Finding Fintech

‘You have to, to serve these markets, re-imagine how
money can be managed and moved, because there’s
going to be more change in the next five years in financial
services than has happened in the past 30,’
– Dan Schulman, CEO, PayPal.

Global investment in fintech companies hit an all-time high of US$27.4bn in 2017, an increase of 18% year on year, with the market showing no sign of slowing down. Led by China, the fintech revolution has spread across the rest of Asia, while simultaneously gaining traction in the UK, US and Europe.

Conversely Hong Kong, which should have been first to be swept up in the trend given its proximity to China, has largely failed to follow suit, gaining it the reputation of being a fintech ‘laggard’. But it hasn’t always been this way.

In the 1990s Hong Kong was seen as a front runner in financial innovation when it came up with mobile payments – a technology that is still being developed in other parts of the world. However since then Hong Kong has taken a back seat compared to the rest of APAC, particularly Singapore, which was quick to emulate China’s success.

‘Hong Kong are trying to figure out what’s next – they came up with this innovative idea of the mobile wallet but that was ten years ago,’ says Theodora Lau, founder of US-based Unconventional Ventures.

‘I do think the energy has picked up, Hong Kong has been sitting on its last great idea and now there is a new infusion of money to spur them on.’

Breaking the Shackles

In his 2018/9 budget speech Paul Chan, Hong Kong’s financial secretary announced he would allocate HK$50bn to the development of fintech, artificial intelligence and biotech, in order to ‘stay ahead of the game’. Over the next five years HK$500m will be injected directly into the financial services sector, a move which should help improve the attractiveness of startups to larger institutions in particular.

‘If you don’t have the banks open to business you don’t have a fintech market. The idea that fintech startups would come and completely change the banking industry single handedly was an aspiration not grounded in reality. What you’ve seen in most emerging fintech markets around the world is a view of collaboration,’ says Steve Monaghan, CEO of Hong Kong-based fintech firm Gen.Life and former chief innovation officer at Singapore’s DBS Bank.

Hong Kong’s de facto central bank and regulator, the Hong Kong Monetary Authority (HKMA), has been criticised for focusing too heavily on encouraging Hong Kong’s large existing financial institutions to innovate, while regulatory constraints have kept out smaller technology players.

‘Hong Kong has a very archaic banking system where until now there has been no pressure on incumbents to modify what they do. This leads to a system that lags behind the likes of Europe and Australia,’ explains Monaghan.

‘In Singapore, you had very much the same dynamic in the beginning – a regulator whose sole answer to every question was no. But now you have someone who is driving the agenda quite actively.’

However, with a major push from the Hong Kong government and a HK$50bn investment to drive innovation, Hong Kong may finally be on the verge of big change.

Rethinking Regulation

With any growing industry comes increased risk and regulation, even more so when you are dealing with people’s money.

The HKMA published revised guidelines on the authorization of virtual banking in Hong Kong in May, with the first licenses to be issued at the end of this year. More than 50 companies have expressed an interest including one of the strongest homegrown players WeLab, the mobile lending company, which secured the largest fundraising in Hong Kong last year of US$220m.

‘We look to be a serious contender for the license, it will allow us to expand and diversify our business, bringing financial inclusion to those that may not otherwise have access to traditional banks,’ says Patricia Ho, senior legal counsel at WeLab.

The HKMA is preparing to launch a Faster Payments System, which will make it possible for people to transfer Hong Kong dollars and yuan between accounts at different banks more quickly, and by using a telephone number rather than a bank account number. The faster payments system is just one of seven smart banking initiatives being introduced by the HKMA. Other initiatives from the banking regulator include the creation of a new policy around opening up banks’ application programming interfaces to technology players.

‘There has been some talk that certain banking processes may be able to be done online, including anti-money laundering (AML) and know your customer (KYC) requirements, without the need for face to face contact,’ says Errol Bong, director, regulatory and legal initiatives at Credit Suisse.

‘Being able to do virtual KYC checks would be a game changer for banks. It would make us more competitive. One issue is the increased use of technology on the on-boarding process such as the use of WeChat by Chinese clients. Banks were not certain whether they could accept KYC documents over WeChat but the introduction of the HKMA’s virtual banking guidelines may indicate that regulators are more willing to accept the influence of technology on the client on-boarding process.’

In an effort to harmonise the development of regulation, HKMA launched its Fintech Supervisory Sandbox scheme in September 2016, allowing banks to conduct trials of newly-developed technology on a pilot basis, without the need to achieve full compliance with existing supervisory requirements.

In a related move, the Securities and Futures Commission and the Insurance Authority announced the creation of their own sandboxes. The HKMA said in a statement that the three would be linked so as to offer ‘a single point of entry for pilot trials of cross-sector fintech projects’.

After being criticised for only being available to authorised institutions, the Sandbox has this year been opened up to technology players – a move commended by the start-up community.

As a result participants have been able to reduce development costs and as of March this year, around 20 products rolled out to the market.

‘Start-ups in particular tend not to have free cash flow to pay hourly rates, which means law firms that follow traditional economic and pricing models are less likely to be able to develop new and innovative ways to serve fintech start-ups and achieve an acceptable win-win,’ says Ben McQuhae, general counsel of FinFabrik.

Leading Lawyers

It can be difficult for start ups to attract experienced lawyers when they are in the early stages of development, hence many do not have an in-house legal team until reaching further stages of maturity.

‘In our experience legal has been a catalyst for greater efficiency. Founders often find themselves negotiating directly with potential investors and strategic partners and having to produce documents and make decisions of a legal nature with little, if any, legal or negotiating experience,’ says McQuhae.

For FinFabrik, who hired an in-house counsel much earlier than usual, the benefits of having a lawyer on board have been paramount. Joining in the midst of Series A funding negotiations, McQuhae’s experience helped the company secure the best possible financial backing.

‘We realised the terms on offer were not the best available and quickly closed a seed deal instead, preserving founder control and a significant majority equity position for future rounds. It was a great outcome for us.’

Larger, more established fintechs such as WeLab have prioritised the role of legal counsel so that it sits within the company’s top team.

‘My CEO recognises how important compliance is to driving growth. I am empowered to raise awareness to all staff so that everyone understands the latest developments and how to deal with them practically. An in-house lawyer must build themselves in as a stakeholder of the business,’ says Ho.

However the role of the in-house lawyer is still in its early stages, much like the regulatory frameworks they are expected to advise on. McQuhae counsels that it is vital not to separate legal from the fin or the tech.

‘For us, clear regulation can’t come quickly enough, though we have no doubt that current regulatory uncertainty around fintech and cryptos is temporary. It is encouraging to see more jurisdictions introducing new regulations to provide certainty, and to see established global financial institutions investing in fintech infrastructure,’ he says.

‘For Hong Kong there is no single established set of fintech rules to date – the sooner this happens the better.’

One area that is currently sparking debate in Hong Kong is the movement around blockchain and consumer privacy data.

‘The future of European and more mature markets has to be where the customer completely owns their own data. Privacy standards and consumer expectations are a lot higher abroad, more so than in China,’ says Monaghan.

The issue of privacy is a particularly difficult one in terms of regulation, as McQuhae points out.

‘There is a loud and ongoing debate around crypto-assets and blockchain which we believe should be separated. Blockchain is a technology and whilst regulators will need to educate themselves about its potential use and associated risks in their markets, it is important that regulation does not stifle innovation by regulating technology,’ he says.

‘We’ve seen the distribution of products through platform providers, under new online distribution rules there becomes a lot of onus on who is providing these digital platforms. The day of someone putting up a platform to distribute a product and just taking a step back are over in Asia.’

Hong Kong on the International Stage

The rethought approach taken to regulating fintech in Hong Kong has been welcomed across the board from financial institutes large and small, with further changes to better harmonise Hong Kong with China improving the attractiveness of the wider financial landscape.

‘We’re seeing more domestic reforms, such as Bond Connect, Stock Connect, the virtual bank. We are also seeing the introduction of open-ended fund company rules to attract more funds to set up shop domestically in HK as opposed to in the Caymans. These are two big reforms,’ says Bong.

‘We’ll be looking at the domestic initiatives to make Hong Kong more competitive. If we get more funds setting up shop here and they’re private funds, the regulators have specifically mentioned that perhaps these private funds can use prime brokers as their custodian, which would be good for people and institutions that have a prime brokerage business, who are happy to service those funds. So hopefully that will make Hong Kong a more attractive destination for everyone all round.’

Hong Kong’s proximity to China means it attracts the best of Chinese talent and investment, while sharing a similar market that is both more western and relevant to the rest of Asia.

‘One thing you have in Hong Kong which is an advantage over Singapore, is an ecosystem. There’s a fantastic market in Hong Kong, it’s scalable – you can walk across the border in 30 minutes and test in China with the consumer’, says Monaghan.

‘What you do in Singapore doesn’t translate to Indonesia or the Philippines, there’s much less of a market for learning. The Monetary Authority of Singapore is still far ahead but Hong Kong is closing that gap quickly which is great to see.’

The HKMA has also ramped up its cross-border collaboration following the signing of a UK-Hong Kong FinTech Bridge, in 2017. The Bridge, which commits both parties to encourage fintech firms to participate in industry focused events, creates a single point of contact for fintech companies by the UK Department for International Trade and InvestHK, and provides support for fintech start-ups to establish themselves in the opposite jurisdiction.

The impact of this is already beginning to show. According to data analysts Accenture, investment in Hong Kong fintech companies more than doubled in 2017 to US$545.7m, up from US$215.5m in 2016 and US$107.5m in 2015, putting it well ahead of its rivals Singapore, and Australia.

The China Connection

As the ongoing ‘trade war’ between China and the US continues to fray, testing relations between the two, Lau sees the potential for Hong Kong to capitalise on its role as a gateway – which could prove a boon for fintech.

‘Hong Kong doesn’t have that same obstacle – it has autonomy, it’s legal and administration systems are separate which allows it to do more things,’ she says.

Lau, who was born and raised in Hong Kong but lives in Washington DC, notes that there has also been a noted move toward attracting and retaining talent.

‘There’s a lot of talk at the moment of students from overseas not wanting to come to the US, or if they do there is a higher tendency for them to go back to China and Hong Kong to work,’ she says.

One reason for this is US immigration policies which Lau says are not ‘necessarily welcoming’. In contrast, the Hong Kong government is actively promoting an agenda of its own – last month (August) it introduced a new immigration policy to attract talented professionals. The ‘Talent List’ is open to people around the world who specialise in 11 professions that the Hong Kong government defines as the most crucial for the country’s economic development. These include innovation and technology experts in blockchain technology, artificial intelligence, data engineering and robotics.

‘When you look at the efforts from the government and regulators in Hong Kong and China, and the push to get people back to the territory, it’s never been a better time to start something there,’ says Lau.

Adding to the potential of Hong Kong in the medium term is the ongoing Greater Bay Area initiative, a project seeking to create a world-class city cluster, connecting the Guangdong-Hong Kong-Macau region. By 2030, the region is expected to play a leading role in manufacturing, innovation, shipping, trade and finance.

‘I think this will be one to watch. It has the physical connection to mainland China, a diverse and educated talent pool, investment and infrastructure. Whether they will be able to recreate in Asia what we have in the US – a Silicon Valley – will be interesting to see,’ says Lau.

‘The fact the Greater Bay Initiative includes Hong Kong and Shenzhen – the PRC’s tech epicentre – presents a huge opportunity for tech companies and investors.’