Industry Views: Will Fintech Cause the Next Financial Crisis?

Earlier this week, an opinion piece in Bloomberg suggested that the next financial crisis could spring from Silicon Valley instead of Wall Street. While the article acknowledges that “fintech has broadened access to capital to new and underserved groups, making finance more democratic than it has ever been,” it cautions that “revolutions often end in destruction.”

Paybefore reached out to payments industry experts on both sides of the pond to get their takes on the idea that fintech could pose a threat to the economy. Here’s what they had to say:

Characterizing rapid innovation as a source of risk is natural. As in any industry, however, the reward of encouraging evolution in the financial sector is long-term stability. The future will bring challenges that we cannot currently anticipate. Industries that encourage creativity and innovation will be best able to adapt to these future challenges. In the meantime, many fintech companies will fail, of course. That’s capitalism. But these failures are unlikely to cause a broad financial crisis. Fintech companies—whether viewed individually or collectively—are nowhere near the size of the money center banks at the center of the last financial crisis. The failure of fintech companies, therefore, is unlikely to destabilize the financial markets. On balance, the innovation that we currently see in the fintech industry should be viewed as a source of strength, rather than as a threat.

—Jeffrey Alberts, Partner, Pryor Cashman LLP

The next financial crisis will not be triggered by the fintech sector for a number of reasons. The very reason the fintech sector evolved is because the traditional players were either unable to innovate quickly enough to provide solutions to end customers or bring products to market on restricted budgets.

There’s no doubt that some fintechs have had excessive multiples on their valuations, but as long as their products continue to solve existing problems and they acquire customers with relative ease, investors will keep pumping money into the venture.

Inevitably, there will be casualties in the sector when investors no longer see any return on investment and pull the plug on funding. Although this may effect overall sentiment for fintech investment, the fallout is isolated and will not mean end customers have lost money unless they have specifically invested themselves. Let not forget that for any fintech’s that are providing services with stored value [in the U.K. and EU], these funds are safeguarded in “ring fenced’’ accounts held in tier-one banks. Even the hype around ICOs is isolated from the rest of the financial sector, which is warning the public of their imminent demise.

—Suresh Vaghjiani, Managing Director, Global Processing Services

Are fintechs dangerous? William Magnuson argues that the next financial crisis likely will be caused by fintechs rather than banks and other large financial institutions.

While he makes some interesting points (for example, I agree wholeheartedly with the suggestion that the sandbox approach used in many other countries would be an excellent option to use here in the U.S.) I believe there is an essential flaw in his analysis on the risks posed by emerging fintech companies.

He appears to assume that given the complexities of new technologies, regulators are not focusing on fintechs, and the nascent fintech industry is developing without regulatory oversight. However, as a lawyer working with many fintechs both in the U.S. and globally, I see a very different picture.

Regulators and law enforcement are very worried and even suspicious about the emerging fintech industry. The Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) moved quickly to regulate prepaid payments and virtual currencies. Numerous states have extended their money transmitter licensing regimes to fintechs. Government agencies such as the CFPB and SEC have issued warnings about new fintech programs. The recent boom in initial coin offerings (ICOs) has resulted in SEC warnings and enforcement proceedings.

The regulatory landscape for emerging fintech businesses is not simple or easy. Any lawyer who works in this space knows that one cannot underestimate the risks of launching new products or services when there is so much scrutiny and distrust by regulators and law enforcement.

—Judith Rinearson, Partner, K&L Gates LLP

The fintech boom is certainly a bubble, and will some people lose money: Yes. But will it cause a financial crisis: No.

The last financial crisis caused banks to fail. This in turn had major economic structural effects on global economies. If an Uber failed tomorrow, there are already lots of competitors that would step in and provide employment for those drivers.

What perhaps is more concerning and interesting is the rise and power of the new global corporates such as Apple, Amazon, Google with money and wealth larger than many countries. But even if one of those companies failed, would it cause a financial crash: No. Would it, could it cause some hardship for some people: Yes, but the world of fintechs is so fragmented that even a major company going under would merely leave room for new players to emerge.

Just like in a forest when a large tree is cut down, you quickly see that where before it had cast a shadow new saplings that can finally receive sunlight are growing.

—David Parker, CEO, Polymath Consulting

Rather than debate the many mis/overstatements in this op-ed, I’ll focus on two points to highlight: 1) the difference between the first financial crisis (the “Wall Street Slip Up”) and the second (the “Fintech Failing”) that hasn’t happened yet, and 2) that fintech being complicated doesn’t make it inherently bad. Rocket science is complicated, but no one is saying that scientist are going to cause the next collapse.

As someone who’s been involved with fintech companies for almost 10 years, I am constantly amazed how little people (regulators and reporters alike) who cover the space actually know about the industry. Aside from bailouts, what was the response to the 2008 financial crises? Regulation.

Nonbank financial technology companies are subject to some of the most expensive/onerous compliance requirements of any new business out there. The costs of compliance make it increasingly challenging for new firms to become profitable and innovate. Yet, time and time again, whether it is members of Congress, the director of the Consumer Financial Protection Bureau, or a writer at Bloomberg, we hear that fintech is un/under-regulated.

Hard to monitor? Nonsense. Most fintech companies are licensed, registered in some form or another or are operating in partnership/under the supervision of a bank. How can the cure for the last collapse (more oversight/regulation) be the cause of the next one?

Very few, if any, fintech companies are operating outside of the main financial systems. Most fintech companies are looking to improve the customer experience and not change legacy banking systems. By Mr. Magnuson’s own words, “fintech has greased the wheels of finance, making it faster and more efficient. It has also broadened access to capital to new and underserved groups, making finance more democratic than it has ever been.” Those are good things.

Everyone knows that our financial systems are outdated, but the cost to replace them to date has been more than any one “disruptor” can bear. Therefore, the discussions about a fragmented, highly complicated, unregulated, series of startups that can innovate in the dark is really a case of #fakenews.

—Joel Sherwin, President, U.S. Operations, Neopay

In the European market, we’ve seen a huge amount of investment funding aimed at fintech, whether via traditional means of venture capital or the now-popular crowdfunding. It has meant that disruptors have been able to grab customers with fee-free models, which has proven incredibly risky.

The U.K. market particularly has seen disruption with prepaid products being the foundation for challenger banks. The call for open and fair access to the banking system has been answered, and there is a line of potential new suppliers preparing products for when this goes live. This poses risks that the regulator has under serious consideration.

Industry traditionalists in the European market are concerned that it takes one fintech to collapse or experience a breach and it could have a catastrophic impact on the market; however, big banks are still looking at collaborations. The market poses a great deal of opportunity currently, but with all change comes an element of risk.

—Emily Baum, Independent Payments Consultant

The author is correct that there is often a mismatch between “new and innovative” technologies on the one hand, and “old and outdated regulatory structures” on the other. But the author’s implication that this regulatory uncertainty creates an anarchic state in which fintech companies can frenetically deploy new technologies without any regulatory oversight isn’t accurate. In fact, when laws and regulatory structures lag behind technological progress it more often acts a drag on innovation and slows the deployment of new technologies.

Just because a regulatory scheme is “old and outdated” doesn’t mean it doesn’t apply. Often it does apply—forcing companies to find ways to comply with requirements that might be inappropriate. (That’s the benefit of a regulatory sandbox—providing regulatory relief—which the author curiously lauds immediately after decrying the (nonexistent) lack of regulation.)

Also, the “Wall Street v. Silicon Valley” narrative that serves as the backdrop for the argument doesn’t reflect the fact that there is a lot of cooperation and integration among fintech innovators and traditional financial institutions. As a general rule, fintech companies are more likely to partner with, license their technologies to, or even be acquired by major financial institutions than to completely displace them. For example, remember when conventional wisdom said that plucky startups with online trading platforms were going to topple old line brokerage brands like Fidelity, Charles Schwab, Edward Jones, etc.? Old financial dogs might not come up with the new tricks, but they can still learn them.

—David Beam, Partner, Mayer Brown LLP

Digiliti Money Plans to Delist from Nasdaq

Digiliti Money (DGLT), which is in merger negotiations with Urban FT, is planning to delist from the Nasdaq, according to its most recent SEC filing.

The Minneapolis-based mobile banking technology provider said it received notice from Nasdaq’s Listing Qualifications Department indicating its noncompliance with the stock market’s majority independent board requirement and continued listing standards.

The notice of noncompliance is based on the company’s failure to: 1) timely file its quarterly report on Form 10-Q for the period ended June 30, 2017; and, 2) comply with Nasdaq’s majority independent board requirement and the audit committee, compensation committee and nominating committee composition requirements, the company said.

DGLT previously disclosed the departure of four directors from the board in SEC filings dated Sept. 1 and 7, 2017. Robin O’Connell, James Spencer, Darin McAreavey and Brittney McKinney all left the board for “personal reasons,” according to the filings.

The company had until Sept. 20, 2017, to submit a plan to Nasdaq outlining its proposed actions to regain compliance with the continued listing standards. Instead, the board determined that, while regaining compliance with some of the requirements could be cured promptly, others would require significant funds and resources, according to a Sept. 15 press release.

“The board has also determined that allowing the delisting of the company’s stock from Nasdaq would actually facilitate financing, M&A and corporate restructuring opportunities that would otherwise be more time-consuming and costly to complete while on Nasdaq. As a result, the board believes that it is in the best interest of the company to delist from Nasdaq to facilitate its current restructuring plans,” DGLT said.

If the company is delisted from Nasdaq, it plans on applying for listing on one of the OTCQB, QX or PK markets once it satisfies the appropriate financial reporting and other listing qualification requirements.

As previously reported, DGLT had announced the delay of its Q2 earnings report after it launched an internal investigation following the resignation of its auditing firm.

A Sept. 14 SEC filing shows that the company has hired Wei Wei & Co. LLP, an independent member of BDO Alliance USA, as its new independent registered public accounting firm, to perform independent audit services for the fiscal year ending Dec. 31, 2017, and to re-audit the company’s financial statements for the fiscal year ended Dec. 31, 2016.

Urban FT CEO Richard Steggall told Paybefore earlier this month that he anticipated closing a deal with DGLT on or around the 29th of September.

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U.K. Watchdog Approves Cardtronics’ Purchase of ATM Provider DCP

Cardtronics’ $460-million purchase of rival ATM provider DirectCash Payments (DCP) finally has been approved by the U.K.’s Competition and Markets Authority (CMA), according to Banking Technology (Paybefore’s sister publication).

Back in May 2017, Houston-based Cardtronics had to offer undertakings due to competition concerns, and initially didn’t. The CMA said at the time: “As Cardtronics has not offered these undertakings, the CMA will now refer the merger.”

There was an “in-depth” investigation by the CMA, but today (Sept. 22) this saga may be over.

“With the CMA merger inquiry concluded and approval granted, Cardtronics will now begin working through the process of combining the existing U.K. operations of Cardtronics and DCPayments. Cardtronics’ acquisition of DCPayments has not been subject to review in any other country,” Cardtronics says.

Cardtronics and DCP are independent and supply cashpoints to site owners, such as convenience stores and pubs. The CMA said such companies face competition from banks and building societies to supply ATMs to large site owners in high footfall locations such as supermarkets, shopping centers or transport hubs.

However, independent firms also supply smaller non-corporate customers whose cashpoints typically have lower numbers of transactions and are often pay-to-use. Cardtronics and DCP supply both free-to-use and pay-to-use ATMs.

Following its initial investigation, the CMA believed that, in those local areas where there is “insufficient competition” from rival ATMs, the merger could lead to increased surcharge fees for customers withdrawing cash. Given the “potential lack of suitable sites” and the cost of supplying new ATMs, entry into these local areas by competitors would “not be sufficiently likely to prevent an increase in fees.”

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Innovators’ Spotlight: SPENT Money

Getting to Know SPENT Money

Marketplace Names: SPENT Money, SPENT App

Primary Locations: New York City, Oulu, Finland

Open for Business: 2015

Founder: Erno Tauriainen

Funding: Angel investors

Line of Business: Money Management

Secret Sauce: At SPENT, our focus is on enabling people to be smarter spenders so they can maximize their money. Our first product, SPENT MONEY delivers on this by offering a unique combination of cash back on purchases at thousands of places with tools for automated money management. By pairing expense management with cash back, SPENT allows the users full control of their finances, maximum reimbursements and the ability to earn hundreds of dollars a year on purchased products and services.

Business Philosophy: We take a user-first approach. To be a valued service we must understand our customers and continue to meet their needs but also find ways to surprise them with features they didn’t know they wanted. We strive to find new ways to help our customers make smarter spending decisions so they keep more of their money.

Something You Might Not Expect: SPENT is a team of forward-thinking creatives, spanning 10 time zones, from New York City to our tech base in Oulu, Finland.

Rather than being top of wallet, SPENT Money wants to help consumers manage and earn rewards from what’s already there—at least for now.

Users link their existing prepaid, credit or debit cards via the app to automatically earn up to 25 percent cash back at participating shops and restaurants, as well as online. SPENT doesn’t offer its own card at the moment but might in the future.

The company, which is based in New York with tech headquarters in Oulu, Finland, is targeting two popular demographics for fintech startups, gig economy workers and small businesses.

“It’s no secret that the traditional idea of a 9-5 job is being redefined, largely due to the rise of Gen Z,” says founder and CEO Erno Tauriainen. “As the workplace becomes saturated with employees who have grown up in the digital era, employers need to introduce new products that will help them embrace the values that are important to this generation and also the rise of freelancers in businesses. We want SPENT to be a product that empowers entrepreneurs with tools and information to allow them to make smarter spending decisions and keep more of their hard-earned money.”

In addition to cash back from brands such as Avis and Intuit, the SPENT app offers automated expense management and receipt storage to help users track business deductions or complete expense reports. The service is free, but for $4 a month, users can integrate the app with Intuit Quickbooks and automate reimbursements.

The primary revenue stream is commission on cash back purchases.

“We’re fortunate to have several large partners that provide our users access to cash back at major hotel, car rental, live events and the top online retailers,” Tauriainen adds.

SPENT also partners with thousands of independent businesses so users can earn cash back in their neighborhoods.

International Expansion ahead

The app launched in the U.S. first because of its thriving freelancer industry, according to Tauriainen. He points to a recent study showing that 35 percent of the total U.S. workforce is made up of freelancers, but SPENT is testing in a few markets outside the U.S., as well.

“Today we support thousands of banks in 50 countries,” Tauriainen adds. “We are slowly testing into market expansion. Our rollout strategy is being prioritized based creating a strong portfolio of cash back offers per market.

“We are designed to meet the needs of a new workforce where business and personal life are interconnected,” he continues. “We start with the person so we’re ‘company-agnostic’ and our focus is helping them optimize their money vs. managing expenses—this sets us apart in the marketplace. The ability to earn cash back, whether it’s a business or personal purchase allows our users to get more out of each dollar.”

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TerraPay Partners with Bux for Mobile Money Transfers to India

TerraPay, a mobile payments switch, has partnered with bux, a mobile app money transfer service, to enable instant cross-border money transfers from Australia, Hong Kong, the U.K. and Europe to India.

Bux customers now are able to transfer money from their mobile phones directly to bank accounts in India. The money transfer service is up to 45 percent cheaper than competitors, according to an announcement. Traditionally when sending money home, migrants would have to travel to agent locations or bank branches and would face high fees and transaction times of up to a week to send small-value transfers, the companies said.

Based in Australia, bux offers remittances in more than 200 countries, but this partnership opens up the Indian market. Although India’s remittance volume fell by 8.9 percent in 2016, the country is still the largest recipient of remittances worldwide, according to the World Bank. India received around $62.7 billion in remittances in 2016.

TerraPay is a B2B company incubated by Mahindra Comviva, which is part of the $18 billion Mahindra Group.

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