Many fintechs have based their business model on cloud computing. By outsourcing the heavy computational lifting to the likes of AWS, Azure, Aliyun or others, they can offer clients cutting-edge service at razor-thin costing. Financial institutions, meanwhile, are tentatively exploring the benefits of moving surge activities to cloud vendors.
This pretty picture was marred in late December with the news that the chips used for cloud services and mobile phones, produced by the likes of Intel, AMD and ARM Holdings included flaws making it possible for hackers to steal encrypted information. While “Spectre” is a Microsoft-specific vulnerability, “Meltdown” enables a program running on an Intel chip to bypass the operating system (OS) and access data in separate programs.
As chipmakers scrambled to release patches, confusion deepened in January when a Microsoft official in the U.S. suggested users might prefer not to address these flaws if it meant losing performance – a tempting thought for many startups.
DigFin asked Padraig Walsh, Hong Kong-based partner at Bird & Bird, a law firm with a fintech clientele, to suggest how fintechs relying on cloud computing to think about this problem. He writes:
Here’s a dilemma. Patch your software to account for latent deficiencies in CPU processors: lose performance, but avoid or mitigate data breach. Or do nothing, and this latent deficiency may result in a systemic data breach (and by the way, your chances of being targeted have increased). For fintech businesses, Spectre and Meltdown provide this “damned either way” scenario.
Realistically, there is no choice. The only decision is to patch, patch and patch again, with every solution and update provided by any operating system (OS), cloud or app service provider. Users have to use the recommended precautionary measures recommended to mitigate their own liability.
Fail to do that, then a systemic data breach may mean any number of nasty outcomes. In Hong Kong, there is the prospect of an action from the Privacy Commissioner (if personal data is involved). One of the core privacy principles in Hong Kong is that a data user must take practicable steps to safeguard personal data from unauthorised or accidental access, processing, erasure, loss or use. Similar rules apply elsewhere.
There could be regulatory action from a regulator such as the HKMA or the SFC, if the business is a regulated entity. Also, if there is a breach of contract or confidence, then there could be civil claims with catastrophic consequential damages. So, serious stuff.
There are four areas of potential liability:
- Product liability: Intel and ARM have said the problems do not arise from a design defect or flaw. Intel has characterized this as a weakness in how all processors have been designed. It is true that a number of processor firms have been affected. That is likely to be tested in court. Class actions have already been filed in the U.S.
- Delay: Google informed CPU manufacturers of the design flaws on 1 June 2017 for Spectre and 28 July 2017 for Meltdown. The planned announcement was scheduled for 9 January, but was rushed to 4 January 2018 when news leaked. Did the CPU manufacturers work fast enough? Should the news have been released to market sooner? Could end user losses have been avoided? Pending litigation will argue this.
- Ongoing losses: The security solutions to mitigate Spectre and Meltdown will result in a loss of performance. For older OS using these CPUs, this could be up to 30%. Realistically, in the financial services sector, it is unlikely to be as bad as that. However, marginal performance deterioration could arguably give rise to significant impairment of financial returns. Also, not all businesses may implement the measures at the same time, potentially magnifying the loss for some. It will be difficult to prove causation – namely, that patches to address Spectre and Meltdown resulted in specific losses that otherwise would not have occurred. But, I expect there will be litigants who will try to prove just that.
- Supplier losses: Apple, Microsoft, Google, Amazon and Linux are just some of those who have provided patches to address the risks of Spectre and Meltdown. They have incurred costs in doing so. They are likely to believe those costs are recoverable from Intel, ARM and other CPU manufacturers.
What does this mean going forward?
Cloud computing is most vulnerable to these design flaws. Nonetheless, Spectre and Meltdown are highly unlikely to discourage cloud-computing use, provided the industry responds with confidence to demonstrate safety. Its use is too embedded in business operations now.
Here is AMD’s sensible statement: “Total protection from all possible attacks remains an elusive goal”. CPUs – like all technologies – are designed by humans. There will be flaws.
(These comments express the personal views of the author, and not the official opinion or views of Bird & Bird. Nothing in these comments is intended to, or actually provides, legal advice.)
Korea’s fintech scene growing fast: C.S.
A Credit Suisse report highlights activity in fintech by internet companies, startups and banks.
Customer demand, regulatory support and advancing technology are fuelling a boom in fintech in Korea, according to an equity research report by Credit Suisse.
Fintech is part of a broader trend in tech startups and unicorns (startups valued at $1 billion or more), of which there are now eight in Korea, according to the August 29 report, written by lead analyst Park Jeehoon.
Biotech and retail services are the hottest areas winning the most investment. But fintech investment is also thriving, especially in payments, crowdfunding, and virtual banking.
Today there are more than 9 million daily users of mobile banking services in Korea, about double the number from 2013. Even more striking: 90% of banking transactions in Korea are today made online.
Show me the money
This helps explain the ongoing flood of money going into the country’s startup scene.
The Korea Venture Capital Association says startups received W3.4 trillion of investments in 2018 and are on track to receive W4 trillion this year. In the first half of 2019, 826 startups received investment, up 16.3% year on year (there are now over 300 fintech startups in Korea). Funding for startups is also shifting from mainly early stage to also include growth-phase companies.
Within fintech, payments and money transfer account for 32% of investment (see chart, main image); ‘techfin’, that is investments from internet companies like Kakao and Naver, is 25%; lending and credit startups are getting 24% of the money; digital wealth 16% and insurtech 3%.
Korea’s fintech leaders
Credit Suisse cites several fintechs as new standardbearers for Korea. The biggest startup in terms of valuation is the unicorn Viva Republica, whose backers include PayPal and Altos Capital. Valued today at W2.7 trillion, the 2013-vintage company operates a popular financial platform app called TOSS.
Others include Wadiz, a crowdfunding platform that provides seeding solutions for startups and new business ventures; and insurtech Bomapp, supported by conglomerate Lotte Group and KB Financial.
The leading banks have also teamed up to jointly fund Honest Fund, a digital wealth and lending platform; its shareholders include KB Investment, Hanwha Investment, and Shinhan Capital, a Who’s Who of Korean private-sector banking.
Just as notable, Korea’s traditional banks are also busy with their own fintech initiatives.
Hana Financial is setting up a globally integrated platform based on blockchain; Shinhan is operating a mobile financial service that combines banking, insurance and wealth management; and Nonghyup Financial is the market leader in open banking, using APIs to connect with affiliates and third-party companies to share customer data (on customer request).
Oddly, the Credit Suisse report omits analysis of the hugely successful Kakao Bank or its fellow virtual bank, K-Bank (our story on VBs touted Kakao as the most important model for incoming VBs in Hong Kong and Singapore). It does list out the 33 tech investments made by internet parent Kakao into startups, from payments to crypto to gaming and healthcare.
But it does mention that the regulators in Korea are preparing to license a third virtual bank in 2020.
This is just one aspect of how regulators in Seoul have supported fintech, and why it continues to attract new players and financial backing.
The Financial Services Commission has taken steps over the past several years to support innovation. It has eased regulation on how firms authenticate customers, legalized crowdfunding and virtual banking (aka neo-banking), and blessed a blockchain-based authentication platform called BankSign.
This year, in April, the FSC launched a fintech sandbox giving companies a four-year forgiveness period to test new products. This coming month, it will set tougher mandates for open banking, to be followed next year with the debut of “MyData”, requiring open APIs between banks and fintechs to provide new financial services based on customer personal data.
Toyota and the origins of innovation
A visit to Toyota’s museum in Japan sheds some useful light on fintech.
Last week I spent a week of holiday in Japan, during which time I visited a museum located just outside of Nagoya dedicated to Toyota’s history. It’s excellent, so do visit if you get the chance; and it also got me thinking about innovation.
Fintech is supposed to be driven by innovation; DigFin’s mission is to chronicle the impact of the Information Revolution on finance.
Fintech is, by itself, not that sophisticated: it depends on more foundational innovations in computing power, data analytics, computer networking and connectivity. Fintech applies these in novel ways to address shortcomings, pain points and vulnerable margins in financial services. It has the potential to transform money itself.
Because fintech is now completely digital in nature, the way people in the industry think about “innovation” is based on the Silicon Valley paradigm: disruptive, decentralized, agile –“move fast and break things”; or by China’s recent experience, which relies on scale, relentless iteration, and aggressive ‘platforming’ so that a technology developed for a consumer in one field is deployed to other activities.
But is the digital experience the only relevant one? No, especially not to companies with ambitions to truly transform finance – companies whose founders believe they are creating businesses that will endure long after they’re gone – businesses that will come to define the 21stcentury.
Toyota Motors is a company that defines the 20thcentury. It’s the world’s third-largest carmaker, and the sixth biggest company worldwide in terms of revenues. It employs nearly 365,000 employees and claims the largest market cap in Japan. Today, in its 93rdyear, Toyota Motors is also the global leader in hybrid electric vehicles.
The first display to greet you in its company museum is a giant circular cotton loom (main image). But wait, you say – a cotton loom? I thought we were here for automobiles!
The company’s origins are in Toyoda Automatic Weaving Mill, founded by Sakichi Toyoda in 1911. The company was something of an outsider, Toyoda the unknown son of a carpenter.
Japan had already began headlong modernization following the Meiji Restoration of 1868, but this was led by family-owned conglomerates such as Mitsui and Mitsubishi that controlled banks, monopolized particular industries, and enjoyed cozy government and military ties. Sakichi, lacking such connections, therefore had to beat these incumbents with superior technology. He would go on to become Japan’s preeminent industrialist.
He ultimately patented around 50 inventions, but the most important was his circular loom. This was not just because of the physical technology, although that too is impressive. Since the dawn of the Industrial Revolution in 18thcentury Britain, inventions such as the Spinning Jenny had mechanized sending a shuttlecock back and forth to spin thread. Sakichi’s loom took this two-dimensional concept and made it 3-D in the shape of a circle, which allowed for continuous weaving while requiring far less energy.
Toyoda initially developed coarse fabrics for the low end of the market. Sakichi avoided competing against the incumbents, whose mills produced fine textiles. This was an early example of disruption by using tech to make it economic to meet the needs of the underserved. While the big conglomerates relied on their status and government ties, Sakichi kept iterating until he had developed a loom so good that could overtake the big players.
Innovation the Toyoda way
Key to the many moving parts of this loom were mechanisms to automatically stop the machine whenever a problem occurred. Sakichi promoted an idea of the ‘five whys’, which gave his workers a template to understand the cause of errors and figure out a way to resolve them.
This was a precursor to Toyota Motors’ famous “just in time” processing, as well as the foundation of today’s lean methodologies. Japan lacks natural resources, and therefore Sakichi obsessed on ways to improve productivity and achieve high quality without waste. What followed was a philosophy of getting to the core of “value”, what a customer would be willing to pay for, and discarding the rest.
So all of those Steve Jobs, Eric Reis and Jack Ma bromides about being lean, agile, and customer-focused owe a great debt to Sakichi Toyoda and the early Japanese textile industry.
Sakichi put these into words. His circular loom was invented in “the spirit of being studious and creative”, and dedicated to “the importance of making things”. Furthermore: “No creative thing should be put on the market unless fully proved in the commercial trial.”
The mission statement, then and now
Later on the company would develop five precepts, what today we’d call a mission statement. They are:
- Always be faithful to your duties, thereby contributing to the company and to the overall good;
- Always be studious and creative, striving to stay ahead of the times;
- Always be practical and avoid frivolousness;
- Always strive to build a homelike atmosphere at work that is warm and friendly;
- Always have respect for God, and remember to be grateful at all times.
What’s notable is that the company’s philosophy was not “customer first”. Rather the combination of these tenets is what leads to products and services that delight consumers.
This package of attitudes is about a million miles away from Mark Zuckerberg’s “move fast and break things” philosophy, but it’s also far more grounded than Facebook’s official mission statement (“to bring the world closer together”) and other generic bumf common to Big Tech companies (to say nothing of WeWork’s execrable “elevating the world’s consciousness”).
Toyoda also assumed a patriarchal attitude toward employees. The company took care of its people: during the Great Depression, it used some funding proceeds to help workers in financial distress; these were the early days of lifetime employment.
The company’s philosophy also differs somewhat from today’s Big Tech ethos in Toyota’s emphasis on relentless testing before putting a product into the marketplace. Being agile is great, but launching a consumer app is just as complex and fraught as introducing a car. The rush to be first to market has, I suspect, ended in more failures than successes.
Today, tech companies have a lot more leeway to test and learn from apps already in the wild, while banks’ traditional slow path of testing is now lampooned. And times have changed: what worked for Sakichi isn’t always going to work today. But the company he built is more than 90 years old and still relevant.
From textiles to cars
The company’s move into automobiles germinated in the early 1920s with Sakichi’s son, Kiichiro, who toured the U.S. and Europe and was amazed by the popularity of cars – and impressed by what this said about Western levels of industry and wealth. Kiichiro had grown up among his father’s textile machinery. He went to university to study mechanical engineering, although it would be the friendships he made – later a business network – that would be just as important.
Kiichiro saw the need for a Japanese carmaker, but the big incumbent conglomerates and their government friends didn’t: modernization had been built on rail and shipping.
Kiichiro got his chance when an earthquake in 1923 leveled most of Japan’s infrastructure, while the handful of cars and buses played a critical role in recovery. Then Ford and General Motors set up plants in Japan. With his father’s blessing, Kiichiro began a secret R&D project, importing key machines for textiles that he could adapt to cars. He then negotiated the sale of the circular loom rights to a British manufacturer and used the proceeds to invest in R&D for automobiles.
Many of the technologies invented by Sakichi for textiles proved adaptable to cars (such as seats and airbags), although Kiichiro also invested in an in-house capability for steel, to make parts. They also reverse-engineered American cars. The goal was to figure out how to make good-quality vehicles at lower cost than American imports, but without having to rely on volume. Japan was never going to match America for scale.
So once again, Toyoda found itself relying on technology to take on powerful incumbents. And again, the tech it deployed was a combination of engineering marvels and superior organization, with Toyota Motors (spun off as its own company in 1937) now giving name to its “just in time” operations.
To produce “just in time” meant, first, empowering the workers along its assembly line to stop production when confronted with errors, in order to prevent having to make costly fixes later. Secondly it meant extending the concept upstream to Toyota’s suppliers, and downstream to its bespoke dealership network.
This combination of innovations enabled Toyota to surpass the incumbent conglomerates and become Japan’s most important company, and then to beat the Americans. By the 1970s, Japanese cars were outselling American ones. In a panic, American companies strove to understand why they were getting outgunned by a competitor that just a short while ago was producing crappy, bottom-market tin.
G.M. and Ford eventually survived by adopting “just in time” operations, a trend that has since extended throughout the world of logistics, manufacturing, transport – and is now reaching consumer finance, through notions such as data-driven personalization.
Toyota helped pioneer a lot in the world of disruptive tech that we so admire, or fear, today: finding an underserved niche, using technology to make it profitable to serve, and then leveraging that learning and agility to overtake incumbents in core markets.
Toyota also led the way in adapting frameworks developed for one industry (textiles) and deploying them elsewhere (cars) – an industrial precursor to, say, Alibaba’s ability to dominate seemingly unrelated sectors.
It did so by taking care of workers, which in Toyoda’s day meant empowering them to make decisions on the assembly line, and helping them through difficult times. Just-in-time techniques allowed huge productivity gains in assembly but required workers to be well trained and rewarded for loyalty. And the supply chains and dealerships created in Toyota’s wake were major employers as well. The lifetime employment culture has created its own problems in Japan today, but at least industry was adding more jobs than it was displacing.
It’s up for debate whether fintech will have the same beneficial impact, but I’d wager that banks or fintech founders that want to be around for generations, rather than until the first business exit, should be thinking about this. A trip to the Toyota commemorative museum in Nagoya may not be a bad place to start.
Review: “The Future of Finance”
The new textbook by Henri Arslanian and Fabrice Fischer needs pairing with more traditional learning.
The Future of Finance: The Impact of Fintech, AI and Crypto on Financial Services is a consultant-academic-banker-founder-cheerleader mashup to help people make sense of technology’s impact on financial services.
Its co-authors are Henri Arslanian, head of fintech and crypto consulting for Asia at PwC, and Fabrice Fischer, former CFO of A.I. shop Sentient Technologies and now founder of blu, an artificial-intelligence consultancy.
They are both entrepreneurial people who have built their careers in Asia but with a global reach. It’s good to have a textbook with that DNA at its core.
That’s primarily what FoF is, a textbook. It seems aimed at two audiences. The first is students. Universities around the world, and certainly in Asia Pacific, are inventing fintech-oriented curriculums, trying to marry their traditional computer-science or tech departments with business schools.
By “student” I also include people who need to study enough of fintech to “get it” but who may not be directly employed at a tech company – such as journalists, PR and marketing pros, and headhunters. The next junior reporter or salesperson I employ will read, and learn from, this book.
But FoF has its limits. Take the university student. Personally I’m skeptical about a full-blooded fintech degree. How many fintech companies fail because they don’t understand the complexities of financial services? That’s not a problem the authors of this book can solve…but they face the same problem. FoF offers a very good overview of fintech, crypto and AI, and if deployed on top of a deeper dive into finance, it’s useful. But it’s a supplement; students (or journos, etc) treating fintech-related trends as paramount are ill-served without a better understanding of the legacy systems and histories being challenged.
But for students studying things like accounting, business management, and finance, and who want a fintech layer on top, FoF will be useful and probably enjoyable. The writing is clear, not too heavy, and can rise to the challenge of chapters such as “The Basics of Cryptography and Encryption”.
The second audience for this book is people in financial services looking to get to grips with tech developments. Here the book serves a different role, filling in some gaps and helping tie together the bigger trends. The early chapters do a good job of building this context.
The book’s section on explaining crypto-assets is probably its biggest strength: the authors devote considerable time exploring the subject. For people leaving banking for the exciting world of crypto or blockchain, it’s a quick primer. Furthermore, this topic is actually hard for people who are not programmers or techies (that is, most of us). FoF provides a useful explainer that I intend to keep on hand.
Other sections, however, are too generic for practitioners. The section on fintech fundamentals is skimmable; any regular reader of DigFin will be very familiar with these topics. And the section on A.I. is disappointing. Its two chapters are comprehensive in that they define types of A.I. and touch on applications, but shallow.
The challenge for the authors, I suspect, is that a lot of A.I. work in finance is actually quite boring. But it’s also increasingly important. Unfortunately this book’s treatment of A.I. is too superficial to train a future data scientist, but also unlikely to help a future business executive understand the decisions they will face.
I think the A.I. section could have been livened up by providing several case studies to demonstrate how hedge funds, corporate banks, consumer banks, and insurers are actually using the tech and its variants, its successes and failures, and where it’s headed. I’m back to the argument that studying “fintech” (like studying journalism) is actually kind of useless without an underlying domain knowledge.
FoF ends well with a few speculative scenarios that pull together possible futures in which data, A.I. and blockchain technologies are intertwined. This part of the book is the most fun and I won’t ruin it with spoilers.
To sum up: FoF is helpful and welcome. It will serve as a useful starting point for students interested in the field, and can help bring finance professionals up to speed if they haven’t been exposed to these trends. It gets high marks for educating readers on crypto and blockchain, but the section on A.I. falls flat, and the description of generic fintech developments feels cookie-cutter. Ultimately this sort of textbook is like a glass of wine: best paired with a fuller menu of financial history, corporate finance, and accounting.
The Future of Finance by Henri Arslanian and Fabrice Fischer, Palmgrave Macmillan: Cham, Switzerland, 2019, 312 pages.