FinTech for Breakfast
To be held on Wednesday, February 8, 2017, 8.30-10.00am
With support from Dentons
Kadhim Shubber (FT Alphaville)
Giles Andrews (Zopa)
Normally, we have tough decisions to make each month about which stories to include in our FinTech for Breakfast session. This month, we had Mark Carney’s speech at Davos to help point the spotlight for us – so what’s on the Bank of England’s FinTech radar?
Mark Carney talks FinTech at Davos
The big focus in Carney’s speech was on managing FinTech to prevent a rise in systemic risk. The overall theme is that disruptors may reduce the stability of the existing system – but the pinch points highlighted were interesting:
• Will Open Banking undermine banks’ customer relationships and make their deposits flakier?
• Will new lenders introduce higher levels of credit risk into the system?
• Will algorithmic trading create unwitting herding worse than the unwitting herding of human investors?
• Will innovations in market infrastructure turn out to be robust?
• And will all this extra IT introduce unmanageable levels of operational and cyber risk?
So, a couple of things to chew on this month. Thankfully we have the excellent Kadhim Shubber of FT Alphaville and the equally excellent Giles Andrews from Zopa to help steer us through it.
Pressure on big banks?
McKinsey put out a report on the double threat of regulation and FinTech facing banks. It’s sobering stuff, with the potential pressure on UK banks so severe that profits could halve by 2020, according to the consultancy.
Still, there are some big assumptions underpinning the estimates, not least of which is the ease with which ‘disruptors’ can poach customers of big banks. Does it really only cost $5 for a start-up to acquire a financial services customer? We have a few experienced hands in the room who’ll hopefully shed some light.
Whether McKinsey’s estimates are realistic or not, big banks are taking the threats (and opportunities) seriously, with HSBC announcing a fairly big-hitting advisory board.
First things first: Mark Carney was clear that the P2P lending market doesn’t (yet) pose systemic risks. Equally, he was happy to echo at least some of Lord Turner’s concerns (the refined ones from October, not the early-2016 off-the-cuff ones). Specifically, the concern is that as marketplace lenders evolve we may see:
“business models evolving in ways that introduce conventional risks, including maturity transformation, leverage and liquidity mismatch, or through the use of originate and distribute models such as those seen in securitisation in the 2000s.”
Underlining how fast institutional money is flowing into P2P platforms, Aegon extended its commitment to German lender Auxmoney with an extra €1.5 billion. Whether it’s by embracing securitisation, or taking on deposits to smooth mismatches between supply and demand, P2P firms have certainly been looking at banking models to help smooth their growth.
The more marketplace lenders look like banks, the more regulators are likely to treat them as such – although not everyone in the P2P industry will necessarily find that a bad thing.
PSDII meets Open Banking
Carney also had a few words on the coming Open Banking and PSDII:
“The opening up of the customer interface and payment services business, could… signal the end of universal banking as we know it”
If banks lose their grip on retail deposits and their advantage in customer data, which gives them more accurate product pricing and cheaper distribution, then the resilience of big universal banks could be seriously tested. But as always, it pays to read the small print…
Last week, the Treasury issued its consultation paper on the EU’s Payment Services Directive II (“PSDII”). Unless you’re a specialist (or fancy reading a few teach-ins like Deloitte’s paper on the importance of the EBA’s draft regulatory technical standard, or “RTS”) you might skip to clause 6.10:
“The government therefore sees the PSDII implementing regulations as providing the legislative foundations on which the Open Banking API Standard then sits.”
With PSDII as the legislative basis of the UK’s Open Banking, things like the European Banking Authority’s regulatory technical standard (RTS) on strong customer authentication (SCA) and secure communication seriously matter for Open Banking.
Depending on what’s in the EBA’s proposals, we could see two factor authentication (2FA) required on e-commerce transactions as small as €10 (and that’s already causing concern). If the authentication and communication standards of PSDII apply across all of Open Banking (not just the payments side) then customer adoption could be an issue – but universal banking as we know it should be safe a while longer.
The EBA’s RTS on SCA and communication should arrive around Valentine’s Day.
Algorithmic trading & robo
Some stats from the Carney speech: 75% of equities trading and 40% of FX trading are now algorithmic.
Adam French from Scalable Capital took exception to the inclusion of robo advice in the BoE Governor’s list of potential sources of risk - and, in fairness to French, robo advice is hardly big enough to be systemic yet. The wider point is that model validation, audits and reporting are an important part of supervision and regulators may take a keener interest – particularly in how the algorithms respond to market disruption and illiquidity.
Distributed ledger initiatives announced this month include: Deutsche Börse’s new collateral management team-up; SWIFT trying a proof-of-concept to reinvent the nostro system and make inter-bank settlements smoother; and DTCC has a white paper out calling for a joined-up approach to post-trade settlement.
As much as innovation has the capacity to introduce instability into market infrastructure, the recurring story so far has been the opposite. Deutsche Börse, SWIFT, DTCC and indeed all the other big firms looking at the issues are risk averse. An awful lot of test projects have been announced – and until they’ve been tested and tested and tested we’re unlikely to see many of them hit production. So, as much as it’s wise to recite the risk, the chances of any significant player taking unnecessary risk in this space looks (for now) remote.
On the cyber front, Carney put ‘chameleon risk’ on the table. Customers and investors trust financial brands to look after their money. Under the bonnet of every financial firm is a complicated engine of countless third-party providers supplying software, hosting, connectivity, processing and so forth.
The Davos speech signalled the Financial Stability Board’s willingness for regulators to ‘pop the hood’ and make sure that – as more and more FinTech companies provide components for the big engines of the financial system – those components are properly tested and roadworthy.
New York looks to be leading the way on this one, with an updated proposal for cyber regulations issued at the end of last year. There’s a fair amount in it requiring CIOs to take ownership of the risks of their third party providers.
What didn’t Mark Carney talk about?
Insurance didn’t get much of a mention. Cyber insurance came up, but insurtech isn’t big enough yet. Still, we’re pretty fond of it, so honourable mentions for Cuvva and Bought by Many for securing new funding rounds.
Anchoring for us this month will be FT Alphaville’s Kadhim Shubber, and joining him will be Giles Andrews, chairman and co-founder of Zopa (and co-author of the Blackett Review on FinTech). Between them, they know a thing or two about peer-to-peer loans, which is good as there has been a fair bit going on in marketplace lending.
Fortunately, they also know a good deal else, as it looks like we have a lot of ground to cover. It has been a bearish (bleak?) month so far, with focus firmly on the threat to the status quo:
- Mark Carney pointed out the elephant in the FinTech room at Davos, noting that disruption to traditional players may lead to less stability;
- McKinsey tried to quantify how much of UK and European banks’ profits are at risk from digitization and regulation – estimating that the combined effect could halve profitability by 2020;
- HSBC appointed a tech advisory board to help it stay ahead of the challenge;
- InsurTech start-ups continued their popularity with investors into 2017, with both Cuvva and Bought by Many securing new funding;
- Lloyds Bank reportedly came under siege from a huge distributed denial of service attack – although it maintained service throughout; and
- City law firms could be next in the queue to deploy machine learning and robotics, according to a report from the Law Society.
If you (or a colleague) would like to join us, and share your own priorities and perspectives, please let us know by emailing firstname.lastname@example.org or calling the office on 020 7621 1056. Thanks to our friends at Dentons, there will be plenty of tea, coffee and sticky buns to keep us going.