zero-expense mutual funds. Fidelity raised near $1 billion in the month after the launch of its first two no-fee funds. This initiative came out shortly before Vanguard Group launched commission-free trading on all ETFs. According to a research of Bain & Company, asset management face three avenues: the first two, scale and technology, lead to survival, the third one is “death”. In some cases, one survival avenue doesn’t rule out this other: in the US, the asset management giant BlackRock launched Aladdin, an operating system for investors that seeks to connect the information, people and technology needed to manage money in real time. Created in the late ‘80s as an internal risk tool for BlacRock employees Aladdin is the past, the present and could be the future of the asset management industry: 85 asset managers, including BlackRock’s historical competitor Schroders, are using the system, managing about $20 trillion of total assets through the platform. According to Credit Suisse, Aladdin manages 9% share of the asset management industry worldwide and a 15% share of the insurance market. The case of Aladdin is the living proof of the extent to which technology can change asset management industry, not only in the US.
Besides that, robo-advisory, artificial intelligence and blockchain offer a unique opportunity to strengthen the asset management industry. Pwc estimates that the assets managed through robo-advisors will grow of 350% in the next four years, from $371 billion dollars to $1350 billion in 2022. The US will lead this growth, but the Italian robo-advisory market is expected to grow at the yearly record-rate of 71% in the next four years, bringing the AuM from $191 million to $1.6 billions.
In Italy high households wealth is often cited as a key strength of the economy. Indeed, Italian households financial wealth is estimated in 4.4 trillion euros, which make Italians among the biggest savers in the euro area. Despite this huge amount of resources, the Italian asset management industry is at risk if it doesn’t invest in technology. What policies can help cutting edge technologies to emerge in the asset management sector, so that we do not let down this valuable industry? How can we help asset managers to foster a dialogue with tech providers?

10. Digital hubs: a two worlds comparison.

New York remains the leading American FinTech Hub. Back in 2011, the New York State Council redefined the State’s approach to economic development through the establishment of NYC seedstart, a consortium of venture capital firms that provided seed stage entrepreneurs with capital and support. The fund brought together 14,000 startups and 250 investors over the years.
Another organization which is worth mentioning is the Partnership Fund for New York City, the $150 million investment arm of the Partnership for New York City: the main objective of the Fund is to create jobs investing in for-profit and non-profit New York-based ventures. Among the various initiatives launched by the Fund, all regarding tech and innovation, there’s a program called FinTech Innovation Lab that specifically addresses early and growth stage companies developing cutting edge technology products for the financial services industry. With the mentoring, advising and training of senior executives in the world’s leading financial firms, the new entrepreneurs can improve their products, their business models and their networks. According to the report “Fintech on the Cutting Edge”, the New York Fintech market size is estimated at 8 billion dollars and the ability to attract 2 billion dollar investments per year and create 57,000 jobs.
On the other side of the Atlantic, London consolidates its position as Europe’s number one FinTech Hub for global investors. London has the world’s largest financial sector in Europe, supported by a booming tech sectors: the ecosystem can rely on the “Fin” of New York, the “Tech” of the US West Coast and the policymakers of Washington, all within a 20 minutes journey by public transport. The London fintech industry has profited from both the government’s action and the business world support. The UK government has supported the industry development through financial incentives such as grants, tax incentives and a direct fund investing in companies active in research and development. In parallel, the business community has undertaken a number of initiatives: Barclays, for instance, is running a highly sophisticated fintech acceleration program – “Rise”. Companies and the government partnered to establish London East Tech City, a concentrated cluster of technological firms ranging from innovative start-ups to some of the world leading technological companies, such as Facebook, Vodafone, Cisco and Qualcomm, that opened their headquarters in this area. The UK government supported the initiative with 15 million pounds funding, facilitating the creation of the cluster. As a result, 2017 has been a roaring year for UK’s FinTech sector, which has reached an all-time high 3 billion pounds of venture capital investments.
At European level, in March 2018 the Commission adopted an action plan for FinTech, with the aim of fostering a more competitive and innovative financial sector in the European Union. The plan is intended to make the whole Europe a global hub for Fintech and includes the establishment of a EU Fintech laboratory and a EU Blockchain Observatory and Forum. On the regulatory side, the Commission will present a blueprint with the best practices for regulatory sandboxes.
In 2017 total investments in European Fintech companies have reached 4.7 billion euros, thanks to over 400 deals. In the Deloitte’s report “A Tale of 44 cities” (2017), 20 out of 44 identified global hubs were in Europe. Among the new hubs, introduced in this edition of the report, Milan stands out as the only Italian city in the list. Given the prominent role of London, other notable European “following” cities are Zurich, Frankfurt and Stockholm. Until now, in Europe most of the debate has been focused on the geographical scope of Fintech markets, (i.e. whether they should be national or pan-European). A single European market would allow companies to scale-up and increase their global competitiveness. However, the project to create a single European Fintech hub seems to clash with reality. As in the case of New York and London, the co-existence of financial institutions, innovative companies and regulators is an essential condition for the development of a favorable Fintech environment. The synergies enabled by the geographical proximity are hardly replicable on a continental scale, thus it’s possible that some hubs will retain the benefits of the EU Commission Action Plan more than others.

The digital era is relatively recent, yet promises to catalyze the attention of investors, academics and institutions for many years to come. This unprecedented wave of technological innovations seems to have found in the financial sector a breeding ground to flourish. Facts and figures listed in these few pages prove that the revolution is just unfolding, spilling into contiguous sectors and deeply affecting our society. As mentioned above only a proper identification of the challenges and opportunities brought by fintech and digital payments, together with a comprehensive approach, able to go beyond the simple financial dimension and to account for social effects, will help us be prepared and make the most out of it. This roundtable gives us the opportunity to discuss fundamental issues for the future of our economic system, our relationship with money, and above all our everyday life.

Credit

Let me remind you that credit is the lifeblood of business, the lifeblood of prices and jobs.

Herbert Hoover

Health

Good health is essential to social and economical development and it empowers all of the public sectors.

World Health Organization

Innovation

Innovation is the specific instrument of entrepreneurship. The act that endows resources with a new capacity to create wealth.

Peter Drucker

Human Capital

Talent is a source from which water flows constantly renewed. But this source loses its value unless it is properly used.

Ludwig Wittgenstein