‘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 happened in the past 30.’
Dan Schulman, chief executive, 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. 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 has not always been this way.
In the 1990s Hong Kong was a front runner in financial innovation when it saw the first 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 is trying to figure out what’s next – it 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 it on.’
Breaking the shackles
In his 2018/19 budget speech Paul Chan, Hong Kong’s Financial Secretary, announced he would allocate HK$50bn (US$6bn) to the development of fintech, artificial intelligence and biotech, to ‘stay ahead of the game’. Over the next five years, HK$500m (US$64m) will be injected directly into the financial services sector, a move which should help improve the attractiveness of start-ups 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 start-ups 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, chief executive 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 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. This leads to a system that lags the likes of Europe and Australia,’ argues Monaghan.
‘In Singapore, you had 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 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 dealing with other people’s money.
The HKMA published revised guidelines on the authorisation of virtual banking in Hong Kong in May, with the first licences to be issued at the end of this year. More than 50 companies have expressed interest, including one of the strongest home-grown 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 licence, 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.
With any growing industry comes increased risk and regulation, even more so when dealing with other people’s money.
The HKMA is preparing to launch a Faster Payments System, which will make it possible 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 one of seven smart banking initiatives being introduced by the HKMA. Other initiatives from the 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 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, 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 the three would be linked to offer ‘a single point of entry for 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 cash flow to pay hourly rates, which means law firms that follow traditional economic and pricing models are less likely to develop 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 in the early stages of development, hence many do not have an in-house legal team until further stages of maturity.
Says McQuhae: ‘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.’
For FinFabrik, who hired an in-house counsel earlier than many peers, 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 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. 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 says that it is vital not to separate legal from the fin or the tech.
‘Clear regulation can’t come quickly enough. It is encouraging to see more jurisdictions introducing new regulations to provide certainty, and to see established global financial institutions investing in fintech infrastructure. For Hong Kong there is no single established set of fintech rules – the sooner this happens the better.’
One area sparking debate 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,’ says Monaghan.
The issue of privacy is a particularly difficult one in terms of regulation, as McQuhae points out.
‘There is a loud, ongoing debate around crypto-assets and blockchain, which we believe should be separated. Blockchain is a technology and while regulators will need to educate themselves about its potential and associated risks in their markets, it is important regulation does not stifle innovation by regulating technology,’ he says.
‘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.’
Steve Monaghan, Gen.Life
‘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.’
The rethought approach to regulating fintech in Hong Kong has been welcomed from financial institutions large and small, with further changes to 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 Hong Kong as opposed to in Cayman. 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 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.’
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.’
The HKMA has also ramped up cross-border collaboration following the signing of a UK-Hong Kong FinTech Bridge in 2017. The initiative, aimed at encouraging 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 start-ups to establish themselves in the opposite jurisdiction.
The impact of this is beginning to show. According to 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 collection
With the ongoing trade tensions between China and the US, Lau sees the potential for Hong Kong to capitalise on its role as a gateway.
‘Hong Kong doesn’t have that same obstacle – it has autonomy, its 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 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.’
One reason is US immigration policies that Lau says are not ‘necessarily welcoming’. In contrast, the Hong Kong government is promoting an agenda of its own – in 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.
Adding to the potential of Hong Kong in the medium term is the ongoing Greater Bay Area initiative, a project 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.
‘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.’ LB
Alex Speirs is editor of GC magazine.