The growth of internet finance has been incredible in China, providing not only access to credit that were otherwise impossible, but also additional investment options in a market where the government controls most financial institutions and the capital markets are not fully developed. At the end of last month, I presented Totum Wealth at the Continuum SF Innovation and Credit Conference in San Francisco, hosted by my friend Gabriel Hai’s SyncUS International. The conference connected fintech companies from both China and the U.S., featuring innovative ideas and strategies in the lending marketplace, mobile finance, credit assessment, microfinance and crowdfunding.
From the perspective of both a U.S. fintech entrepreneur and China native, I observed four trends at the conference that will shape the future of lending and investing: global hybrid wealth management, big model risk assessment, increased regulation, and securitization of online loans.
Global Hybrid Wealth Management
The explosive growth of online lending in China, despite teeming with fraud and lacking regulation, is a manifestation of the country’s large and underserved consumer investor base. With five times the U.S. population, China’s stock market is only one-fifth of the size of the U.S. Until the emergence of internet finance, the mainstream investment options in China remained limited to bank deposits and the highly volatile stock and real estate markets. (Figure 1) While online platforms provide access to additional asset classes, regulations are always one step behind fraud. In contrast, the U.S. market not only has a spectrum of meaningfully different domestic asset classes, but also investable asset classes in other countries.
This is why Chinese fintech players are looking towards the U.S. for additional investment options. Conforming to capital control and anti-money laundry laws, fintech platforms can still offer products that the other country has demand for. One example is the collaboration between CreditEase and Prosper Marketplace, which enables U.S. borrowers to access capital from China. Other Chinese lending platforms, such as Wheat Finance and Maimaiti are looking to offer loans to international students in the U.S. The overseas client base of Phoenix Internet Finance can benefit from USD-denominated investment solutions that diversify from RMB assets.
The other aspect to this trend is what I call “hybrid advice”. Robo-advisors are becoming more prevalent and intelligent, but investors still often need the human-touch. I explored how global hybrid wealth management can work during the conference, as illustrated in Figure 2.
Chinese platforms can collaborate with Totum to leverage our expertise in holistic risk assessment and interactive client engagement. Such a partnership can help diversify businesses from short-term lending to longer-term wealth management, and capture Chinese households’ demand for global allocation.
“Big-Model” Risk Assessment
Risk assessment was a popular topic at the conference and most speakers discussed the quality of the borrowers. Totum looks at the risk capacity of investors, along the lines of “Big Model” that Robert Krzyzanowski, director of engineering at Avant, leverages to price interest rates for borrowers who cannot easily access credit with their FICO scores. In the U.S., many online lenders no longer rely just on FICO scores. Steve Carlson, CEO of Ascend, believes that the FICO range of 580 to 660 is the worst modeled and they help people in that range get credit.
In China, credit history data is sparse. A few firms are vying for the limited number of licenses to become credit bureaus, including JD Finance and Alibaba’s Ant Financial. It’s encouraging to see innovation that helps both the platforms and borrowers understand risk. Similar to Totum’s philosophy, Icekredit, founded by fellow Los Angelino, Linyun Gu (previously at Zest Financial), collects data from alternative sources in China and attempts to understand a borrower’s holistic situation, which may be different from what the credit history indicates.
License to Lend
Amy Huang, CEO of Wheat Finance, brought up the topic that China will require companies to obtain a separate license to provide each type of financial services, such as consumer finance, lending, financing guarantee, factoring, third party payment and fund management. Under the new rules, platforms without the appropriate licenses are only allowed to match the lender and borrower directly. This will challenge the existing business model of many lending and investment platforms.
For example, Wheat Finance acts as a portfolio manager of its lending products, securitizing them as investment products for funding. The underlying asset of its 8.88% annual return investment product is a portfolio of loans made on the platform and cash instruments. To keep this business model, the new regulation will require eight licenses totaling $128 million.
Individual investors have limited insight into the underlying asset of most online “wealth management products” that tout a guaranteed annual return, not to mention the risk involved. It’s scary to learn that many firms use their balance sheet to guarantee the returns on these unsecured loans often without collateral and with annual interest rates north of 8 percent. This practice of the platform using a “capital pool” to guarantee against loan defaults will also be banned.
Securitization of Fintech Loans
In the U.S., hedge funds and institutions are the predominant source of investor of online loans. Olivier D’Meza of Pine River Capital advocates securitization, which I agree is a natural progression. It will not only expand the funding source for online lending, but it will also provide income alternatives for a broader base of investors.
Having worked on Wall Street during the subprime crisis, I do have concerns about the adverse incentive of underwriting and rating these securitized loans. Back then, the models used correlation assumptions that had not been experienced and mispriced the risk among the tranches. The advancement in data science can help to the point where software can automatically scrutinize every single loan in the securitization pool, the way Michael Burry looked at them in the Big Short, the Michael Lewis book which was recently made into a Hollywood movie.
Many participants at the conference are considering collaboration with counterparts in the other country, as well as expanding into the broader wealth management space. Totum’s solutions continue to evolve as we learn about the needs of other players in the fintech and wealth management industry. Please reach out if you would like to discuss potential ways we can work together.