UV7736 Apr. 26, 2019 A Global Fintech Overview What Is Fintech? Fintech is the use of technology to solve financial services problems. It can be understood as traditional financial services segmentation and the technologies influencing these segments. 1 Part A: Financial services segmentation Lending Payments Wealth/investment management Insurance technology (insurtech) Regulatory technology (regtech) Part B: Influential technologies Application program interface (API) Artificial intelligence (AI) and machine learning Blockchain and distributed ledger technologies (DLT) Cloud computing (cloud) Edge computing (edge) Quantum computing (quantum) 1 A number of formal definitions for fintech exist: “products and companies that employ newly developed digital and online technologies in the banking and financial services industries,” Merriam Webster, https://www.merriam-webster.com/dictionary/fintech (accessed Dec. 17, 2018); “A portmanteau of finance and technology...[referring] to businesses [that] are using technology to operate outside of traditional financial services business models to change how financial services are offered. Fintech also includes firms that use technology to improve the competitive advantage of traditional financial services firms and the financial functions and behaviors of consumers and enterprises alike,” KPMG, The Pulse of Fintech 2018: Biannual Global Analysis of Investment in Fintech (July 31, 2018), 57. This technical note was prepared by Joseph M. Becker (MBA ’19) and George (Yiorgos) Allayannis, Paul Tudor Jones II Professor of Business Administration. Copyright 2019 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an email to sales@dardenbusinesspublishing.com No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. Our goal is to publish materials of the highest quality, so please submit any errata to editorial@dardenbusinesspublishing.com Page 2 UV7736 Part A: Financial Services Segmentation Lending Lending is at the core of banking and is a massive market uniquely positioned for technological improvements. While recognizing the importance of technology in lending, one may be tempted to conclude that fintech lenders have the ultimate edge. 2 However, a thorough analysis reveals that relative strengths exist between banks and fintech lenders, and collaboration between these entities may enable both sides to capture value in a growing sector. The fintech lending market is large. Market analysts have identified a $1 trillion addressable market for online marketplace lenders, excluding mortgages, and have estimated that loan origination volumes will reach $90 billion by 2020. 3 Potential reasons for the emergence and growth of fintech lending include the following. o Technology rapidly developed and was broadly adopted by consumers and economies. Increasing consumer comfort with and use of technology, such as the iPhone (which debuted in January 2007), contributed to the emergence and growth of fintech lending. Between 2006 and 2016, the number of US and Chinese internet users grew at a compound annual growth rate (CAGR) of 3.4% and 18.2%, respectively. By 2016, US and Chinese internet users totaled over one billion. 4 o A reduction in available credit from traditional sources followed the global financial crisis (GFC). Many believe small businesses struggled to obtain credit as standards tightened during and following the GFC. 5 Additionally, many banks retreated from personal loans after the GFC as they experienced a significant increase in losses. Lending volumes decreased, which arguably created an opportunity for fintech companies. 6 o Investors sought yield in the post-GFC interest-rate environment. Short-term interest rates hovered around zero following the GFC. 7 Fintech lending provided a new investment category to retail and institutional investors seeking a way to earn a yield in this low-rate environment. 8 o Fintech lenders faced less-stringent regulation. It is commonly believed that fintech lenders were subjected to more lenient regulation. Fintech lenders were not chartered, deposit-taking banks, and as a result, they avoided certain regulation based on their business models. 9 More lenient regulation, in turn, likely provided a competitive edge that supported growth. 2 Fintech lending initially emerged as peer-to-peer (P2P) marketplaces that provided individual investors with the ability to extend financing to individual borrowers; however, the investor base and business models have since evolved. The investor base for fintech lending has expanded from individuals to institutional investors, hedge funds, and financial institutions. Two primary business models emerged: direct lenders that originate loans to hold in their own portfolios (i.e., balance sheet lenders), and indirect lenders that partner with an issuing depository institution to originate loans and then purchase the loans for sale to investors as whole loans or by issuing securities such as member-dependent notes (i.e., platform lending) ( Exhibit 4 ). OnDeck Capital, Inc. (OnDeck) and LendingClub Corporation are prominent examples of direct and indirect lenders, respectively. US Department of the Treasury, Opportunities and Challenges in Online Marketplace Lending , May 10, 2016, 5–8; UBS, On Deck Capital Inc initiating coverage, March 27, 2018. 3 US Department of the Treasury, 9. 4 Statista, Internet Usage in the United States , 2018; Statista, Internet Usage in China , July 2016. 5 Julapa Jagtiani and Catharine Lemieux, “Small Business Lending after the Financial Crisis: A New Competitive Landscape for Community Banks,” Economic Perspectives 40, no. 3 (Federal Reserve Bank of Chicago, November 2016): 2. 6 AnnaMaria Andriotis and Peter Rudegeair, “Lenders Shunned Risky Personal Loans. Now They’re Competing for Them,” Wall Street Journal , August 24, 2018. 7 US Department of the Treasury, “Daily Treasury Yield Curve Rates (2009),” https://www.treasury.gov/resource-center/data-chart-center/interest- rates/Pages/TextView.aspx?data=yieldYear&year=2009 (accessed Dec. 17, 2018). 8 Bank for International Settlements (BIS), “International Banking and Financial Market Developments,” BIS Quarterly Review (September 2018): 30– 36; David W. Perkins, “Marketplace Lending: Fintech in Consumer and Small-Business Lending,” Congressional Research Service (September 4, 2018): 6–7. 9 Perkins, 2, 16–17, 20. Page 3 UV7736 Growth in fintech lending is expected to persist as financial sectors develop in emerging markets, and as technology enables improvements in loan accessibility and convenience in developed markets. 10 Lending growth is expected to be particularly strong in China, which had more than 85% of global alternative lending transaction values as of 2017. 11 (“Alternative Lending” and additional terms are explained in Exhibit 1 . For an overview of fintech lending in China, see Exhibit 2 .) Technology is uniquely positioned to solve lending problems. Technology helps solve two major problems facing lending: access and convenience. o Access. Technology reduces the need for costly bank infrastructure and enables digital application processes and automated underwriting. Technology may provide fintech lenders with operating- cost advantages. 12 Lower fixed and operational costs may permit fintech lenders to offer smaller- value loans more economically, thereby increasing small business and consumer credit access. 13 Additionally, technology may enable access for individuals and businesses excluded under traditional credit methodology (e.g., FICO). Numerous fintech lenders use alternative data sources, big data, and machine-learning technology for credit decisions and monitoring. 14 Many banks partner with fintech lenders to access these technologies and the customers they serve. 15 o Convenience. Speed and ease are valued by credit applicants. 16 Lenders leverage technology to provide quick and automated credit decisions and monitoring. For example, Kabbage, Inc., an Atlanta-based small business fintech lender valued at over $1.1 billion, claims it can assess a loan application in minutes. 17 Additionally, technology enables seamless, consumer-focused experiences. In the United Kingdom, companies such as WDFC UK Limited (i.e., Wonga), a payday loan provider, facilitate a fully digital customer journey, and companies such as Zopa Financial Services Limited provide an integrated digital platform for other offerings (e.g., investing). 18 In the United States, fintech payment providers that are also involved in lending, such as PayPal, Inc. (PayPal), and Square, Inc. (Square), are repaid automatically by the companies to which they lend through deductions from the companies’ sales. 19 Although technology solves major problems facing lending, and as a result, could bolster fintech lenders, gaining an edge in lending requires more. Table 1 provides additional details on the advantages and 10 Fintech credit will be impacted by factors affecting all forms of credit (e.g., economic growth, financial development, and quality of institutions). Fintech lending varies greatly across economies. Differences reflect economic development and financial market structure: fintech lending is greater in countries with high incomes, less competitive banking systems, and less stringent banking regulations. BIS, 29, 36, 44–45; Statista, “FinTech Report 2018: Alternative Lending,” Statista Digital Market Outlook: Segment Report (September 2018). 11 Statista, “FinTech Report 2018.” 12 One analysis estimated that loan processing and servicing costs for marketplace lenders as a percentage of loan amounts were 61% lower than those for traditional banks. Perkins, 7. 13 Katie Darden, Tom Mason, and Eric Turner, “2017 US Fintech Landscape,” S&P Global Market Intelligence (2017): 5. 14 Julapa Jagtiani and Catharine Lemieux, “Fintech Lending: Financial Inclusion, Risk Pricing, and Alternative Information” (working paper, Research Department, Federal Reserve Bank of Philadelphia, June 16, 2017): 3, 8. 15 Small business lending historically has had high search, transaction, and underwriting costs for depository institutions relative to earnings potential. Extending business loans entailed significant fixed costs associated with underwriting, servicing, and collection, which made smaller loans particularly challenging. In fact, it is estimated that only half of small firms receive the full amount of financing requested. Given the market dynamics, banks are increasingly partnering with fintechs; for example, Fifth Third Bancorp invested in ApplePie Capital, Inc., an online lender specializing in franchise loans; and JPMorgan Chase & Co. licensed technology from OnDeck to offer Chase customers small business loans in an entirely digital process. US Department of the Treasury, 13; Jagtiani and Lemieux, “Fintech Lending,” 35. 16 One-third of small firms that applied with large banks indicated that they were most dissatisfied by credit decision wait times, and 28% were most dissatisfied by a difficult application process. Also, 70% of small firms that applied with online lenders noted speed as an influencing factor, compared with just 28% and 34% of small firms applying with small and large banks, respectively. Federal Reserve, Small Business Credit Survey Report on Employer Firms (2017): 11. 17 Pitchbook, Kabbage Company Profile ; Jagtiani and Lemieux, “Small Business Lending,” 13, 23. 18 Elena Mazzotti and Francesca Caminiti, “Where Fintech Lending Will Land and What It Means for Banks: The Time Is Right for Strategic Collaboration. Focus on Europe,” Accenture (2017): 9. 19 PayPal and others have used small business lending to grow payment transaction volumes as opposed to focusing on lending as a standalone business. Jagtiani and Lemieux, “Small Business Lending,” 13–14. Page 4 UV7736 disadvantages held by US banks and fintech lenders, and Exhibit 3 , Case Study No. 1, provides information on a prominent investment bank’s foray into consumer lending. Table 1. Who has the lending edge? Banks versus fintech in the United States. Criterion Potential Advantage Why? Funding Source Banks Banks are funded through deposits, which are lower cost/more stable than capital market funding/securitization used by fintech lenders. Whole loan purchases and equity investments by hedge funds and private investment firms are increasingly important to fintech lenders. 20 Customer Acquisition Banks Banks may benefit from existing relationships across many business lines. Fintech lenders spend heavily on customer acquisition. 21 Potential customers may perceive security risks for new platforms. 22 Underwriting Unclear/TBD 23 Banks have been tested in a range of economic-/interest-rate environments. Many fintech lenders do not hold loans on balance sheet, and therefore earn much of their revenue through origination/servicing fees; this could incentivize weaker underwriting standards. 24 Fintech lenders could have an edge through tailored models and the use of alternative data sources, big data, and machine-learning technology. Regulation Unclear/TBD Stringent banking regulation deters fintech lending activity; fintech may be advantaged versus depository institutions subject to the US Federal Deposit Insurance Corporation (FDIC), US Office of the Comptroller of the Currency (OCC), US Federal Reserve (Fed), and other forms of regulatory oversight. 25 Banks are able to pursue national or state charters under dual banking; fintech lenders are presented with reduced flexibility and face added complexity via state-by-state nonbank lending license and other requirements. 26 On July 31, 2018, the OCC announced that it would begin accepting national bank charter applications from fintech lenders. 27 Data source: Created by author from sources cited. Payments The global payments sector is massive and well positioned to benefit from improvements in speed, convenience, and cost brought by technology. Payments can effectively enable entry into other areas of financial services, such as lending, resulting in even larger and more diverse commercial opportunities. 28 Unsurprisingly, fintech companies and incumbent financial services firms have a keen interest in payments, and opportunities in payments have inspired both competition and collaboration among these companies and firms. The payments sector is sizable and growing. The total addressable market in payments may be as large as $110 trillion, and global payments revenue is expected to rise from $1.2 trillion to more than 20 Perkins, 1, 3, 5–6. 21 40% to 50% of fintech lenders report negative EBIT. Mazzotti and Caminiti, 3. 22 Darden et al., 6. 23 Major fintech lenders are tightening underwriting standards following a wave of defaults. Many US fintech lenders have incurred high default rates and have increased write-offs, even as US economic conditions remain strong and unemployment levels fall to multidecade lows. In response, major fintech lenders are tightening underwriting standards and shifting toward shorter-term loans. Shelly Hagan and Adam Tempkin, “Online Lenders Tighten Rules after a Wave of Defaults,” Bloomberg , May 30, 2018. Additionally, conditions are troubling within the massive Chinese fintech lending market. Hundreds of platforms have failed. In fact, more than 400 Chinese fintech lenders collapsed between June and August of 2018, including PPMiao; PPMiao’s collapse resulted in the loss of as much as $117 million for as many as 4,000 people. “How China’s Peer-to-Peer Lending Crash Is Destroying Lives,” Bloomberg , October 2, 2018. 24 Perkins, 0, 23. 25 BIS, 29–30, 36, 38. 26 Jagtiani and Lemieux, “Small Business Lending,” 15. 27 “OCC Begins Accepting National Bank Charter Applications from Financial Technology Companies,” OCC press release, July 31, 2018. 28 Examples include Square and PayPal, as discussed in Part A of this note. Page 5 UV7736 $2.1 trillion in 2026. 29 Strong growth will likely persist as check and cash usage decrease, and as digital commerce and mobile device usage advance. 30 Growth will be pronounced in emerging markets, which are projected to constitute 60% of total payments revenue by 2026. 31 Technology is well positioned to solve problems in payments. The underlying problems in payments are speed, convenience, and expense. There exists a growing gap between current payments capabilities and those needed and expected in the digital economy—fast, convenient, and accessible to all. 32 The Fed has looked to technology to facilitate transformational change, and noted that technology providers may be able to develop new services or enhance existing services that could ultimately benefit all consumers by lowering costs. 33 For example, current cross-border payment infrastructure lacks standardization and automation in inter- and intrabank networks, often resulting in manual intervention to collect and repair data, the inefficiencies of which in turn raise costs throughout the ecosystem. 34 Payments serve as a gateway to other financial services offerings . One major fintech trend is the “unbundling” and “rebundling” of financial services. 35 Payments is no exception to this trend. Payments companies are well positioned to progress into other areas of financial services, using payments and the data generated thereby as a gateway to financial services scale. 36 This trend is particularly important to incumbents given that payments “represent the beachhead for the entire banking relationship...and that a strong payments plan [needs to be offered] as part of a comprehensive strategy for digital banking.” 37 Fintech and legacy incumbents both offer value propositions in payments. Fintech companies, unencumbered by existing technology infrastructure and slow-to-change culture, are positioned to propose agile, innovative, and consumer-centric solutions, while incumbents are positioned to benefit from trust and 29 PayPal Investor Day Presentation, 2018; Mohammed Badi, Stefan Dab, Pierre Paoli, Maarten Peeters, Prateek Roongta, Olivier Sampieri, and Yann Sénant, “Global Payments 2017: Deepening the Customer Relationship,” BCG , October 16, 2017. 30 Boston Consulting Group (BCG) estimated that 20% of all transactions will be digital by 2020. According to Visa, Inc. (Visa), retail mobile commerce sales are expected to grow between 26% and 35% between 2016 and 2020, reaching a 2020 total of $335.8 billion. Badi et al., 11; Visa, “The Importance of a Digital Payments Strategy,” https://usa.visa.com/partner-with-us/visa-performance-solutions/importance-of-a-digital-payments- strategy.html (accessed Dec. 18, 2018). 31 Noncash growth has occurred at the expense of checks, with credit and debit card usage increasing and cash usage for low-value transactions remaining prevalent. In China and emerging markets, adoption of mobile payments and wallets have driven growth. Going forward, noncash growth in emerging markets will be driven by three factors: promotion of cashless societies, technological innovations, and financial inclusion efforts; growth in mature economies will be driven by a combination of mobile payments and contactless technology/near-field communications. It is estimated that emerging markets will experience noncash transaction growth of 21.6% (CAGR) between 2016 and 2021. Capgemini and BNP Paribas, World Payments Report 2017 (2017): 5–7, 9–12, 16; Capgemini and BNP Paribas, World Payments Report 2018 (October 2018): 5, 9, 11. 32 Lael Brainard, “Supporting Fast Payments for All,” (speech, Fed Payments Improvement Community Forum, Chicago, Illinois, October 3, 2018). 33 A 2016 US Consumer Payment Study determined consumers are focused on ease, regardless of payment method used, and mobile and digital payments may provide the solution. According to Visa, convenience was the main reason (64%) why mobile payments users chose related solutions. Brainard; “2016 U.S. Consumer Payment Study,” TSYS (2016): 26, 32–33; Visa, “What Does the Mobile Payments User in Europe Look Like?,” https://www.visaeurope.com/media/images/v2%20visa%20digital%20payments%20european%20fact%20sheet%2010.10.16-73-40177.pdf (accessed Dec. 18, 2018). 34 Yoon S. Park, “The Inefficiencies of Cross-Border Payments: How Current Forces Are Shaping the Future,” Visa , November 2006, 5, 8–10, 14. 35 Many fintech companies were founded to fill and/or improve upon a specific offering within the larger financial services landscape (i.e., “unbundling”). Following successful execution within such an offering, many fintech companies then expand into other areas of financial services (i.e., “rebundling”). For example, Ant Financial established Alipay as a designated online payment service for Alibaba Group Holding Limited’s (Alibaba’s) Taobao marketplace; in other words, Ant Financial unbundled the myriad of financial services offerings to fill a specific need of online payments on Taobao. In 2013, Ant Financial expanded into wealth management, and as of 2019, it provides payments, wealth management, insurance, credit score, and consumer lending services (i.e., “rebundling” financial services offerings). Matthew Wong, “Ant Financial: Unpacking the $150B Fintech Giant,” CBInsights 36 For example, cross-border transactions generate substantially higher margins than domestic, and they serve as a foundation for a broader array of client services. Sukriti Bansal, Philip Bruno, Olivier Denecker, Madhav Goparaju, and Marc Niederkorn, “Global Payments 2018: A Dynamic Industry Continues to Break New Ground,” McKinsey, October 2018, 4. 37 The average customer interacts with her bank at least twice a day for payments-related matters, and these interactions represent more than 80% of customer interactions with banks, making payments an ideal platform for cross-selling other financial services. Olivier Denecker, Sameer Gulati, and Mark Niederkorn, “The Digital Battle that Banks Must Win,” McKinsey, August 2014. Page 6 UV7736 reputation, as well as from scale and regulatory competencies. 38 Given the importance of payments and varied value propositions, both competition and collaboration exist between fintech and incumbents: Competition. 39 Early Warning Services, LLC, a decades-old consumer reporting agency owned by major financial institutions such as Bank of America Corporation (BofA) and Wells Fargo & Company (Wells Fargo), debuted Zelle in 2017. 40 Zelle enables money to be sent by mobile directly between almost any US bank account, typically within minutes. 41 In its first year, Zelle processed more than 320 million transactions valued at $94 billion. 42 Collaboration. In July 2017, PayPal announced a partnership with JPMorgan Chase & Co. (JPMorgan) through which JPMorgan customers would be able to link their credit cards to PayPal and pay with Chase Ultimate Rewards points wherever PayPal is accepted. 43 In the following month, PayPal announced a partnership with Synchrony Financial to launch the Mastercard-branded PayPal Cashback credit card. 44 Fintech and bank collaboration will likely make the payments landscape unrecognizable in a decade. 45 While the future is uncertain, ongoing trends in India may foreshadow the development of payments ( Exhibit 3 , Case Study No. 2). Wealth/investment management Following the emergence of online or “discount” brokerages, trade execution was largely commoditized, with brokerage firms reducing per-trade charges and introducing new pricing models. 46 It is argued that the wealth management industry is now experiencing its own “discount” moment, with algorithms driving the commoditization of portfolio creation and with competitive industry dynamics compressing margins. 47 To succeed in this environment, incumbents and digital wealth managers (DWMs or robos) alike are leveraging fintech. 48 Portfolio creation is becoming increasingly commoditized. Robos introduced algorithms and digital platforms that have enabled low-cost portfolio construction, rebalancing, and monitoring based on objectives, risk tolerance, and other criteria. 49 Many large incumbents have responded with their own offerings. 50 While DWM and incumbent robo offerings surpassed $200 billion in aggregate assets under management (AUM) in 2017, robo offerings hold a small amount of overall AUM; in North America, 38 Capgemini and BNP Parabas, World Payments Report 2018 , 13, 31, 33. 39 According to McKinsey & Company (McKinsey), banks’ customer relationships, structural security, multichannel capabilities, and stability should ultimately combine to win payments, which is the gateway into overall financial relationships; however, banks will succeed only if they can match the solutions, operational efficiency, and client-service skills of attackers. Denecker et al. 40 Julia Glum, “Should You Use Venmo, Zelle or Cash App? Everything You Need to Know about the Hottest Mobile Payment Apps,” Money , September 4, 2018, http://money.com/money/5376350/venmo-cash-app-zelle-better/ (accessed Dec. 6, 2018). 41 “Frequently Asked Questions,” Zelle company website, https://www.zellepay.com/support/what-is-zelle (accessed Dec. 6, 2018). 42 “Zelle Moves 100 Million Transactions Totaling $28 Billion in Second Quarter 2018,” Zelle press release, July 26, 2018. 43 “JPMorgan Chase and PayPal Strike Payments Partnership to Enhance Payments Online, in App and in Store,” JPMorgan Chase press release, July 20, 2017. 44 GlobalData, Alternative Payment Solution: PayPal , March 2018, 14, 17. 45 Accenture, Driving the Future of Payments: 10 Mega Trends , 2017, 9. 46 These new models split advice from transactions: full-service brokers began charging on an asset-under-management basis versus fees per trade. PwC, Asset & Wealth Management Insights: Exploring the Impact of FinTech , January 2017, 6. 47 Joe Ngai, Jill Zucker, Patrick Kennedy, and Simon London, “Wealth Management in an Era of Robots, Regulation, and New Money,” McKinsey, March 2018. 48 PwC, Digital Wealth Management: Driving Engagement through Data-Driven Insights , January 2018. 49 Ngai et al.; PwC, Asset & Wealth Management Insights , 10. 50 The Charles Schwab Corporation (Charles Schwab) launched Schwab Intelligent Portfolios; Vanguard Group, Inc. (Vanguard), launched Vanguard Personal Advisor Services; and Morgan Stanley launched Access Investing. Additionally, T. Rowe Price Group, Inc., JPMorgan, and Wells Fargo have launched or are planning to launch robos. “As Robo-Advisors Cross $200 Billion in Assets, Schwab Leads in Performance,” Barron’s , February 3, 2018, https://www.barrons.com/articles/as-robo-advisors-cross-200-billion-in-assets-schwab-leads-in-performance-1517509393; Theresa W. Carey, “Morgan Stanley Launches Robo-Advisory,” Barron’s , December 9, 2017, https://www.barrons.com/articles/morgan-stanley-launches-robo-advisory- 1512791864; Vanguard company website, https://investor.vanguard.com/advice/personal-advisor (all accessed Dec. 27, 2018). Page 7 UV7736 the value of AUM amounted to $37.4 trillion in 2017. 51 While currently a fraction of total assets, robo is expected to continue growing, likely due to incumbents ( Exhibit 5 ). 52 Competitive industry dynamics are compressing margins. An increase in low-cost robo offerings will only continue the trend of fee compression. A shift from actively managed funds to low-cost passive funds has persisted for years, and zero-cost exchange-traded funds (ETFs) and no-fee index funds may further accelerate this trend. 53 At the same time, expenses continue to rise, including those associated with regulation, such as the Markets in Financial Instruments Directive in Europe (MiFID II); increasing fee compression and expenses have squeezed profit margins. 54 Data analytics and technology prove vital. In addition to leveraging data and technology to provide robo offerings, DWMs and incumbents (collectively known as managers) are utilizing data analytics and technology to grow AUM and profit margins. o AUM growth . Managers are beginning to leverage big data, AI, and machine learning to more effectively analyze investment opportunities, optimize portfolios, mitigate risks, and provide enhanced real-time insights to clients, all of which may enable stronger performance and may attract and retain clients. 55 To attract and retain clients, mobile and omnichannel capabilities are also necessary. “The mobile channel now accounts for [nearly 35%] of client interactions...and is the fastest-growing channel across financial services,” and clients increasingly prefer omnichannel solutions, presenting opportunities for managers that effectively couple digital and mobile capabilities with data-driven personal communication. 56 Personalized communication is vital, and 51 Outside North America, countries such as China have exhibited strong AUM growth. AUM in China grew from approximately $1.27 billion in 1998 to $2 trillion in 2018, and it is estimated to reach $5.6 trillion by 2025. Such growth has occurred via fintech; for example, Alibaba’s money-market fund, Yu’e Bao, is now the world’s largest money-market fund (370 million account holders and over $210 billion in assets), and is twice the size of its closest competitor, JPMorgan. Yu’e Bao was originally established to permit Alipay users to park idle cash sitting in mobile wallets. Additionally, Chinese fintech lenders such as Yirendai and Lufax offer wealth-management products in addition to loans. https://www.barrons.com/articles/as-robo-advisors- cross-200-billion-in-assets-schwab-leads-in-performance-1517509393; Renaud Fages, “Global Asset Management 2018: The Digital Metamorphosis,” July 19, 2018; “Meet the Earth’s Largest Money-Market Fund,” Wall Street Journal , September 13, 2017, https://www.wsj.com/articles/how-an-alibaba- spinoff-created-the-worlds-largest-money-market-fund-1505295000; Sara Hsu, “China’s Fintech Giants Have the Money and Means to Dominate Despite the Wider Slowdown,” Forbes , August 31, 2018, https://www.forbes.com/sites/sarahsu/2018/08/31/chinas-fintech-giants-have-the-money- and-means-to-dominate-despite-the-wider-slowdown/#4a6f7cde465f (all accessed Dec. 31, 2018). 52 The number of individuals using robo advice in the United States is expected to grow from 2 million to 17 million by 2021, and by 2025, 57% and 58% of Americans expect to use some form of robo advisors or robotics, respectively. While over 80% of current US robo advice users are millennials (60%) or Gen X (23%), baby boomers, who represent over 50% of households in North America and stand to be the generation with the most wealth in the coming decade, are increasingly comfortable with robo offerings; 45% of boomers expect to use a robo by 2025. It is argued that growth will come from incumbents, which have thus far outperformed DWMs in accumulating AUM; for example, as of February 2018, Betterment LLC (Betterment) and Wealthfront Advisers LLC (Wealthfront) had $11.9 billion and $10 billion in AUM, respectively, while Vanguard Personal Advisor Services and Schwab Intelligent Portfolio had $101 billion and $27 billion in AUM, respectively. It has been estimated that Betterment and Wealthfront need as much as $40 billion in AUM each to generate revenue in excess of operating and advertising expenses. Charles Schwab, “The Rise of Robo: Americans’ Perspectives and Predictions on the Use of Digital Advice,” November 2018, 2–4, 8; Ngai et al., 3–4; “Small Robo-Advisors Battle Vanguard, Charles Schwab,” Barron’s , December 4, 2018, https://www.barrons.com/articles/small-robo-advisors-battle-vanguard-charles-schwab-1543949504 (accessed Dec. 27, 2018). 53 In August 2018, Fidelity Investments became the first company to offer no-fee index funds, and in the first month, attracted nearly $1 billion in assets. Investor preference for low-cost funds and rising cost pressures have led several distributors to drop funds from their platforms; five of the top eight mutual fund distributors have cut funds offered by an average of 28%. Eric Rosenbaum, “Fidelity’s New No-Fee Index Funds Bring in $1 billion in First Month,” CNBC , September 4, 2018, https://www.cnbc.com/2018/09/04/fidelity-offers-first-ever-free-index-funds-and-1-billion-follows.html (accessed Dec. 27, 2018); Deloitte Center for Financial Services, 2019 Investment Management Outlook: A Mix of Opportunity and Challenge , 2018, 1, 5. 54 Bain & Co. estimated that profits per AUM have decreased by 2% CAGR since 2012, and will decrease by 7% through 2022, leaving profit margins at just 8.3 basis points, an amount below that experienced during the GFC. Matthias Memminger, Mike Kuehnel, and Cyrosch Kalateh, “Asset Managers Can No Longer Ride an Easy-Money Boom,” Forbes , August 7, 2018, https://www.forbes.com/sites/baininsights/2018/08/07/asset-managers-can-no- longer-ride-an-easy-money-boom/#35614e2c3ac1 (accessed Dec. 27, 2018). 55 “Fintech in Investment Management,” CFA Institute, https://www.cfainstitute.org/en/membership/professional-development/refresher- readings/2019/fintech-investment-management (accessed Dec. 27, 2018). 56 Without digital enablement, advisers cannot scale to serve a larger customer base, as there are only so many hours in a day and only so many calls that people can make; technology can enable a more efficient adviser team. Additionally, DWM clients reported satisfaction levels 5 to 10 times higher than incumbents’ clients, suggesting that streamlined digital and mobile capabilities could provide improved experiences. David Schiff and Adele Taylor, “Key Trends in Digital Wealth Management—and What to Do about Them,” McKinsey , October 2016; PwC, Beyond Automated Advice: How FinTech Is Shaping Asset & Wealth Management , 2016; PwC, Digital Wealth Management ; Pooneh Baghai, Brant Carson, and Vik Sohoni, “How Wealth Managers Can Transform for the Digital Age,” McKinsey , August 2016. Page 8 UV7736 managers such as Morgan Stanley are combining machine-learning algorithms with analytics to assist financial advisers in generating customized advice for clients. 57 o Margin growth. Additionally, data analytics and technology present managers with the ability to streamline operations and reduce expenses. For example, managers such as T. Rowe Price Group, Inc., have migrated to the cloud to “achieve operational scalability and lower fixed costs.” 58 Mobile and digital adoption can allow managers to decrease reliance on multipart, paper-centric account opening and maintenance, which could reduce manual costs and costly errors. 59 Further, it is argued that automated customer analysis can lower the costs of customer onboarding, conversion, and funding. 60 Finally, emerging technologies such as blockchain could reduce costs associated with databases and could enable smart contracts that impact the wealth management value chain by augmenting or streamlining processes. 61 Insurtech Just as insurance is a subset of financial services, insurtech is a subset of fintech. Insurtech is the use of technology to solve insurance-related problems. Insurtech utilizes technology to enter new insurance markets and to “squeeze out savings and efficiency from the current insurance industry model.” 62 Because insurtech enables industry growth and improvement, it is generating significant interest. In fact, between 1998 and June 2018, insurtech investment totaled $12.52 billion, reaching an inflection point in 2013. While investment totaled $296 million in 2011, it reached $1.59 billion in 2013, $2.95 billion in 2015, and over $4 billion in 2018. 63 Insurtech enables insurance industry growth. The insurance industry is massive, with global premiums of nearly $5 trillion. 64 Despite the insurance industry’s size, many products, services, and segments are unserved or underserved. Insurtech can fill the void: 40% of insurtech companies have a primary value proposition of increasing growth by introducing new products or services or by entering new segments. 65 Examples of insurtech-enabled growth are noted in Table 2 57 Deloitte, 2019 Investment Management Outlook , 6. 58 Cloud adoption may also help managers meet MiFID requirements of recording client communications and storing them for at least five years. Deloitte, 2019 Investment Management Outlook , 8–10. 59 Deloitte, 2019 Investment Management Outlook , 13. 60 PwC, Beyond Automated Advice 61 PwC, Asset & Wealth Management Insights , 7. 62 “Insurtech,” Investopedia , https://www.investopedia.com/terms/i/insurtech.asp (accessed Dec. 19, 2018). 63 CBInsights, Quarterly InsurTech Briefing Q4 2018 , February 2019, 34, 36; Deloitte Center for Financial Services, InsurTech Entering Its Second Wave , 2018, 1–4. 64 “Global Insurance Premiums Continued to Rise in 2017 with Emerging Markets Leading the Way, Latest Swiss Re Institute Sigma Study Says,” Swiss Re news release, July 5, 2018. 65 Of insurtech companies, 22% have a value proposition built around lowering acquisition costs, typically by providing customers with a digital interface using a direct distribution model. The remaining insurtechs have focused on lowering costs for claims management, policy administration, and other tasks through digital and streamlined processes. Tanguy Catlin, Johannes-Tobias Lorenz, Björn Münstermann, Peter Braad Olesen, and Valentino Ricciardi, “Insurtech—The Threat That Inspires,” McKinsey, March 2017. Page 9 UV7736 Table 2. Data capabilities and digital and mobile insurtech offerings drive growth. Company Product/Offering Achmea Insurance, Netherlands Homies, an alarm and security platform that seeks to lower the number of burglaries and fire fatalities in undeserved community housing projects, uses intelligent and connected burglary sensors and interacts with enrollees through messaging apps such as WhatsApp and Facebook Messenger. 66 Amazon.com, Inc. (Amazon) Amazon Protect (in the United Kingdom) offers protection against accidental damage, breakdown, and theft of Amazon purchases ranging from washing machines to tablets. 67 BIMA, Sweden Mobile microinsurer that provides insurance in emerging markets, in which mobile penetration is high and coverage very low. 68 Root Insurance Company, United States Online auto insurer that allows applicants to test-drive performance utilizing telematics-based technology. 69 Slice Insurance Technologies, Inc., United States Coverage for homeshare (e.g., Airbnb) and rideshare (e.g., Uber). 70 ZhongAn Online Property & Casualty Insurance, China China’s first online-only insurance company, cofounded by Alibaba’s Jack Ma and Tencent’s Pony Ma, was the largest fintech IPO to list in Hong Kong. The company utilizes big data and analytics to better determine product price and control risk. 71 Data source: Created by author from sources cited. Insurtech can improve existing business models. 72 Fundamentally, insurance companies pool risk from an individual customer and transfer that risk across a larger group. Insurtech enables insurers to focus on the individual customer while improving overall risk management. Additionally, insurtech can help solve operational problems and reduce operational expenses. o Customer-centricity. Financial services customers reported significantly fewer positive experiences and lower satisfaction levels with insurance firms compared to those with banks, likely because fewer customer touchpoints exist in insurance. 73 Insurtech can improve the quantity and quality of consumer interactions. Emerging technologies such as connected devices and advanced analytics make it possible to connect with customers and to derive better insights on individuals. 74 Better insights may support personalized produ