The Socialisation of Finance April 2015 Introduction crowd funding, peer to peer lending, socialized payments and automated investing

Transcription

1 The Socialisation of Finance April Introduction An insightful report published in March 2015 by the leading investment bank, Goldman Sachs provides some interesting perspectives on how finance is going social. This article draws heavily from that report. Developments in the regulatory environment, changing consumer behavior and SMAC technologies are combining to herald a new era in banking. This new era will be characterized by improved transparency, ease of use, cheaper products and services and greater access to financial services for both individuals and businesses. The buzzwords in the new era will be crowd funding, peer to peer lending, socialized payments and automated investing. The key message for the incumbent leaders in financial services: Upto $ 4.7 trillion of revenues is up for grabs by the new online entrants whose key weapons are technology and the ability to serve emerging market segments without being handicapped by past baggage. Current leaders who do not embrace new technologies aggressively, run the risk of getting left behind. Raising money Crowd funding means that instead of one or a small group of financiers, a network of people, each making a small contribution can support a new initiative. This is dramatically changing the way in which films are funded, new products are developed, decisions relating to charity are made and venture capital is raised. The value of crowd funding touched $ 10 bn in 2014, up from $ 1.5 bn in In quick time, crowd funding has evolved from being a primarily donation and charity fund raising platform (GoFundMe) to a rewards platform (Kickstarter) and equity investment platform (AngelList). In the US, the rise of crowd funding has been facilitated by some key changes in the regulatory framework. In the past, Regulation D did not allow general solicitation by an issuer not involved in a public offering and exempt from registration with the capital market regulators. So a startup could not publicly campaign for funds. In September 2013, amendments were introduced to permit general solicitation in certain cases. Soon, AngelList was able to feature on its website 1,000+ startups that were raising money publicly. More deregulation expected later this year could further open up the equity crowd funding market. According to Goldman, crowd funding could address a $1.2 trillion opportunity over time. This estimate is based on the combination of the most popular sources of funding for small business owners: bankcard loans, home equity loans, consumer financing loans, and VC and angel investors. Roughly 60% of crowd funding occurs in North America, 36% in Europe, and 4% in the rest of the world. What kind of initiatives are being funded? On Kickstarter if we go by the number of projects, the top categories are film & video (21%), music (17%), and publishing (11%). By amount of funding, these are games (21%), film & video (17%), and design (17%).

2 Wealth Management In wealth management, the traditional paradigm has been to use well trained client advisors to serve ultra-high net worth individuals with a high touch, personalized approach. Now a new breed of players is emerging. These players are trying to cause a paradigm shift by using automated investing, passive investment and viral customer acquisition strategies, enabled of course by technology. A simple and transparent fee structure also makes them more popular among customers especially the millennials. And these online players are also focusing on a new segment called the HENRYs (High Earning not Yet Rich. Think of our SMs and ADs!). HENRYs are essentially millennials who seem to have less trust in client advisors and more in their own social network for personal investing advice. HENRYs also seem to treat personal investing as less of an individual activity and more of an open and engaging social activity. The overheads of traditional wealth advisers necessitated a much larger size of customer accounts. The new players are able to leverage a lower cost structure, the benefits of viral customer acquisition, and automated advice/investment strategies to serve much smaller accounts. The online environment means that the fee structure is simple and transparent. And because of lower costs, the fee also tends to be low. Platforms such as Openfolio, Estimize and Mint have improved transparency and are making data publicly available. This is empowering consumers to make their own investment decisions. Openfolio allows users to link their brokerage accounts to better analyze their performance across various metrics, (e.g. returns and sector allocations), as well as benchmark their performance to peers and other successful investors. Estimize seeks to build a comprehensive platform of investor expectations for equities and other economic indicators. By creating a public platform of data that historically has only been available to those with market data subscriptions, this is further empowering consumers to make their own investment decisions. Mint, a personal finance management tool provides a single platform aggregating a consumer s balances and transactions. Features include real-time financials monitoring, budgeting tools, and custom financial planning tips. The new players in the wealth management space include Wealthfront, Betterment, Personal Capital and Future Advisor. Incumbents are taking note of the threat and responding in various ways. Schwab has launched Schwab Intelligent Portfolios in March 2015, an automated investment advisory service with no advisory fees. This product offers among other features, automatic portfolio rebalancing. Asset Management According to PWC estimates, there was $33 trillion in total assets under management (AUM) in North America in This figure should increase to roughly $49 trillion by The growth in the overall industry and the growing share of passive AUM within total AUM should create big opportunities for automated advisors. Over the last 2 decades, AUM in passive mutual funds grew from 3% of total MF AUM in 1995 to 9% in 2005 and to 16% last year. This trend is driven by multiple factors such as lower fees and total performance but the increasing participation from millennials is also helping. Millennials have a clear preference for passive

3 investing. Automated, passive investing may not beat the market but is designed to be reliable, consistent, rational and not prone to human errors / misjudgment. Loans Peer to peer lending has taken off following the global financial crisis for multiple reasons. Regulatory restrictions have put the shackles on traditional payers and forced many of them to become bank holding companies, which are more strictly regulated, and find it expensive to compete in certain markets. Startup financial services companies are now taking advantage

4 of this opportunity. And they are doing so in a way that leverages the psyche of millennials who have an affinity for online/ mobile access, automated processes, and transparency of data and information. They dislike traditional lending processes, which are generally in-person, involve a lot of paperwork, and tend to be opaque. Millennials are also underserved by traditional banking systems. So they are increasingly depending on online market places for their borrowing needs. The availability of data on an individual loan basis and sophisticated technology platforms are enabling online lenders to create more robust credit risk models, that take into account many more factors than can be done with tranche-level performance data alone. This is turn enables them to offer a quick loan application, and approve or reject applications almost instantaneously. Further, they are not directly regulated by agencies such as the FDIC. This gives them greater flexibility in offering different rates to different types of borrowers. In general, these lenders operate with much lower capital, have automatically matched assets and liabilities, and lower regulatory overhead costs. The 8 largest technology-enabled lenders LendingClub, Prosper, OnDeck, SoFi, Zopa, Funding Circle, Ratesetter, and Kabbage have originated more than $16bn of loans to date and served more than 1 million borrowers, primarily in the US and the UK and mainly in the consumer revolving credit (Credit card is a good example of revolving credit.) and small business loans verticals. The aggregate size of the immediately addressable opportunity may be more than $1.7tn. It is now quite possible that marketplace lenders can enter other consumer credit verticals, including the largest segment, mortgages. SoFi is an example of an early entrant into the mortgages vertical in 2014 with a focus on reducing transaction times during the mortgage application and approval process. By their very nature, these marketplace lenders benefit from strong network effects. As more borrowers come to the platform, there is a more robust track record. This leads to improvements in their credit risk models, allowing more accurate assessment of credit risk and potentially improving returns for investors. And this in turn attracts more investors to the platform. In addition to these traditional network effects, the marketplace lenders are also benefiting from the largely organic and viral growth on the borrower side of the platform. How do the new players get around regulations? Some examples will illustrate. LendingClub has tied up with WebBank, that is state-regulated and issues the loans. LendingClub buys the loan from WebBank and lenders fund the loan. So LendingClub is effectively outsourcing the regulatory compliance to WebBank. Prosper maintains a similar relationship with WebBank as its primary issuing bank. On the other hand, SoFi has also chosen a different regulatory framework by outsourcing the compliance function and by using private insurance on its customers deposits instead of FDIC insurance.

5 Payments Payments is another area where technology is causing a paradigm shift. Peer-to-peer payments platforms are currently dominated by cash-to-cash and equivalent transactions today. The growth of these platforms will benefit from the overall digitization of money, as transactions continue to shift from being predominantly cash to credit & debit, and over time, to fully electronic platforms. Venmo, a leader within pure-play peer-to-peer payments has succeeded because of its inherently social nature in the form of push notifications, social newsfeed of payments, and referral bonus. Similarly, social networks such as Facebook, Snapchat, and Twitter are all increasingly developing payments and commerce functionality to take advantage of their installed bases of users. New technology is making things easier for customers. It takes 5 taps to send money through Venmo but at least 15 through Bank of America. The step that involves the most friction ( i.e. stands in the way of a seamless experience) when transferring money through a traditional bank such as BofA is the process of manually adding each recipient s name, phone number and address, and then verifying it with a Pass code sent to our cell phone. In contrast, by connecting Venmo with Facebook, a user s entire social network is immediately set up on the platform, significantly reducing transaction time. While the US domestic peer-to-peer payments market is crowded with little differentiation, there is a huge opportunity in the international money transfers segment. According to the World Bank, roughly $550bn was sent internationally in Emerging platforms like TransferWise that are able to offer lower fees and more efficient exchanges are rapidly capturing a big share of this market. Incoming foreign wire transfers at the 10 largest US banks cost $18 on average, while outgoing transfers cost $48 on average. Assuming an average transfer amount of $1000, an outgoing foreign transfer translates into an average fee of 5%. This compares to a roughly 1% fee for a similar transaction through TransferWise. Some companies are also taking advantage of younger consumers decreasing usage of credit cards by providing alternative payments methods. For example, Affirm, launched in 2013 by

6 PayPal founder Max Levchin, provides credit to consumers that may not be interested in using a traditional credit card. In addition to using traditional credit history data, Affirm has built a credit system with more than 70,000 personal attributes using data available from social media and proprietary marketing databases. Younger consumers use more cash and debit while older consumers use more credit and checks. There is tremendous potential to convert younger consumers use of cash into electronic payments platforms such as Venmo.

7 Concluding notes The socialization of finance is a trend that is gathering momentum. It is being driven by a new generation of tech startups with a completely different mindset. These players are leveraging both digital technologies and a deep understanding of the psyche of millennials. How should the incumbent players respond?