From saving you money, or lending you money, through to providing investment advice - the FinTech sector is stripping out inefficiencies that have plagued the Finance industry for far too long. With access to greater information and end-to-end solutions, there’s a growing number of digital disruptors with platforms that can be leveraged by your business.
- What defines a platform, product or service as FinTech
- How FinTech applications can improve doing business
- How BlockChain can be useful to business and when should it be applied
- Impact of the national framework for e-invoicing which is targeted at all Australian businesses
- Issues facing the sector including trust, security and privacy
What is FinTech?
‘FinTech’ is a broad term that can cover anything from a bank through to a software company with products that manage transactions, or transfers data of financial transactions. It’s essentially the solving of a finance or transaction based problem using technology.
At this stage its definition is still somewhat loose as new products will continue to define what the space is as players look to solve financial related problems using tech.
There are pure FinTech companies that are building platforms that other people can use. There’s also secondary FinTech companies that deal in a specific vertical (ie a platform that allows you to save for you children’s education).
The foundations of modern investing or Modern Portfolio Theory only came about because of the advent of modern computing. The ability to crunch massive amounts of data enabled the creation of products like Index Funds. Whilst the term ‘fintech’ is new, technology has always been integral to investing.
FinTech is an enabler for other industries. It unlocks efficiencies, access to capital, information and services that other industries may not have previously had access to.
What is blockchain?
At a simple level a blockchain is a network, just like the internet is a network. It’s also a very ‘dumb’ network that doesn’t care what you transport on it – a file, photo, financial transaction, video or contract. This makes it versatile meaning it has many uses, some of which are FinTech related.
There are two types of blockchains:
- Public – i.e. Bitcoin (the most common). Permission less, peer-to-peer and accessible by anyone with adequate technology
- Private / Consortium – i.e. within an industry such as banking and secured by user rights
There’s currently over 10 blockchains that exist and over 1,000 blockchain start-ups across the world. It’s now the largest distributed network globally. Attempts to hack it have been unsuccessful, though there have been successful attempts to hack the systems in place at the edge of the blockchain network. It’s important to be clear what is blockchain and what isn’t. For example, a mailbox exchange sitting at the edge of the system is a centralised database that has all the flaws of any centralised application and not part of the blockchain itself.
Most blockchains, including Bitcoin, require ‘mining’, which is essentially block validation by proof of work. Every block in a blockchain contains a hash of the block’s data and the previous block’s hash. Mining is the process of solving the equations to confirm blocks on blockchains that depend on cryptography to build it.
Blockchain could be considered like a distributed ledger in that it keeps records. If anybody interferes or changes them then it’s immediately noticed because they no longer match. This immediately stops fraud.
It’s currently a very confused and over-hyped space (probably sitting just below the peak of hype!). Australia accounts for 3% of the block chain startups in the world.
Can blockchains grow infinitely?
Yes, they can get bigger forever, however there are methods for managing that. Mathematical methods allow for the data to be compressed and it’s currently a challenge being explored by miners.
What does blockchain mean for the banking system?
Blockchain means that lots of the expensive banking systems that have been maintained for decades, can be in theory be replaced by something that’s very reliable – in theory.
This implies a huge change management project – an aspect that hasn’t necessarily been looked at, or received enough attention.
Rather than replacing the entire system within a business, it’s likely that the technology will be adopted for small sectors of the banking process. This will mean radical change for some small sections of the banking business, rather than the entire business.
Part of the motivation for this is because It will be easier to build a new bank rather than change legacy banking software. Players like the R3 Consortium are currently experimenting with various applications for banking.
Australian banks, being ‘transaction’ focused, are attracted to blockchain as it’s an international trend and to be considered serious players in the global banking market, they need to be involved.
In theory peer-to-peer transactions are a threat to banking but probably a small threat. At this stage the Australian regulatory requirements keep this at a minimum. FinTech is currently a bigger threat to Australian banks than blockchain specifically as it’s more mature.
Examples of the small banking processes that blockchain may replace in the near future
One area of immediate interest is the swift process for international transfers - breaking down those and replicating that using blockchain.
Unit registry is another area of interest. This is the book of records identifying a change of ownership. Every large investor will have a custodian or unit registry system behind them which is potentially one book. Blockchain could theoretically replace CHESS.
The Land Titles registry is another example. Ethereum is a decentralized platform that runs smart contracts and is built on blockchain. This can teach users the process of running a smart contract to buy a title of land in the virtual world. This will cost you 1 ether and secure you a title to that virtual property, which you may then transfer to someone else. (https://www.ethereum.org/)
Major international banks BNY Mellon, Deutsche Bank, ICAP and Santander have recently joined UBS and Clearmatics to advance the development of the Utility Settlement Coin concept. USC is a digital cash model aimed at facilitating payment and settlement for institutional financial markets. The group will collectively build on the successful outcome of initial explorations of the USC concept, performed by UBS and Clearmatics.
The ASX is currently working with Digital Asset Holdings (subsidiary of Goldman Sachs) in New York with a view to replace the CHESS settlement system with a P2P and blockchain system.
Can police access data from blockchain?
All transaction data within Bitcoin is open, meaning you can look at account balances or even trend map behavior. However, this data is recorded by number, not by name.
If the blockchain is KYC (Know Your Customer) then the name of the account holder could be provided, if not then police would need to do some detective work.
The relationship between the person conducting the transaction and the transaction may actually be undiscoverable unless someone’s been spying on it. The Bitcoin blockchain is pseudo anonymous. The fact that it runs autonomously means that there’s no authority to go to for the information.
There are other types of crypto-currencies beyond Bitcoin which are designed to be anonymous. For example Dash - https://www.dash.org/
What are robo-advisors?
Robo-advisors provide automated financial advice to investors. They seek to democratise advice to allow the 80% of Australian that don’t get financial advice, to access some level of advice through digital means.
How is regulation impacting robo-advisors?
The challenge is whether robo-advising can work within the current legislative framework. The ASX’s greatest concern is an algorithm going rogue and providing inappropriate advice. The advice is 24/7 – 365 days a year meaning in theory you could generate a statement of advice at 2am in the morning. If that’s incorrect then there’s no one around to rectify that.
Last week the ASX released their position which looks to assess:
- Are the people behind robo-advisors competent?
- Do they have sufficient skills across both finance and tech?
- What’s the veracity of their algorithms and the process for reviewing those before they’re deployed?
The responsibility of checking the algorithms lies with the Australian Financial Services License ‘holder’ or a representative of a licensee. The issue with this is that most robo-advisors have an outsourced license model rather than holding their own (Clover hold their own). The ASX deem the responsibility to fall on the licensee – which may not even be the robo-advisor.
The ASX had also wanted third party validation of algorithms by an actuary or global consulting firm that can verify the veracity of them. This was pulled last recently, meaning the final responsibility lies with the license holder.
The concerning issue is - does the licensee have the appropriate skills within its organisation to verify the quality of the robos that they’re effectively licensing?
How can robo-advising be utilised by business as opposed to individuals?
Version 1.0 targets individuals and is very much about non superannuation advice, though Clover have built their technology to be able to be used by a super fund.
Robo advice 2.0 will start to look at things like gamification. Ideally if users are willing to provide a richer understanding of themselves then robo-advisors can provide better advice. Currently it’s quite binary. If you could log into the robo-advising platform via Facebook or another social media platform then they could gain insights such as how the user responds in stressful situations, what their behaviours were at Brexit – how they might start to respond in the next mini-financial crisis.
Baby steps are needed to ensure the technology is right in its infancy. Ultimately it will morph to a hybrid model where financial advice firms and wealth managers use elements of robo-advice to deliver better outcomes to their clients at lower cost and to do it more efficiently.
An outcome of the GFC meant that compliance for providing financial advice now forms about 30% of the cost of giving advice. This has priced advice out of the reach of many Australians. Robo-advice can help overcome some of these frictions as it starts to get applied by the big end of town.
Will robo-advice evolve to the next step beyond asset allocation, to how funds should be distributed within the asset class?
It could. The current version is very much about portfolio construction and asset allocation. The elements of financial planning that are math based could be managed by a robo-advisor as they’ll beat a human advisor every time by being faster and more consistent. They’re also not exposed to behavioural biases that human advisors naturally are.
In regards to elements of active management – i.e. can the robo take a short to medium term view on Australia versus the US or developed markets versus emerging – there are robos that are starting to go down this path.
How do we close the loop to understand the change in people’s total wealth to assess whether robo-advisors really are good or not?
This is the complexity continuum. The most natural place for robo-advice is for younger Australians who are starting their journey and don’t have a huge amount of complexity as far as assets and structure is concerned.
The big end of town is very interested in algorithmic trading. In some cases you could argue that high frequency trading is already this. Hedge funds will probably be the early adopters in this space, where over time hedge fund managers will eventually start trusting their algorithms more than their traders. The difference between this and something like Clover is that the latter aren’t trying to beat the market, they’re trying to removal behavioral biases and cost of providing financial advice to the investor.
How can we secure privacy of information in open cloud based platform technology?
Traditional strategies include hashing, salting and encrypting passwords, usernames and transaction IDs and employing SSL certificates and performing regular penetration testing. However, the security models in existence are full of more holes than a piece of Swiss cheese.
Security in the internet is built on a compilation of Microsoft Word documents and Excel spreadsheets. Its procedure based – multiple questions. The problem with it is that it’s all dependent on a human being following these processes. Most data is in plain text format and sent via programs like Outlook. Data that we’re exchanging needs to be encrypted more securely.
Ozedi has recently released an end-to-end encryption engine which takes the data, i.e. an invoice and encrypts it at the source. The only person who can decrypt the payload is the recipient. Encryption is not the total solution but must form part of it.
Another new technology that’s looking to improve security is the Safe Network (https://safenetwork.org/) which assumes that things are not shared as default so you actually have to choose to share them.
What’s reaction from government regarding security?
The Government are talking about using 3 factor identification which is cumbersome and too hard and impractical for users. They are scrambling on how to deal with this.
The ATO is possibly the most focused on security because of the financial data they send and receive, and because of large digital transformations in the pipeline like Single Touch Payroll – due to come online in 2017. This requires that every single payroll event go to the ATO, every pay cycle -containing every employee’s data.
There’s currently no holistic government approach to security.
Why governance needs to be promoted up the FinTech agenda
The Singapore Bitcoin Currency Exchange was hacked recently and lost $96M. The bank then advised all account holders that they were deducting their collective accounts by this value. This is exactly why regulation is required – the periphery or behaviour of blockchain has zero governance around it currently.
Governance in FinTech is generally not being spoken of enough, however there are organisations like the Digital Business Council that are focused on governance. Their purpose is to build a standard framework for exchange of business documents in Australia.
Their framework recently established for einvoicing looks at how the 1.2B invoices generated each year in Australia will be moved around the country and is projected to have a cost saving of around $16B pa.
How will the einvoicing framework impact businesses?
The framework uses a businesses’ ABN and AUSKey as proof of identity to establish some level of security in the exchange. For example, a company running Xero can generate an invoice which is encrypted at the source. That’s sent across to the intermediary server which looks at the Digital Business Locator (effectively a White Pages of every business in Australia) to identify the ABN and provide instructions on where to deliver it. The recipient receives a notification of the incoming invoice which is delivered directly to the Accounts Payable system of their accounting software package – which could be different, like Sage. No data entry is required for this resulting in a massive cost saving.
According to Small Business Ombudsman Kate Carnell, small businesses currently owe $56B – most of it overdue by 60-90 days and mostly owed by large companies. There’s a $13B inefficiency in the economy in chasing these late invoices – time lost and interest expense in covering these debts. By delivering invoices electronically and having the recipient download it, the sender receives a read receipt proving the client has the invoice which provides certainty to the sender.
Developing the einvoicing framework has required the cooperation of every Australian software company.
Learning from the European model, the decision was made to focus on invoices initially, rather than the whole procurement system. From here it will be a graduated approach with the intention to eventually turn it into a fully electronic procurement system for Australia including purchase orders, product catalogues and remittance advice.
The framework has received sign off from the Federal Government under the premise that they will adopt the standard that business and the software companies develop. The fact that has been developed by private enterprise and supported by government - rather than legislated by them makes it a fascinating case study.
With so many regulations & big players in the accounting software space, what’s the attraction for start-ups?
There’s still opportunities to improve the way small and micro businesses operate. Dragonbill started as an escrow payment system for small traders after identifying that the system would help those in this market who had late paying suppliers.
For small and micro businesses where the owner is working 100% in the business they often don’t have time to learn an accounting package or the funds to hire a bookkeeper. Platforms like Dragonbill have the advantage of plugging into larger software packages (i.e. Xero) but offer limited features that are targeted directly at the needs of their audience, making them more affordable and simpler to use.
The open cloud based system means these providers can take advantage of data collected from multiple users and begin to provide industry averages that allow business owners to understand how they fair compared to their competitors.
Advice to other start-ups who are looking to build something incredibly automated regardless of the craft, that doesn’t yet exist
Ideally you want to have the tech skills to do the development yourself, or seek a co-founder with tech skills.
Research the market and validate the idea first. Ensure there’s a demand for the service – or find a way to create demand. Alternatively find another idea, or another application for the idea.
Fintech is unlike any other tech. In many other tech spaces you can spin up an idea and get to market quickly. FinTech is finance first and therefore an incredibly regulated field. Building a roboadvising platform is probably an 18-24 month process because of the regulatory requirements.
Look to join an association or get involved with your peers as this will provide exposure to what you’re creating.
What role is User Centred Design playing for FinTechs in Australia?
It is considered all the way through to customer experience. It’s a global marketplace and in order to compete with other applications in the FinTech space it needs to be a priority.
What would you like to see happen in the future in FinTech?
- Open API standards for banks – the UK government currently working on this and leading the way globally. Having the ability to look at a user’s pay bank account would be hugely beneficial for understanding their behavior and making recommendations based on this, rather than guessing or requesting users manually upload this data
- Greater security amongst banks. They currently have a form of security as a result of a legacy of redundant software. Improved security means better outcomes for both businesses and consumers
- Data standards - Legislation is too cumbersome and difficult to implement and not necessary. The workable alternative is to force suppliers to adhere to standards and if they don’t comply then they won’t be part of the system. Getting software providers to cooperate together (i.e. through the Digital Business Council) and create a framework for the banking system for moving data around so that banks can’t access our data and we operate in a low cost environment
- Tax incentives offered to early stage investors can encourage small, unsophisticated investors to invest in startups. This helps foster innovation in the next generation. Hearing their parents talk about the success of the start-ups they’re investing in as opposed to their rental properties or blue chip stocks will change the culture around investing in future technologies.