Auguries of Fintech's Future
Auguries of Fintech's Future?
Just got back from Day 1 of Hong Kong fintech week which inspired this article and served as a barometer for fintech’s future.
Churchill once said that those who ignore history are doomed to repeat it. I thought about that when I heard the rather bombastic former Commissioner of the U.S. CFTC (in black cowboy boots and Jesus-like hair) (billed as “Commissioner” without the important qualifier “former” in the online marketing materials preceding the event) flippantly recite current fintech events in a poem to dazed Asian audiences (who are usually not accustomed to seeing regulators even former ones behaving so lively). Surely a different style from Steve Jobs’ presentation style. Diversity is good and a little entertainment is always appreciated especially in long drawn-out conferences full of people in dark suits and ties.
The former Commissioner was on stage discussing the poor state of American infrastructures and lambasting the current U.S. President which may be interpreted as being inappropriate in my humble opinion considering that he was on stage to discuss the “Future of Fintech, Global Perspectives” and not the “Future of the U.S. Presidency”.
The last time when regulators (even former ones) were so flippant was back in 2007. For example, on April 1, 2007 the U.S. SEC issued an April’s Fools’ Day prank announcement. (Here and here.) At the time we all thought it was funny. Then within a few months, we were in the middle of the great financial crisis of 2008. Nobody was laughing then.
This essay extrapolates upon materials and themes from Day 1 of HK fintech week to discuss the following broader points:
- sufficiency of diversity of views on current fintech issues (Part I);
- whether a gathering storm is approaching for ICOs (Part II);
- the apparent lack of interest (and knowledge) in the cybersecurity aspect of fintech (Part III); and
- under-appreciation on the importance of intellectual property protection for fintech innovations (Part IV).
Part I: A Tale of Two Conferences
Conferences are expensive to hold (especially in expensive cities like Hong Kong) so it’s rather understandable that only those who pay for sponsorships are allowed to speak at them, the so-called “pay to talk” business model. However this model does not allow for much diversity of views considering that entities like NGOs, academic institutions, fintech scholars, pension funds like CALPERS, and investors’ advocate groups often are not interested in paying to talk (due to their limited budgets and ethical rules of engagements).
Building A More Inclusive Fintech Viewpoint
Let’s compare HK Fintech Week Day 1 to a recent public hearing on blockchain technology held by the U.S. SEC to build a broader more diverse picture of fintech today.
Today’s U.S. SEC has been taking a serious look at the crypto-assets world. Recently on October 12, 2017, the Investor Advisory Committee (“Investor Committee”) held a public hearing on blockchain or distributed ledger technologies. The Investor Committee was established under section 911 of the Dodd-Frank Act to advise the U.S. SEC on regulatory priorities, the regulation of securities products, trading strategies, fee structures, the effectiveness of disclosure, and on initiatives to protect investor interests and to promote investor confidence and the integrity of the securities marketplace. Its members consists of senior executives from some of the world’s largest pensions and retirement schemes such as CALPERS and labor unions like the AFL-CIO, as well as academics (Harvard Law School) and consumer advocators. Certainly a very different crowd than the panelists sitting on fintech conferences.
Understanding their insights helps fintech players obtain a more balanced (and perhaps a sensible) view of the direction of the industry as a whole.
In contrast to the buoyant former U.S. CFTC Commissioner who spoke at HK fintech week, Mr. Jeff Bandman who himself is a former regulator at the U.S. CFTC (having created its LabCFTC) gave an excellent overview of the regulators’ role in governing and managing the risks and challenges created by emerging technologies. He discussed four major issues: 1) the role of the regulator; 2) blockchain’s potential to give investors greater control over their own data; 3) ability of regulators to harness real-time data from blockchain technologies to conduct real-time regulation; and 4) obstacles to regulators’ educating themselves on the new technology.
The Investor Committee raised many questions on a topic that often times is ignored or under-represented in private fintech conferences: investors protection. I was counting the number of times the words “investors protection” ever popped up during the discussions which I attended in Day 1 of HK fintech week. The tally was “zero” (well, 0.5 if we can count the former U.S. CFTC Commissioner’s comment that he “cares about the average American investor”). At the U.S. SEC’s hearing however, the panelists appearing before the Investor Committee got an earful of that.
Mr. Damon Silvers, Director of Policy and Special Counsel at the AFL-CIO (one of the largest trade union organizations in the world), gave short shrift to crypto-assets in general and hammered the panelists hard about their apparent attempt to evade discussion on the law on whether crypto-assets are deemed securities (see webcast here).
The Investor Committee overall gave the impression that they were wary of cryptocurrencies but acceptive of the potential benefits of blockchain. Anne Simpson, Investment Director, CALPERS summed up the Investor Committee’s attitude the best when she stated that “[w]e need to make sure protections are in place for the savings of ordinary working people. The financial services industry exists to service end-users”. She stated that the purpose of the the financial system is to protect the savings of investors and reminded the audience of the lessons of the tulip bubble.
Part II: A Gathering Storm?
Was the flippancy shown by the former U.S. CFTC Commissioner an omen of what is to come for us as world markets have been experiencing the meteoric rise of ICOs and cryptocurrencies? The ICO market is so euphoric for token issuances that investors have been signing up to entirely lob-sided unbalanced ICO deal terms completely against their favor without any sort of corporate governance, shareholders’, or regulatory protections. (See my article on ICO best practices here.) Token buyers are not even shareholders. They are just that: token holders. This reminds us of the days before the 2008 crash when global securities lawyers (including those representing investors) accepted securities without traditional covenants protective of their clients’ interests in so called “covenant-lite” loans and related financial instruments. We all know how that “innovation” which helped fuel the market for credit default swaps ended: with a loud crash and a lot of broken dreams.
To what extent are we seeing the beginning of the ICO and cryptocurrency bust? As I have written before, when governments like China and Russia issue their fiat virtual currencies, how will cryptocurrencies survive? Recently Russia said it will ban all cryptocurrencies in its borders with the introduction of the virtual Russian crypto-ruble.
Even HK fintech week Day 1’s panel on “best practices for ICOs” was extremely pessimistic about ICOs which to me was surprising considering that the panel was made up of a big four accounting firm (a platinum sponsor of the event), a Wall Street law firm (a silver sponsor, slightly lower in grade) and a regulator from the Gibraltar Stock Exchange (also a silver sponsor) (all actors typically in favor of issuers’ interests). Despite the valiant efforts of the learned moderator, the panelists did not set forth any concrete “best practices” but left dire warnings to would-be ICOs investors (and their issuers) noting that they would be “fleeced” (thus implying that ICO issuers are doing the fleecing) in “scams” which would lead to massive “class actions”. These are not the typical buzzwords surrounding ICOs at a major regional fintech conference with all the dramatic bells and whistles.
I felt sorry for the theatrically energetic MC who had to introduce the next panel trying to work up the audience for more enthusiasm. It was hard to be enthusiastic when some of the audience just heard they will be “fleeced” (if they are prospective ICOs investors) or sued in “massive class actions” (if they are prospective ICOs issuers).
Part III: Cybersecurity Sessions Drew Little Interest
You know cybersecurity is in trouble when two excellent workshops on its application to fintech struggled to have over 35 attendees (a drop in the bucket considering that there were over 2,000 registered attendees for the whole conference). The HK ASTRI’s team gave an interesting and insightful lecture on cybersecurity practices in fintech followed later by a good panel talking about securing corporations in the cloud both of which were significantly under-attended. This was not a good sign when fintech players are not interested in the technicalities of cybersecurity and cloud security. They were probably just out to lunch, literally, as it was about lunch time. Is this an omen to plague fintech to come? Time will tell. I sort of got a hint of that answer in the session sandwiched in between the two workshops.
In a ‘cybersecurity in fintech’ talk, I asked the presenter “how would smart contracts built on Ethereum affect cybersecurity” hoping to start a discussion about the risks that third party open sourced software libraries present to such smart contracts on a blockchain (see here and here). The question it appears flew right over and he launched into a discussion about privacy issues. Talk about two ships passing in the darkness of night. Hmm, interesting. Maybe it was a misunderstanding?
Part IV: Intellectual Property Attention Deficit ("IPAD") Syndrome
I looked over the entire schedule for all 5 days of Hong Kong fintech week and there was not one panel on the relationship between intellectual property (“IP”) protection and fintech. Even in the legally-oriented panel sessions in Day 1, this topic was noticeably absent and went un-discussed. See my comment letter to the world's key central banks here and Hong Kong Stock Exchange here for the importance of IP in fintech, especially in the patent wars (that would mirror the smart phone IP wars) to come which I will write more about soon.
First IP & Fintech Camp: “we don’t care about proprietary IP”
Some friends in the industry and I have been talking about the development of a phenomenon particularly acute outside of the U.S. It’s what we call the Intellectual Property Attention Deficit syndrome or “IPAD” syndrome for short. Its symptoms and diagnosis are explained as follows.
There are two camps when it comes to IP and fintech. The first camp does not care about it or greatly discounts its significance. They belong to this first camp by choice (like certain charities, see Gates Foundation later) or unwittingly, like most fintech players I have met in Asia.
For example, a panelists on a Day 1 session of HK fintech week noted that “[f]intech is 90% about regulation and 10% about technology”, (a CIO in a Swiss firm helping startups through the ICO process). One can say almost every business activity is “90% regulation” because no company can conduct a business that is banned by a government. Why should technology constitute only 10% of fintech when it obviously defines the very nature of “fintech” itself. In contrast the Executive Chairman of Alibaba Jack Ma coined the term “techfin” giving prominence to technology over finance. To underscore the importance of technology, Mr. Ma’s company Alibaba on October 11, 2017 announced its plan to invest more than US$15 billion over three years in a global research and development project to include fintech as one of its ambitious R&D programs.
Considering that Visa and Mastercard each holds over 300 patents in blockchain technology alone, you know that there will be trouble for those companies operating in activities which these vital patents cover.
Open source means free IP?
Many with whom I have discussed this issue in Hong Kong usually dismiss the idea of IP protection in what they see to be an “open” sourced business model. Doesn’t open source mean free IP? There is nothing wrong with this attitude. It’s just that they are doing their investors a great disservice if they are not taking the right steps to protect, build and monetize a world-class IP portfolio.
If fintech firms are in the business of a charity (like the Gates Foundation) and they just want to better society, then of course, they would not need to patent the IP of their inventions. They are more interested in offering their inventions to the world for free to help advance humanity. For example, a few days ago, the Gates Foundation announced an open-source software to create interoperable payments platforms that connect all digital financial providers and customers. It is hoped that this new platform will expand financial inclusion (a term much discussed in fintech circles without much action) to those who Mr. Gates call the "unbanked" and help them gain access to financial services hitherto unavailable.
In fact the majority of the world’s widely used “open source” coding (like those listed below), came from developers working on research grants (ie., free money and not on any private companies’ shareholders’ dime):
Sure, if a fintech firm does not need to make money and its founder is already a billionaire (like Mr. Gates), it would not need to worry about launching proprietary business models and can afford to be focused on launching world-saving open source software platforms.
But I suspect that most players in the fintech world are in it to make money (so they can be the next Bill Gates and hopefully do good for us) and the smart players have been racing to apply for and receiving valuable IP protections for their fintech related inventions.
Second IP & Fintech Camp: “Coopetition”
An executive from Visa was sitting on the panel on “Open APIs: Building a digital society with open APIs” in Day 1 of HK fintech week. I was extremely interested in hearing what she had to say about doing business in an “open” digital society using “open” APIs and how that relates with her company’s mammoth global blockchain patent portfolio. I was not disappointed from what I heard and it confirms my point here. She used a word which I thought was interesting “coopetition” which in the context meant a combination of the word “cooperation” with “competition”. I suspect most if not all of the audience failed to appreciate the true significance on her careful, subtle and apt choice of this word: “open” APIs does not mean “free” IP!
Although companies in the fintech payment space must cooperate with each other via mutually-connected APIs (since the panelists rightfully agreed that no one bank can “do it all”), they would still need to compete with each other!
One of the key ways that fintech players (whether they are smaller, nimbler fintech firms, legacy financial institutions or “big tech” like Apple or Microsoft) will compete with each other will be through the strength of their respective IP portfolios.
If you are doing business in fintech, are successful at it, but lack an adequate IP portfolio protecting your inventions, then your operations may be significantly disrupted by the vicissitudes of an international patent litigation campaign launched by your competitor to shut you down and/or be forced to license your competitor’s IP rights at costly terms. Either way, you and your shareholders’ lose (just hope the latter don’t sue you for it too, that would be a double-whammy).
IPAD Syndrome & HK fintech?
Based on two panels on Day 1, it is pretty clear into which camp Hong Kong’s fintech world falls generally (though exceptions undoubtedly exist).
In the session “Blockchain Economy Development and the Law” composed of a panel of a global law firm and accounting firm, the words “intellectual property protection” were never mentioned. Since it was a session on the “law”, it was interesting that there was no discussion about the need to protect fintech innovations. Instead, they presented the usual justifications of why Hong Kong would be a better jurisdiction to host fintech projects and companies: relative low corruption and rule of law. Excuse me, but these are simply justifications used from the 1990s up to now on why companies should list their shares in Hong Kong. How are these justifications (re-hashed from the IPO context) particularly relevant to the new challenges and opportunities that 21st century fintech presents? The panel showed its draft list of recommendations to the Hong Kong regulatory authorities and none of them addressed IP protection. Unfortunately, the panel did not permit Q&A so I did not have a chance to let the panel clarify their position. This was a missed opportunity to try to influence the Hong Kong authorities on a vital issue underpinning Hong Kong’s future success as a fintech hub: IP protection.
Hong Kong Patent Office Lacks Original Patent Jurisdiction
For some odd reason, the Hong Kong Intellectual Property Department does not have the power to issue a patent. It expressly states in its website that “[w]e do not conduct substantive search and examination of the novelty or inventiveness of your invention.”
Instead it can only “register” a patent that was granted in the People’s Republic of China, the European Patent Office and the United Kingdom Patent Office. In other words, if a fintech player in Hong Kong wants to apply for a patent to protect its invention, it would first need to go to China, the United Kingdom or the European Union to do so and then bring it back to Hong Kong for it to be registered there. This can be an expensive two-stepped process. This inability to issue an original patent in Hong Kong greatly undercuts the financial incentives for doing fintech in Hong Kong which has a very tiny market compared to China, the EU or the UK. Even one of Hong Kong's major newspapers laments this fact. If a fintech player needs to spend time and resources in applying for a patent in a jurisdiction whose market size and potential are significantly greater than that of Hong Kong, then such a player would most likely be incentivized to conduct its fintech business in these larger markets instead. Most tech startups have been complaining about basing their operations and R&D efforts in Hong Kong when they can do so in a much larger market.
At the session called “USA Delegation: the American Fintech Ecosystem”, two fintech firms (Goonder and HireAthena) based in Silicon Valley presented their respective business model. To test my theory, in the Q&A session, I asked “how important is intellectual property protection in your operations”. Without hesitation, HireAthena stated clearly that IP protections play a huge role in both their clients' businesses and its own. Goonder agreed. The significance of IP protection is not lost on tech companies from Silicon Valley. They get the game and understand how critical IP is. However the executive from InvestHK also on the panel stated somewhat dryly (perhaps from a pre-scripted response I suspect) that companies doing business in Hong Kong are provided with “a list of practitioners” to help them protect their IPs. Out of respect for InvestHK and to give them face in public (since after all they were one of the event co-sponsors) I did not point out that these “practitioners” would have a hard time patenting any inventions for their clients in Hong Kong. Is it fair to pass the buck of telling investors that Hong Kong cannot issue original patent grants to private practitioners?
In contrast, Hong Kong’s arch-nemesis Singapore associates fintech competitiveness with IP protection. The Monetary Authority of Singapore’s website contains a link called “Protecting your intellectual property” under its fintech page. There is even a link called “Patenting in Fintech” Is your invention patentable? Why patents matter. The Intellectual Property Office of Singapore does have the power to issue original patents (see here). I have seen several Singapore fintech events that allow fintech startups to learn more about IP protection. Singapore’s endorsement of IP also finds expression in its annual IP conference that features global “IP thought leaders, legal experts and innovative companies, to share insights on IP commercialisation and winning strategies for business growth.” The last one was held in August 2017 and hundreds of attendees from more than 30 countries met to network and collaborate. If Singapore is doing this, why shouldn’t Hong Kong do the same in its fintech conferences to raise awareness in this important area?
These were some of the issues that could have been explored deeper at HK fintech week. There were many parallel sessions that I was not able to attend which may have discussed them further. But I wish the Hong Kong fintech community the best of luck in its endeavors. I have tickets for Days 2 & 3, but my friend convinced me to attend his out of town engagement instead. Sorry.