19 Jan 2016
(And of course the really innovative fintech solutions are already changing the industry even if their market shares and revenues remain tiny.)
" There are – at least temporarily – massive hurdles for some of the more revolutionary fintech ideas to go mainstream."
Andrew Cornell, BlueNotes managing editor
In financial services, it is regtech - innovativee technology to support regulatory and compliance management - that is starting to garner much attention for two reasons: following the financial crisis, this is the sector which has faced not only the most regulatory escalation but also the biggest fines for regulatory breaches.
The other key reason is the financial services sector still has money to spend, especially on technology and compliance.
According to McKinsey & Co, there are more than 2,000 fintech start ups, compared with 800 in April 2015.
“Globally, nearly $US23 billion of venture capital and growth equity has been deployed to fintechs over the past five years, and this number is growing quickly: $US12.2 billion was deployed in 2014 alone" according to McKinsey.
Fintech, especially in the payments and peer-to-peer space, is obviously still of enormous interest but it is already being absorbed into the mainstream. For example, a recent survey by the University of Cambridge and Nesta, an innovation charity, found banks in the UK already account for a quarter of the actual lending originated on peer-to-peer websites.
But there are also – at least temporarily – massive hurdles for some of the more revolutionary fintech ideas to go mainstream.
Take Bitcoin and the blockchain distributed ledger behind it. If it is going to disrupt traditional global payments systems beyond the margin, it does actually need to integrate so consumers and merchants can easily choose.
In global electronic payments, ISO 8583 has been the standard for 35 years. This will be upgraded to ISO20022 at some point when - or if - all the players can agree. This proposed new ISO will deal with 'instant' payments and expanded message formats.
However Bitcoin and blockchain are not compatible with ISO8583 or ISO20022.
As one payment analyst suggests, if the global payment network is to switch to blockchain every key participant needs to switch to the non ISO protocol at the same time - which would not happen with over 209 countries needing to agree to move.
Or else incumbents like Visa, MasterCard, American Express, China UnionPay and the banks would need to run parallel systems at enormous expense.
Consider Visa handles on average around 2,000 transactions per second (tps) with a daily peak rate of 4,000 tps. Visa has a peak capacity of around 56,000 tps and 19,000 tps during peak shopping periods.
But the current Bitcoin network is restricted to a sustained rate of 7 tps due to the bitcoin protocol restricting block sizes to 1MB (for anti-spam reasons). The theoretical maximum is 7tps, the practical maximum is about 2.4 tps.
So what of regtech? The attraction is regtech potentially offers solutions or at least more efficient ways of dealing with immediate problems and costs already being incurred for new regulation.
The Spanish bank BBVA argues Regtech already has strong interest from regulators, central banks, corporate banks and traditional risk and regulatory consultancy firms.
“For financial institutions, addressing those regulatory requirements is highly burdensome, complex and costly," BBVA says in a new report. “According to The Institute of International Finance (IIF), compliance can cost a financial institution over $US1 billion every year."
The bank also cited McKinsey & Co' finding that regulatory fines and settlements in 20 large US and EU universal banks increased by 45 times in the 2010-2014 period.
“An estimate for financial institutions is now around 10-15 per cent of total workforce is dedicated to governance, risk management and compliance," BBVA says. “The main issues for financial institutions are compliance costs, reliance on manual processes in data management and traditional issues related to the quality of data, such as accuracy, lack of common definitions or different formats."
Moreover, as the quality and quantity of data (and data analysis) grows in institutions through more sophisticated use of Big Data, regulators will want access to that too to improve their vision of systemic risk and behaviour, according to BBVA.
Regtech makes sense. There are certainly opportunities to tap the same innovation and disruption evident more broadly in fintech to address regulatory challenges.
But as the peer-to-peer and Bitcoin examples show, there are limits to disruption, often technical but more often due to the complexity of interacting across jurisdictions, geographies and cultures.
Consider just a few examples: the challenges to Google and Microsoft in Europe; the recent Facebook controversy in India; the vastly different regulations governing the Uber ride-share platform around the world or consumer lending in different markets.
Or consider one of the more vexed issues at the moment, the setting – and manipulation or alleged rigging attempts – of lending benchmarks such as Libor (the London Interbank Offered Rate) and its regional variations, either offered rates or real rates such as Australia's Bank Bill Swap Rate.
Theoretically, there could be some neat regtech solutions here, a more efficient and less manual method of gathering, aggregating and weighting lending rates from multiple banks to set a benchmark.
But again, it is in the scopel rather than the mechanics of a solution where problems lie.
Alleged rigging of BBSW is currently being investigated by the Australian Securities and Exchange Commission. Together with proven LIBOR rigging, issues with the integrity of many benchmarks have led to reforms in how they are set.
However on Monday, Reserve Bank of Australia Assistant Governor (Financial Markets) Guy Debelle gave a speech on Interest Rate Benchmarks where he noted increased scrutiny of benchmarks and the withdrawal of some international participants had actually caused new problems.
“While the outstanding stock of bills and NCDs issued by the Prime Banks (which set BBSW) has increased since 2013 to around $A140 billion, trading activity during the daily BBSW rate set has declined over recent years to very low levels," he said.
“There are quite a number of days where there is no turnover at all at the rate set. The low turnover in the interbank market raises the risk that market participants may at some point be less willing to use BBSW as a benchmark."
Yet, as Debelle added, it is essential “BBSW remains a trusted, reliable and robust financial benchmark".
This is not a technology challenge. But it is a regulatory one. More to the point, financial institutions subject to a range of inquiries and new regulation around the world have made the decision to withdraw from certain essential activities.
As Debelle noted “institutions face a potential conflict of interest when they participate in the market underpinning a benchmark as well as the derivatives market that references the benchmark. Many institutions state they are uncertain about how regulators expect these conflicts to be managed. As a result, they are reluctant to trade during the rate set".
No smart app is going to solve that.
The key element is while regtech could feasibly enhance the rate set, the rules and implications need to be understood first.
In the McKinsey research cited above, the emphasis was on how fintechs approach the same regulatory complexity the banks are facing.
“Regulatory tolerance for lapses on issues such as anti-money-laundering, compliance, credit-related disparate impact, and know-your-customer will be low," McKinsey said.
“Those fintech players that build these capabilities will be much better positioned to succeed than those that do not. More broadly, regulation is a key swing factor in how fintech disruption could play out."
The flipside is regtech: regulatory swing could actually be one of the most attractive tunes the fintech industry can dance to.
Andrew Cornell is managing editor at BlueNotes
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
19 Jan 2016
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