- Several papers proposed frameworks for considering the nature and shape of the potential disruption fintech may bring to the finance industry, and these frameworks were debated throughout the day. Would fintech displace traditional financial firms, like Uber in the taxi industry, or be co-opted by them? Would financial firms become the “dumb pipes” of finance with start-ups skimming value off the top, as firms like Netflix have done with telecommunications companies? Or might fintech companies extract value in different parts of the “financial stack”, such that financial firms might effectively end up outsourcing parts of what currently represents their competitive advantage?
- One strong thematic throughout the conference was the idea of a centralised versus decentralised network and operating model. The modern history of the financial sector is one of a centralised network – whether based in firms or exchanges, such as the ASX – where customers need to transact through a financial firm in order to access the financial service or product. In this case, the firm or exchange acts as a gateway, with the aim of both verifying identity and rightful intent of the customer in accessing the network while also acting to protect customers from financial harm. Australia’s currently industry practice and regulatory framework is primarily designed around the idea of a centralised network.
- Emerging technologies – whether sharing platforms such as P2P lending, robo-advice provided by algorithm, or real time settlement offered by distributed ledger technology, hold the potential to change the centralised model of finance into a decentralised model where a greater number of smaller firms and possibly many more customers may have direct access to the financial system. In a distributed network model of operation, how can customer identify and data be both verified and protected? Can such a shift occur and, if so, in what time frame?
- The challenge for regulators in adapting to the emerging world of fintech was a recurrent point of discussion. In a world of decentralised financial service providers and products, how may regulators identify who holds fiduciary responsibility? What are some of the solutions that fintech itself may offer to regulators – for example, the ability to monitor network activity through technological applications? Will it eventually be necessary to regulate the actual technology as new innovations emerge?
The conference discussion is summarised below.
Links to conference papers, and a list of presenters and discussants are provided at the end of this page.
Session 1: The rise of fintech – challenges and opportunities
Although fintech has been on the scene globally for a number of years, Australian bank CEOs seemed to really take notice of the potential impact on their businesses about 24 months ago. Emerging technology-based financial businesses are both directly competing with and/or enabling incumbent financial institutions, demonstrating the impact they are already having on financial services. The pace of the takeup of fintech over the past few years can be attributed to the changing nature of consumer behaviour, including the proliferation of mobile devices, declining levels of trust in centralised institutions, new technological innovation and attractive profit margins within the industry. Globally, these drivers ensured 2015 saw a record $US19 billion invested in fintech companies worldwide, as well the spread of the global distribution of top-100 Fintech companies from the US and Europe over to the Asia Pacific region, including Australia. Although Australia’s involvement is relatively small on a global scale, significant funding in alternative finance has ensured growth in the use of digital platforms at a rate much higher than that of the US and the UK. It is suggested that as much as 75% of the capital raised by credit platforms is currently being used to fund SMEs. As such, established financial institutions are becoming increasingly inclined to engage with and acquire the services provided by these Fintech start-ups, with the aim of generating new sources of value and avoiding the disruption that continuing to compete with these services may result in.
The framework under which we may understand the path of disruption remains a topic of great debate. The last 15 years has seen the ascension of digital media providers, such as Youtube, Facebook and Netflix. These firms have been termed “Over-The–Top” players as they operate on top of an underlying network and utilise this network’s infrastructure free of cost, extracting the value of the telecommunications service without having to invest in the capital required to provide it. The question was posed as to whether a similar phenomenon could take place in the financial services industry, with the introduction of Financial OTTs (FOTTs) that would exploit underlying financial services or product capabilities, resulting in the erosion of current profit pools. FOTTs are currently causing disruption via the disintermediation of financial institutions, the enablement of peer-to-peer market lending and the encouragement of participants to bypass the formal financial system. In emerging economies where a large share of the population does not yet have access to the formal financial system, such platforms and services may allow customers to remain “unbanked” but still provide the products or services they require. Payments, lending and advice represent emerging “battlegrounds”, all involving different forms of transactions. To that extent, there may be the risk of shadow banking emerging in the wake of fintech innovation; potential disruption to the system from unregulated firms will be an area for monitoring by regulators, and partnerships between innovators and regulators are encouraged. Incumbents are now questioning what investments must be made and how their business models must be renewed in order to address the threats posed by this disruptive innovation. Nevertheless, much uncertainty surrounds the extent to which consumers and enterprises alike will adopt this innovation as well as the extent to which these FOTT players will be successful in achieving scale.
Session 2: Robo advice
The Australian superannuation systems gives members a high degree of control over their financial decisions, but research shows many have low levels of financial literacy and are unable to afford financial advice that may cost $2,000 to $3,000 per year. Robo-advice has the potential to provide personalised advice at a much lower cost, reaching a much larger audience than traditional advice. This raises a number of questions about the design and delivery of financial advice:
What constitutes good advice? Advice should assess a wide range of risks facing retirees, consider all products on the market, simulate a range of possible outcomes, and reflect the risk tolerance of consumers. The Actuaries Institute has created a list of principles which is a good starting point and is equally valid for pre- and post-retirement. How broad should advice be? Robo-advice currently focuses on maximising financial returns (retirement income), but it has the potential to cover other elements of lifetime financial wellbeing (avoiding poverty, owning a house and car, paying for school fees and so forth). Who should robo-advice be delivered to? The cost of delivering advice directly is high and many consumers do not have the financial literacy to interpret it correctly. It may be more effective to deliver advice through a distributor (a financial planner) who can explain it. How much do customers need/ want to understand? Improving financial literacy is important and ASIC is doing a lot of work in this area; however even with this most people won’t know enough to make complex retirement income decisions, and many won’t want to devote the time to this. Who is responsible for digital advice and how should it be regulated? The distinction between personal and general advice will be difficult to determine in a digital environment, and it is unclear whether the algorithm’s creator or provider should be responsible for advice delivered. There may be a need for ‘radical openness’ with advisers required to share their code with regulators (and customers) for review. What is the right balance between digital and personal advice? Trust is paramount in financial decision making and it is not yet clear that people will trust digital advice. This may be changing, with recent surveys showing people trust digital corporations (such as Google) more than their banks. There is a large amount of research into the psychology of decision-making that will be useful as robo-advice grows.
Session 3: The paradigm shift in consumer credit data
Three years ago, at the 18th Melbourne Money and Finance Conference, Steve noted that the voluntary comprehensive credit reporting (CCR) regime was about to be implemented. Today, although CCR has been in force for over two years, it has not had the intended effect of boosting competition in lending. Instead, there have been unintended consequences – such as consumers receiving credit that they may not otherwise have been eligible for. Large lenders remain reluctant to share their data with competitors. Some observers have proposed mandating CCR, but lenders might no longer invest in data collection if their data are simply transferred to competitors.
Black letter law is not the solution to confronting this information asymmetry. Instead, technology may help to address the problem. For instance, one new technology ‘impersonates’ a customer (with their permission) in order to access their banking data, which can then be fed into external lending algorithms. ‘Good’ customers are likely to share more data – to assert that they are good credit risks. Placing individuals rather than enterprises at the heart of commerce can help to unblock the two major issues that Australia faces regarding data sharing for credit assessment: limited data access (where good information is unavailable), and oversharing (where unreasonable intrusiveness can compromise consumer privacy).
Session 3 (cont’d): Peer-to-peer lending – Structures, risks and regulation
Peer-to-peer (P2P) lenders are online platforms that match investors and borrowers. P2P operators see a competitive advantage in their online nature – they can theoretically operate at lower cost than traditional banks. There are two broad types of P2P lending model: (1) the active model, where investors can directly select the loans and portfolio that matches their risk appetite; and (2) the passive model, where the P2P operator chooses the investments for them.
There are a number of potential concerns with P2P lending in Australia. Firstly, investors are reliant on the ‘financial advice’ provided to them by the P2P operator, which assesses the creditworthiness of potential borrowers. But P2P lenders have an incentive to maximise the flow of loans, which may cause them to be less stringent in their credit checks. Secondly, there are privacy concerns for borrowers in uploading detailed information about themselves to P2P platforms. Thirdly, P2P lenders do not fit neatly with existing regulatory frameworks. In Australia, P2P lenders are regulated as managed investment schemes. A new approach to regulation is warranted.
Session 4: Crowd-sourcing governance
Corporate governance depends largely on group work processes. Optimising these processes to remove bias and improve group decision making is therefore critical to good governance. This can be achieved through the use of ‘crowd sourcing’, where individuals’ responses are aggregated either once (for example in a survey) or iteratively in response to market feedback signals (a prediction market). Prediction markets have higher accuracy than expert panels, management consultants, surveys or polls, and can assist in surveillance, forecasting and diagnostics, as well as corporate decision making. There are some limitations to the use of crowd sourcing in practice, for example they require a relatively large (30-50 member) group with sufficient ‘cognitive diversity’ and are relatively complex to develop. Further, they may reveal information which a corporation would prefer to withhold, and it may be difficult to establish appropriate incentives to solve more difficult problems.
Session 4 (cont’d): 150 years of fintech – An evolutionary analysis
Fintech is largely seen as a new phenomenon, however the interaction between finance and technology has been occurring for hundreds (if not thousands) of years. The first century of fintech evolution (1866-1967) was characterised by the beginning of financial globalisation, and the next 50 years (1967-2008) by the rapid digitisation of finance. The latest wave of fintech was triggered by the GFC which increased the cost of capital (opening the way for P2P lending and other options for extending credit) and saw a lot of talented financial practitioners re-enter the job market. This coincided with technological changes such as the proliferation of smartphones and tablets, cloud computing, and modern APIs. Simultaneously, fintech evolution in emerging markets was driven by economic development – with basic financial services delivered via technology or telecommunication companies rather than banks. Across both developed and emerging markets fintech is attracting increasing interest from regulators, and although there are a range of approaches to regtech, there is enough commonality that there may be scope for a common international approach that maximises market stability while managing risks to financial stability and consumer protection. There is less agreement on when to begin regulating a new technology, or how to regulate telecommunication providers that provide services that are close substitutes to those provided by banks. Governments in developed countries can support fintech by providing a regulatory carve-out, while in governments in developing countries should take a more active role in promoting fintech.
Session 5: Distributed ledger technology in securities clearing and settlement – Some issues
Distributed ledger technology operates on a distributed network model where nodes in the system automatically and instantaneously verify transactions and store information. Distributed ledger technology can increase efficiency in practises which are currently characterised by multiple layers of intermediation and reconciliation, such as equities clearing and settlement. These efficiencies are delivered through: improved data integrity (as there is no need for a central intermediary and no party can alter the ledger); improved access to data (as each participant has a copy of the ledger); reduced settlement times (as the ledger contains an immutable record of securities ownership); disintermediation (as distributed ledger can displace or fundamentally transform the role of some intermediaries); increased operational resilience (as the majority of the network, not just the central party would have to be corrupted); smart contracts (automation of events in a contract’s life cycle). Despite the benefits, it is likely that the transition to a new market supported by distributed technology will be gradual – reflecting reluctance to adopt the new technology before an industry standard is agreed. This process can be encouraged through the creation of hyperledger groups and building organisational knowledge through active participation in markets. More broadly, the government and regulators are undertaking broad consultation, dialogue with their international counterparts, and technical trials with Data61. The importance of trust in financial transactions suggests that private ‘permissioned ledgers’ are more likely identity-agnostic public models. Distributed ledgers may have interoperability across markets, solving some current problems with data fragmentation. As distributed ledger could significantly alter the way the market operates, regulators will need to consider: security; settlement arrangements; operational performance and resilience; smart contracts.
Session 6 (cont’d): Blockchain and the financial sector: The good, the bad and the ugly
Initial applications of blockchain or distributed ledger technology promoted the elimination of reliance on central institutions and were seen as major threats to existing financial institutions. As they have evolved, these technologies are increasingly being explored and adopted by incumbent institutions. These institutions systematically assess the opportunities for distributed ledger technology to solve problems which require increased trust, transparency, efficiency, and secure decentralised transactions among a number of parties. Incumbents are generally more risk averse than startups, investing heavily in testing (in contrast to the ‘fail fast’ mantra), and their adoption of the technology is restrained by the risk of cannibalising their existing revenue. Existing regulatory compliance obligation also prevent them from entering transactions with unknown parties (essential to the pseudo-anonymity of open networks), however by using private ‘permissioned’ networks with pre-authorisation market participants they can capture the key benefits of distributed ledger. While personal data can be store in a blockchain (creating a ‘digital identity’), the technology does not allow granular privacy protection where the individual can select which identifying items are revealed to other market participants and which remain concealed (although this does exist in Estonia). Distributed ledger is likely to have a significant impact on capital markets, payments, clearing and settlements and securities, however it still faces significant challenges, as highlighted by the hack on The DAO. The DAO (a decentralised organisation) was attacked by a hacker who exploited a bug in the smart contract to steal 3.6m ether (digital currency). This attack exposed vulnerabilities of relying on a smart contract which had not been sufficiently tested, and which was so inflexible so that once the attack began members were not able to react quickly enough to limit the damage. Further, the response to the attack (unwinding the transaction and returning currency to members) required changing the rules of the contract, undermining the immutable nature of blockchain.
Digital Gold, Nathanial Popper
Session 7: Regulatory issues
With an increasing prevalence of technology in financial services and rapid evolution of technology-driven financial products and services, regulators and industry both need to remain well informed on technological opportunities, risks and challenges. The emergence of RegTech – the idea that technology may also provide technological solutions for risk and compliance outcomes – may be a helpful way in which technology can also help to answer some of the challenges it poses. The Australian government has expressed support for the innovations related to fintech, and Australian regulators are at the forefront of emerging global practice on evolving regulatory structures in order to support innovation while maintaining system stability and integrity. Established and start-up players alike recognise the value of ensuring a strong regulatory framework and compliance within that framework, for the benefit of the system and its users. Regulators are thus finding firms are commonly requesting guidance in navigating the regulatory parameters of robo-advice, crowdfunding, marketplace lending, payments and blockchain. Similarly, regulators are proving committed to the facilitation of innovation in financial services, so long as there is the clear aim of benefitting consumers through outcomes. The recently formed concept of a ‘regulatory sandbox’ aims to provide firms with space to prove up their products or services without having to heavily invest in compliance practices that may not be required if their product is either not viable from a commercial perspective – in other words, the sandbox should help start up fintech companies to “fail fast” while maintaining regulatory integrity and consumer confidence.
Session 7 (cont’d): Regulatory Roundtable / Open Forum
The government’s aim is to minimise the obligations new market entrants such as fintech start-ups must adhere to, with regards to customer service and product provision, so as to ensure that these businesses operate autonomously as quickly as possible. Broad principles include maintaining financial stability, ensuring consumers are fairly treated, as well as promoting innovation and competition amongst enterprises. Despite this, there do exist a number of key challenges from the government’s perspective, in terms of incorporating fintech into the financial system. These involve achieving consensus amongst a diverse range of stakeholders before formulating policies, finding a balance between innovation and consumer protection, dealing with low levels of financial literacy, and venture capital for fintechs. These challenges carry over to regulatory authorities, who have always been technology agnostic and encouraging of a gradual approach with regards to new ventures (starting off with lower risk initiatives to be able to learn and grow), and are being forced to regulate networks of expanding magnitude rather than just closed financial institutions. It is also vital that this regulation, as well as seeking to ameliorate the time taken for the model to receive a license, acts as a second eyes which confirms the aptness of a new business model and provides informal assistance, rather than as a source of regulatory relief and a deeper form of education, which eliminates the need for regulatory input from the fintech start-up. A large question mark seems to exist regarding whether or not current legislation is flexible enough to adequately facilitate fintechs. This is largely dependent on whether or not they have a defined profession through the model they offer. It is generally agreed upon that this information could be enhanced by funding statistical agencies that specialise in accruing data, in this instance, related to how many financial service providers exist for each financial service. Such data relating to financial services could also shed some light on the risk associated with engaging with these fintechs, as well as knowledge regarding when this risk is too significant to ignore. Such risk currently exists in the form of shadow-banking and the use of already-existent systems or an underlying network by a start-up for its own profitable ends. Nevertheless, the primary aim of regulatory organisations is to emphasize the benefits that their services can offer start-ups, including opportunities to provide better services and quality contribution, rather than the risk an entrepreneurial venture can result in.
CONFERENCE AUTHORS AND DISCUSSANTS
D1P1 – The Rise of Fintech: Challenges and Opportunities
Presenter: Ian Pollari, KPMG
Discussant: David Cox, Challenger Limtied
D1P2 – Fintech: An Overview of Emerging Issues
Presenters: Meredith Angwin and Maurice Violani, EY
Discussant: David Robinson, Melbourne University
D1P3 – Robo Advice
Presenter: Hugh Morrow, SuperEd
Discussant: Annabelle Butler, Suncorp Group
D1P4 – Robo Advice
Presenter: Frank Ashe, Quantitative Strategies
Discussant: Carsten Murawski, Melbourne University
D1P5 – The Paradigm Shift in Consumer Credit Data
Presenters: Lisa Schutz, Infact Decisions; and Steve Johnson, FIMA
Discussant: Shane Tregillis, Financial Ombudsman Service
D1P6 – P2P Lending: Structures, Risks and Regulation
Presenter: Jacob Murphy, University of Melbourne
Discussant: Martin Joy, ANZ
D1P7 – Crowdsourcing Governance
Presenter: Karl Mattingly, SlowVoice
Discussant: Maurice Peat, University of Sydney
D1P8 – 150 years of FinTech: An Evolutionary Analysis
Presenter: Ross Buckley, UNSW
Discussant: Mike Skully, Monash University
D2P1 – Distributed Ledger Technology in Securities Clearing and Settlement: Some Issues
Presenter: Maxwell Sutton, Reserve Bank of Australia
Discussant: David Link
D2P2 – Blockchain and the financial sector: the good, the bad and the ugly
Presenter: Sophie Gilder, Commonwealth Bank
Discussant: Vincent Gregoire, Melbourne University
D2P3 – Fintech: Regulatory Issues
Presenter: Mark Adams, ASIC
Discussant: Carla Hoorweg, FSC
Regulatory Roundtable / Open Forum
Panel: Leon van Kemenade, APRA; Mark Adams, ASIC; Julie Greenall-Ota, Treasury
The Melbourne Money and Finance Conference is a unique conference series that brings together invited academics, industry participants and regulators under the Chatham House rule to discuss specially prepared and selected papers on emerging matters of significance in the finance sector.