Techfin: The Future of Finance

Big tech companies are increasingly looking to generate massive profits by providing financial services. This is techfin, a clear and imminent wave of disruption breaking on financial markets across the world. How regulators respond will define its impact and help to shape the future of the financial industry.

Big tech companies, like Facebook or Amazon, must inevitably operate financial services within the wider context of their business model. They are the controllers of massive online multi-sided platforms such as e-commerce sites and social networks. These platforms generate network effects; increasing in value for users on each side of the platform the more users there are on the other. Once a critical mass of users has been reached, a feedback loop rapidly grows both the number of users and their activity on the platform. The owner is then positioned to offer a range of services through the platform as well as to harvest massive amounts of data from users and their activity. This is a synergistic system: more services mean more network effects, more network effects mean more data, and more data mean more and better operated services. The synergistic effects scale exponentially as the platform grows.

This makes techfin qualitatively different to traditional fintech, the adoption of technology by a financial institution. An institution like a bank or insurer has expertise and ability relevant to its sector, but little ability to expand beyond that. Adopting technology allows them to enhance and modernise their services or even their business model to great benefit, but they can only do so much to disrupt the industry. The benefit provided by massive online platforms is an order of magnitude greater, hugely enhancing the scalability and efficiency of services provided through them. Techfin companies can therefore enjoy a significant competitive advantage when providing the same financial service.

This is demonstrated by Ant Financial’s Alipay. Alipay is a payment platform set up by Alibaba in 2004. The e-commerce platform at the time suffered from user hesitance to transact through the site. Sellers couldn’t be sure they would be paid if they shipped to buyers and buyers couldn’t be sure they would receive goods if they paid for them. Alipay provided an escrow service to Alibaba, holding money while sellers shipped their goods and providing refunds if buyers did not receive them. Both platforms benefited hugely. Users of Alibaba were much more willing to transact, dramatically increasing the network effects generated by the site, and Alipay was able to freely exploit the user-base provided by Alibaba. These users allowed it to ultimately expand its own suite of services, enjoying the efficiency and scalability benefits of its business model as it did so.

These allowed Ant Financial to blindside regulators with Yu’ebao, a retail-oriented money market fund (MMF). Minimum investment requirements frictionally impede growth of such funds, which usually cannot be avoided, but Yu’ebao is provided through Alipay. This connection means users can invest as little as 0.1 Chinese yuan. Combined with Alipay’s massive user-base, it was able to quickly rise to become the largest MMF in the world, managing so much money it created structural implications. Yu’ebao took on an important role in Chinese interbank funding, exposing those banks to its operations. If a panic hit Yu’ebao’s user-base, mass withdrawals from the fund could severely shock the banking system.

This is illustrative of the regulatory challenges presented by techfin – companies renowned for their ability to move fast and break things may end up doing just that. Regulators must be responsive. The Chinese approach demonstrates this urgency. To ensure financial stability, big techs were prohibited from allowing same-day redemption, leaving those services exclusively to banks. Additionally, MMFs were required to disclose more information and a RMB10,000 cap was introduced to instant redemptions. Further still, Chinese regulators recognised that the rate of disruption is so dramatic that risks must be pre-empted as far as possible. To cut down on potential risks from payment platforms investing deposited funds and adopting shadow-banking activities, such platforms are now required to hold customer balances in reserve at the PBOC.

Unfortunately for regulators, financial stability is far from their only concern. Techfin platforms gather and utilise massive amounts of user data, which creates serious implications for privacy. Additionally, since their competitive advantage increases with their size, major players may be able to dominate a market completely, severely compromising their competition. Data protection regulations and competition regulations are therefore necessary, but they can seriously impact the business model of big tech firms and affect how easily they penetrate and disrupt the financial services industry. As they inevitably do penetrate the sector, they will become increasingly intertwined with the world of finance, and policy arms are going to interact in new and complex ways. Data protection laws might affect the provision of financial services, and competition laws might have systemic implications of their own. Different regulatory bodies will therefore need to discuss with each other and coordinate their goals and policies. As techfins inevitably expand across borders, discussion and coordination must happen on a global scale. Success or failure to coordinate these responses will profoundly influence the nature and extent of disruptions coming to finance in the near future.

Disruption is coming, though, that is clear. Big tech companies will not be able to ignore the massive profits their business model can generate through offering financial services. Their competitive advantages and scalability will exacerbate the systemic influence they have on finance and financial markets. This will put Regulators under tight pressure to respond quickly, effectively and presciently. Their immediate approach will help to define the landscape for the next decade of innovation in the industry and will consequently shape the identity of the global financial system in the near future.