Keynote address by Greg Medcraft, Director, Financial and Enterprise Affairs, OECD
(as prepared for delivery)
Your Majesty, ladies and gentlemen
We are living in a time of accelerating technological change. Long-established business models are being challenged and disrupted. New ideas and ways of doing things flow freely across borders and industries. Few industries are being impacted more than finance – as we have seen with the proliferation of novel fintech offerings, the rise of challenger banks and the establishment of entirely new types of assets and payment systems. Finance is also extremely personal. It touches virtually everybody’s lives. So while these developments are happening globally, they are experienced by consumers locally. The focus of today’s conference, Global Perspectives, Local Insights, could not be more fitting.
I am going to offer my perspectives as the head of the OECD’s Directorate of Financial and Enterprise Affairs, which covers financial and capital markets, insurance and pensions and competition policy, among others.
I will focus today on what I see as the 3 main forces driving change in the financial sector:
The growing importance of trust
The accelerating digitalisation of the economy
The unprecedented interconnectedness of global markets
Today’s conference comes roughly 10 years after the financial crisis. The crisis brought about a collapse in public trust in institutions, including in government and business, as shown in surveys such as the Edelman Trust Barometer and in the OECD’s own research. Trust has since improved, but it is still low and momentum has stalled over the past couple of years – particularly trust in business. Edelman’s measures for trust in business in 2018 show that financial services have the worst results of any sector. Just 54% of the general population trust financial service providers to ‘do the right thing’. This is alarming, but it is hardly surprising. Boston Consulting Group estimates that banks paid USD $345 billion in fines between 2008 and 2017 – including USD $22 billion last year alone.And so far in 2018 we have seen more high profile breaches of trust in the financial sector, from fresh revelations of institutionalised misconduct at Wells Fargo to Equifax’s failure to protect sensitive customer data.
This matters for the financial system as a whole, because low trust threatens the confidence of investors and consumers in markets, which impacts financial flows and financial stability. It also matters for individual financial service providers because, more and more, trust is at the centre of long term sustainability and business success.This is supported by empirical analysis from the OECD. A study in last year’s OECD Business and Financial Outlook found that a business’s social score – its capacity to generate trust and loyalty in its workforce, customers and society – was an overwhelming predictor of strong returns on equity and return on assets.
This comes down to the power of the crowd – a business’s community of customers, employees, investors and other stakeholders. The crowd sets the conditions of the social license to operate – the expectations of behaviour that a business must model in its operations. The crowd will hold business to account based on these expectations, and its power to do so is amplified through social media and the 24-hour news cycle. If a business falls short, it risks being deserted by its customers, employees and investors to its great disadvantage.
In the context of low trust in the financial sector, consumers are not only open to alternative ways of banking and finance, they actually demand it. This has paved the way for the entry of large platforms like Amazon and Ali Baba into financial services, and allowed fintech start-ups to seize on some of banking’s most profitable areas of business. And it underlies the sentiment of initiatives like the Vollgeld campaign in Switzerland, where voters went to the polls about three weeks ago to decide whether to strip banks of their deposits and end fractional reserve banking. While this initiative was defeated in the polls, it attracted around 24 per cent of the vote – that’s a nearly a quarter of Swiss voters who want to bring a revolution to banking and banks’ role in the economy.
In finance, this has spurred innovation, given rise to new business models and brought about efficiencies and better services. It has also meant disruption and a host of new market and regulatory issues.
I see 5 major technological shifts that are having a significant impact the financial sector:
Almost universal access to mobile telephones and internet
Big data and predictive data analytics, including Artificial Intelligence
The development of blockchain and distributed ledger technology
Rising cyber-security risks
Growing data privacy concerns
I will now unpack each of these briefly.
Mobile internet penetration averaged above 100% in OECD countries for the first time in February this year, and continues to climb steadily in emerging markets. This brings better access to services and opportunities for all. It allows financial service providers to bring products to people who may have been under served previously.M-Pesa is one excellent example of this, and I look forward to hearing about the regulatory experience in Kenya in this afternoon’s keynote.
But we also need to ensure that our existing regulatory frameworks – which are largely based on human systems and behaviours – remain fit for purpose.For the financial sector, the OECD has looked at the regulatory principles of ‘robo-advice’ for pensions, such as consumer protection and financial literacy. From a competition standpoint, we also remain aware of the possibility that algorithms could be used to achieve and sustain collusion without any formal agreement or even human interaction. And we are looking to establish an Observatory on Artificial Intelligence to help governments stay abreast of the wider policy issues and developments in AI.
Many of you will have some familiarity with blockchain so I will skip the specifics of the technology. The important thing to know is that through blockchain we can create networks that foster 3 things:
Trust between parties that don’t know one another
Transparency of transactions within the network
Traceability of those transactions from one account to another
Blockchain and distributed ledgers hold huge potential for reducing intermediaries, boosting efficiency and reducing costs. Their use is already driving a new generation of financial products. I could give many examples, but to name just five:
Payments systems, such as Ripple, which can send money in real-time across borders
Peer-to-peer venture capital raising through Initial Coin Offerings
Bond issuance, such as the ‘atomic bond swap’ trialled by the Commonwealth Bank of Australia and the Queensland Treasury
Clearing and settlement systems for payments and securities like the one being introduced by the Australian Stock Exchange or trialled by the Singaporean Monetary Authority
Insurance settlement and payment, like the self-executing ‘catastrophe swaps’ Allianz has trialled for agricultural insurance
Many of these innovations are in their early stages, but together they illustrate just how disruptive blockchain could be to finance. Blockchain is essentially taking us towards a future where the cost of transactions will be zero.
At the OECD, we see great potential for the insurance market to contribute to better cyber risk management. We’ve spearheaded a project on cyber risk insurance, to better understand and overcome challenges impeding the development of the cyber insurance market, with a particular focus on:
Clarity around cyber insurance contracts – because it is still not clear to policyholders whether traditional policies, covering property, business interruption, and general liability also cover an eventual cyber incident.
The lack of incident and loss data arising from cyber incidents – so that cyber risk can be quantified in a manner that would permit coverage beyond just large corporates.
Consumers have legitimate concerns about how personal data is collected, stored, shared and used.This is true for many emerging financial products, such as credit scoring using personal data, which was discussed in the academic conference here yesterday. The answers to these questions will largely determine trust in, and adoption of, digital technologies. And actually, I see blockchain as a part of the answer to some of these big cyber security and privacy questions.
Blockchain’s ability for individual consumers to store their own digital identities and control who has access their data could revolutionise the way we interact with businesses online – a concept called ‘self-sovereign data’ which is being investigated closely by the likes of Microsoft.
The fact that data is stored centrally by large companies makes it an attractive target for hackers and criminals, as we saw with data breaches with Equifax, Sony and many others. Blockchain’s ability to store data securely across distributed databases means data is not concentrated in one place, and makes for a far more difficult target for hackers and scammers.
Global markets have never been so interconnected. The kinds of new financial products and ideas that I’ve just described develop fast and spread quickly across jurisdictions. This has increased the complexity in which businesses operate, and created new cross-border issues that regulators need to manage. Recent experience with Initial Coin Offerings, or ICOs, illustrates these points. ICOs have raised around USD 14 billion to date, most in the past 12 months. Their potential for raising capital for start-ups and established tech-firms alike is clear. However, they also suffer from 4 issues that give rise to legitimate market integrity and investor trust concerns:
They often escape regulatory oversight, which means a lack a formal regulatory market structure – for example around governance of issuance, trading and exchange - and a lack of minimum standards for investor disclosure, both before and after issuance.
They often raise issues of traceability in relation to anti-money laundering and Know Your Customer requirements.
Their tax status is largely undefined, owing to the often shifting nature of the asset – for example they can change from an asset token to a utility token which extends to unclear financial accounting approaches.
There are no global industry standards to support investor confidence.
The response from regulators around the world has been extremely fragmented, and has ranged from banning them outright, to applying existing regulation on a case-by-case basis, to setting up wide-ranging legislative frameworks to govern ICO markets. Industry and investors lack the kind of certainty needed to fully realise the potential of ICOs, while the regulatory and legal void makes criminal activity difficult to detect and counter. When it comes to financial innovation, policymakers need to work together internationally more than ever, in order to achieve 4 things:
Prevent regulatory arbitrage and avoid market fragmentation.
Establish greater legal certainty for business, investors and consumers.
Exchange information and identify emerging best practices.
Raise awareness of the potential risks but also benefits.
As you can see on this slide, the OECD is well placed to lead international co-operation efforts on these kinds of issues because we do 3 things:
We provide a forum for exchange between policymakers and stakeholders
We are an international policy standard setter
We provide capacity building and assist governments in policy development.
We are living in an exciting time for alternative finance. Trust in the financial institutions is low, which is pushing consumers towards innovative new products and platforms – but these new services also need to ensure they meet customer expectations if they are to be sustainable. Digitalisation and new technologies are allowing new financial service offerings to be developed which we could scarcely imagine just a few years ago. Globalised markets are increasing the complexity of the regulatory environment. It is critical that governments work together to maintain a regulatory level playing field and provide legal certainty.
More than ever, policy makers, researchers and industry need to approach developments in financial markets with global perspectives. They also need to and leverage and share their own local insights. Today’s conference is an excellent opportunity to do just that.