2018 Fintech Predictions – the year of macro risks, part deux
It is that time of the year where pundits unabashedly flog the predictions market like a stolen donkey. I will not escape this tragic destiny and am adding my two cents to the mix.
I am doubling down on my macro risks optics – see my post for 2017. Indeed, if 2017 added a macro risk angle to the fintech narrative, 2018 will augment this angle and may have even more of an impact.
In as much as fintech is the act of optimizing or disrupting the financial services industry, this act has unfolded, so far, in an era of globalization and free trade. The rise of national economics and populism, which is a direct challenge to the flavor of globalization we have witnessed to date, will have an impact on fintech. Whether that impact is purely qualitative, reshaping the fintech space, or whether it will also be quantitative, restricting the fintech space, remains to be seen.
The “America first” policy the current US administration is espousing has created a leadership vacuum when it comes to multi-lateral trade and has halted further “business as usual” globalization. To be clear, other countries have espoused similar “me first” views to the point where the probability of a clear breakdown in globalization, as opposed to a reset along more balanced perspectives, is becoming more than a fanciful prediction. Extreme outcomes such as outright trade wars between various economic blocks will have a dampening effect on trade, investments and, as a derivative, on how the financial services industry will be impacted and adapt. Cross border activities such as trade finance, remittances, p2p payments and lending may suffer as a result. Further, cross border fintech investments may be delayed or halted (Chinese corporations investing in US fintech startups for example). Although trade friction is currently more of a US driven issue, we also cannot discount fully the unintended negative consequences of a “no Brexit” deal, although the latest indications introduce a ray of hope. Still, a less than satisfactory Brexit deal as it applies to financial services will put a damper on investment activity or will increase the cost of doing business for any fintech startup with pan-European aspirations. Might we see more UK based fintech startups naturally expanding to geographic locations (b2b or b2b2c models) other than the EU?
We are also witnessing the potential end of a regulatory cycle. The US administration has clearly indicated its willingness to repeal what it deems to be overbearing and costly financial regulations. In as much as these regulatory changes will only have a domestic impact, we should expect a fintech boost to all things lending. If these regulatory changes have an international impact (capital ratios, compensation, leverage) we may see the start of further regulatory divergence between US regulatory frameworks and international ones or the treatment and approach to financial legislation. This will have an impact on capital markets, cross border commercial banking activities and reinsurance to name but a few financial activities. We should expect regulatory divergence to both be a risk for regtech (as the cost of doing business rises, while servicing divergent demands from corporate users will be more complex) and an opportunity (as more sophisticated regtech providers, able to handle more complexity, will be in a high demand).
Macro risks also apply to the world cryptocurrencies and the blockchain space. Many blockchain applications are cross border – see my comment on Trade Finance above. How will these applications fare in a world of trade protectionism? As the world of cryptocurrencies defy Newtonian canon, it is attracting the attention of policy makers at an accelerated rate. The price of maturity is scrutiny. The price of maturity in financial services is regulatory oversight. The price of challenging the monopoly on violence a nation state enjoys is financial “excommunication”. The drums of war will beat louder in 2018 as central banks, bankers, regulators and legislators will rise, some to protect consumers, some to pretend to protect consumers in order to better protect incumbents and their entrenched interests. Interestingly so, this macro risk as applied to cryptocurrencies is a double edged sword as, to date, any governmental clamp down across the globe has had the effect of making cryptocurrencies more popular across a given population. Additionally, launching a fiatcoin (digital or crypto currency managed by a central bank, with the proper design and privacy/bearer caveats) may also be viewed as a macro risk, as it would definitely be a macro policy. It is not inconceivable we could witness the coexistence of fiatcoins and private cryptocurrencies. Even in this configuration cryptocurrencies will be subject to macro risk based on the following two statement: “She who controls mining controls the underlying cryptocurrency” and “cryptocurrencies can be an effective addition to a country’s sharp power arsenal” (disrupting a trading competitor’s markets via indirect manipulation of cryptocurrencies markets may end up the night job of various state actors, if it is not already the case). Paradoxically, the ICO phenomenon may be one which will unite legislators and regulators across the world as most have started to verbalize a common theme: stay within current securities laws.
Assuming readers of this article are exposed to social media, they are all familiar with fake news in its many incarnations. Fake news (disinformation, misinformation, falsified truths, incomplete truths, errors and omissions) have so far been limited to how we consume news. I expect a natural extension of the fake news phenomenon to extend to the financial services industry in a more direct manner. Let us call this trend the “fake data” trend. It is obvious that various actors – private, state sponsored, hybrid – are motivated with sowing confusion and doubt to further various geopolitical goals. We should not be surprised if 2018 will see the rise of similar strategies applies to the financial services industry whether via outright manipulation – see cryptocurrencies – the introduction of fake data, or the corruption of existing data. This prediction becomes even more salient when coupled with cyber attacks. Current cyber attacks should also be viewed as a macro risk – after all the nationality and location of cyber hacks is a mystery – and have so far been passive. By passive I mean they have been for-profit motivated (ransomware, dark markets monetization, fraud). Our imaginations should not be stretched too much by envisioning active cyber attacks augmented with a “fake data” vector, where the goals are wider and deeper, like the destabilization of specific asset classes or markets, or systemically important financial actors. Might 2018 witness such attack vectors? Whether it is the case or not, the opportunity to arm financial services incumbents is an ever growing one. After all, the BIS has listed cyber attacks as its # 1 risk to the financial system for 2018. Fintech startups that address cyber security, the veracity and protection of data will thrive.
The above fake data/cyber attack hydra naturally leads me to my next point: Data.
Regardless which metaphor you are attracted to, “Data is the new oil” or “Data is the new asset class”, the undeniable truth is that the digital world we are building is a data creation engine that thrives on consuming the data it creates to further its growth. Nation states have caught on data’s importance and are presenting us with different macro visions. The EU has opted for stronger consumer protections with GDPR, and to a lesser extent PSD2. This will lead to innovation and growth opportunities for fintech firms and incumbents alike within clear boundaries. China has clearly opted for a more freewheeling approach whereby a more permissive use and monetization of user data is allowed. This will also lead to innovation and growth opportunities, maybe more radical ones. The US is caught in limbo in as much as legislative vision has been absent from the “data” agenda to date. This may mean financial innovation as it applies to the use of data will come from China and Europe rather than the US. This may also mean investment opportunities with innovative fintech firms that handle data may be more skewed towards the EU and China. Additionally, protectionism also applies to data. Russia, China and the EU are very specific when it comes to data generated within their borders and financial services firms with global aspirations need to navigate asymmetric landscapes. As such, fintech service providers that are able to harness these data complexities will thrive.
Let us now address my last macro point: Interest Rates & Stock Market valuations.
Both interest rates and stock market valuations offer risks and opportunities when it comes to fintech. Most analysts expect either 2 or 3 rate hikes from the Fed in 2018. We are undeniably in a rising rates environment across the globe. This is good news for savers, for banks, for institutional investors as they should expect higher yields to pad their respective bottom lines. (Bear with me here and assume either a flat yield curve will still allow financial intermediaries to make money on the short end of the curve, or that the curve will steepen at some point in 2018, making my argument doubly appropriate.) Higher profitability will mean more capital available for further digital transformation which should help fintech startups bent on arming incumbents for a shiny future. On the other hand, higher interest rates introduce more risk into the system. First in lending, where default rates might creep up, and second in how they may impact stock market valuations. So far, the expectation of interest rates has not resulted in major stock market jitters – the strength of the EU economy, the promise of US tax overhaul, stricter Chinese regulatory approaches to an overheated domestic market may have helped. Should this state of contentment not hold – others may refer to a state of complacency – and should rising interest rates, or other macro shocks such as a war, lead to stock market tumbles and worse another financial crisis as banks standings would be threatened, then the risk of the financial system at large may translate into an opportunity for those fintech startups still focused on d2c models designed to challenge incumbents. For that matter, the entire cryptocurrency space would also receive a boost of confidence as consumers at large may feel even more disillusioned with traditional financial services. Incidentally, the BIS also lists current interest rates and stock market valuations as a potential risk to the system.
In conclusion, we are living through a historical realignment both politically and economically. It is safe to assume this realignment will have lasting effects on the global economy and national economies, regardless of which vision steers government. The reintroduction of the political will in the economic sphere is now occurring as new “digital” technologies such as AI, blockchain to name but two, applied to financial services have global repercussions. Fintech startups will have to refine their understanding and sophistication when it comes to these macro risks. Their financial services incumbents are already acutely aware of these risks.