We know the next POTUS but we do not necessarily know what his policies will be at a granular level, although we know some of his pronouncements at a high and vague level. I will refrain from passing judgement on some of Trump’s promises, how he managed his campaign, some of his specific messages and the various forces that helped him get elected, such is not my purpose with this post.
We know, for example, that part of Trump’s platform is to create more US based jobs, which he intends to do partly via tax cuts, partly via the renegotiation of trade deals and potentially erecting trade tariffs, partly via smart infrastructure spending and partly via deregulation.
Without going into budgetary and economics details, a combination of tax cuts and increased infrastructure spending sure looks to me like a recipe for larger federal deficits, i.e. more government borrowing and the potential for inflation. Indeed, financial markets expect just that as the yield curve started steepening with long term rates spiking up immediately after the election.
Bank stocks also rose after the election, which is great news for bank investors as well as bankers. I believe this can be explained by two factors: the first being renewed expected inflation which I just explained and the second being potential deregulation. The former seems a foregone conclusion, the latter needs further examination.
Trump is no fan of regulation and has stated it on many occasions. We should expect many federal initiatives to be toned down, de-fanged or outright destroyed, based on how POTUS and Congress will collaborate. Think of the EPA, the Clean Air Act, Obamacare as being in the immediate line of fire. Trump has also indicated he is no fan of financial regulation, although his pronouncements have been less clear, and we have heard pundit chatter focused on repealing Dodd Frank in whole or in part – the Volcker rule comes to mind – or even bringing back Glass Steagall. He also has stated he is no fan of the current Fed Chair. Further, some of Trump’s supporters have also publicly criticized the recent DOL fiduciary rule intended for the asset management industry or their profound dislike for the CFPB. I am sure I am missing other financial regulatory flash points. At the same time, Trump needs to fill many positions for his incoming administration and the rumor mill is already hard at work, with industry insiders and/or lobbyists names being circulated to help with the transition effort or as outright candidates for prominent positions.
I venture that the complex system that is Trump’s vision and gut decisions on the one hand, his transition team on the other hand, and the influences both will be subjected to will flesh out exactly how populist the Trump administration will be or how friendly to the private sector, financial services firms included. Let’s take one example: the CFPB is one of the few entities that has battled banks’ wrongdoings. We also know that banks are still deeply unpopular due to their role in the great recession. Will a Trump administration rein in the CFPB and in so doing risk alienating part of their electoral base which is surely not pro-banks. As far as this example is concerned I sense a tension between Trump and his inner circle and a Republican Congress and Wall Street. In other words, how will “drain the swamp” will be interpreted and applied. The same lens can be applied to all other financial regulations which are deeply unpopular with the Republican establishment but may be interpreted as rightful banker punishment by the electorate.
Be that as it may and given that the Trump administration will be busy with dismantling other regulations and that the DOJ may be focused on other targets than the financial services industry – based on Trump’s goals – it is safe to say that in the most benign case, financial regulation will not increase and enforcement will move into neutral, essentially hitting the pause button, or in the most extreme case, deregulation will be actively sought. In either case, financial institutions will breathe a sigh of relief – small win vs major win – and will enjoy the fruits of renewed inflation expectations. Indeed, the more reliable story here is that of rising interest rates, obviously far out on the yield curve – this has already happened and will continue to happen I believe – and at some point also with short term maturities when the Fed will stop signaling and start raising. Even more so if the Fed Chair is replaced?
Rising interest rates is good for banks bottom lines. A fatter net interest income does wonders to the income statement and return on equity. The important question here is whether renewed profitability will halt further digitization of the industry or further enable it? Will fintech suffer or go from strength to strength? Will banks, which have resisted change up to only recently, use the excuse of increased profits to stop investing or collaborating in/with startups, stop rolling out ambitious innovation plans and return to a conservative stance? I suspect that in the aggregate the answer may be yes, the more so if return to profitability is swift and material. I also expect leaders to accelerate their plans to reinvent themselves, knowing that secular trends are too important to ignore and that tech giants are the real threat. Thusly a relative retrenching of US fintech related investments may be expected – arguably a continuation from the recent retrenchment – especially in the direct to consumer space. I also expect the third fintech wave to accelerate: deeper digitization via the adoption of enabling technologies sold to incumbents by new b2b startups.
This aggregate vision gives us only partial clarity though. What will be the impact within the fintech sector?
Banks have a natural competitive advantage against alternative lenders or marketplace lenders. In a low interest rate environment this competitive advantage was blunted. In a rising interest rate environment this competitive advantage will be used with ruthless efficiency. Thusly, I expect fintech startups in the lending space to come under pressure – natural outcomes would be further bank collaboration, mergers between alt lenders, acquisitions by incumbents and the inevitable bankruptcies of the weaker platforms. Should regulatory pressure on lending practices abate, this will further strengthen banks. Either way I expect banks to increase their domestic lending activities.
From a capital markets perspective – and to some extent in asset management too – less enforcement actions coupled with potential outright repeal of complex legislation or regulation and the introduction of simpler frameworks will reduce compliance pressure as well as regulatory dislocation. From that perspective some regtech business models may end up having a hard time finding traction. What is clear though is that any regtech solution focused on fighting fraud, illegal activities, tightening AML/KYC and identity verification as well as strengthening security and cybersecurity will remain strong given the broad consensus towards doing more rather than less in that space.
Based on my current understanding, I think the net effect of Trump administration will be neutral for the insurance sector and insurtech – not including health care obviously. I do not have enough data points though so I might be completely off the mark.
We also must deal with the payments sector. Considering an extreme deregulation scenario, might we see further changes targeted at interchange fees, on the credit card side, or more particularly on the debit card side? One cannot discount this entirely – again think of the interaction between a Republican Congress and President Trump. Needless to say that payments solutions that address infrastructure spending, directly or indirectly, will be potential winners. Incumbent cross border solutions that process or finance trade may be hit by a populist Trump bent on renegotiating trade deals and starting a tariffs war – trade finance or supply chain finance platforms come to mind given they cater to onshore/offshore manufacturing/trade value chains.
Switching back to higher level concerns, we should also keep in mind the potential for a global recession. Should the actions and choices of the Trump administration hurt the US economy and via domino effects trigger a deep recession, the financial services industry will be the first to be hurt: weak $, lower growth, less payments to process, less investments to make, less lending, increased risk. “Mainstream” fintech would definitely suffer if this were to happen. I believe this to be a remote event but one cannot discount it entirely.
Based on the last two points, it is therefore logical to infer that cryptocurrencies, blockchain solutions and bitcoin in particular – due to their disintermediated nature – may become even more attractive as alternative modes of payments, stores of value and means to build new exchange rails; whether new policies have a benign negative effect and especially whether we head towards more sever outcomes.
On another note, even though a majority of the tech industry did not support Trump, it is hard to imagine his administration being directly hostile to the technology sector, fintech included, and in so doing hurt job creation – indirect and unintended consequences of supporting “made in USA” and threatening the intricate global supply chains of most tech companies aside. Yet it is far from clear what Trump’s stance is with regards to Silicon Valley and on advanced technologies such as AI, robotics, blockchain, advanced analytics, IoT. Although these have the potential to augment humans, they also have the potential to eliminate them too. How would self driving cars play to his electoral base and his theme of creating mainstream jobs? What about the knowledge economy, the sharing economy, digital natives, digital workers, p2p networks, AI chatbots that would displace bank tellers. All these themes are imbedded in fintech, from payments to helping with lending, to capital allocation, to new financial services.
The above thoughts are focused on US fintech which is somewhat disconnected on the tech side from Europe or Asia. Domestic US payments is a beast in and of itself for example. European or Asian fintech is linked to US fintech via the $. Should Trump’s impact be a net negative on the $ and reduce confidence in the US economy, I would expect an acceleration towards decoupling away from the $ for international trade, international settlements, international payments. Alternative solutions such as a new basket of currencies, the rise of one to one currency settlements such as Euro-Yuan or in the more extreme case relying on a cryptocurrency as proxy for a new standard would de facto re-align global financial exchanges in a drastic new way and global fintech business models accordingly.
In summary I see several potential paths:
1) Extreme populism and no material financial deregulation lead to a global recession: fintech startups and financial services incumbents will suffer; crypto currencies and blockchain will get a major boost.
2) Benign populism and some financial deregulation lead to a slight positives and a middle of the road path: some fintech startup models will suffer and financial services incumbents will be stronger, all else being constant.
3) Watered down populism aligned with major financial deregulation lead to strong growth, at least in the short term: financial services incumbents to be the clear winners along with fintech startups tightly aligned with incumbents’ needs.
The fact that we are faced with such a divergent array of paths speaks to the unique and quasi-quantum state of Trump as a politician and businessman, exhibiting potentially pragmatic and radical intents simultaneously. I will even go further and state – Nassim Taleb who I respect immensely already made this point – that Trump was the ultimate antifragile candidate and that he may reveal himself to be the ultimate antifragile President. (Antifragility works up to a point, see path 1 above with clear winners and losers.) As such, thinking about fintech investment/operating strategies also need to be antifragile. I have already re-aligned my investment themes accordingly.
Trump’s administration picks as well as the decisions he will make in the first 100 days in office will enlighten us as to which is the most likely.