Rapid technological advances are transforming international financial centres around the world. CSj looks at the challenge of disruption and opportunities to create new markets that will be the result of Hong Kong’s own fintech revolution.

Given that financial technology, or fintech, is at the intersection of advanced finance architecture and world-class technology infrastructure, it stands to reason that Hong Kong should lead the world in its creation, development and application.

Both the government and the financial sector are upbeat about what fintech can do to advance Hong Kong’s position as a major global marketplace. ‘The development of fintech is a prime example of the new economy, under which technological advancements have transformed entirely the way that we live, work, communicate and do business,’ Hong Kong’s outgoing Financial Secretary John Tsang told a November 2016 conference.

Major corporations also back fintech. In October 2016, for example, HSBC launched a new research and development (R&D) laboratory in collaboration with the Hong Kong Applied Science and Technology Research Institute (ASTRI). ‘For HSBC, technology is part of the bank’s DNA, comprising all areas of our global business,’ says the bank’s Deputy Chairman, Peter Wong.

From a practical perspective, fintech is defined as the use of technology to advance the development of financial transactions. A number of innovations have significantly impacted the financial services industry, such as peer-to-peer financing platforms, including equity crowdfunding and peer-to-peer lending.

Other developments include new securities trading platforms and digital payment and remittance systems; and distributed ledger technology such as blockchain (a secure method for implementing and recording transactions); smart contracts; robotic financial advisers; virtual currencies; and advances in data security and analytics.

In 2015, Asia-Pacific fintech investment more than quadrupled to US$4.3 billion over the previous year. China accounted for US$1.97 billion of that, followed by India with US$1.65 billion, according to data from CB Insights, a New York-based venture capital analysis firm.

Within Greater China, Hong Kong already sets the global pace in certain aspects of fintech R&D. ‘In some areas, such as wholesale electronic payment systems, Hong Kong is already a world leader,’ says Douglas Arner, Professor of Law at the University of Hong Kong.

Other areas in which Hong Kong is showing progress include banking applications such as distributed ledger technology, but the city is lagging behind the Mainland in retail fintech. ‘Hong Kong has no option but to continue to evolve,’ says Professor Arner, who also coordinates ‘Enhancing Hong Kong’s Future as a Leading International Financial Centre’, a Hong Kong Research Grants Council project. ‘If it does not keep up with developments and influence them, it is at risk of erosion of its position,’ he adds.

Leveraging financial strength

Given its population of nearly eight million, Hong Kong has an outsized financial services sector that leverages its geographical location, education and work-skill levels and respected legal environment. The city is also an ideal access point for entrepreneurs wishing to tap the Mainland market.

A November 2016 International Monetary Fund staff report noted that Hong Kong can leverage its existing strong position as a regional financial centre. ‘Opportunities can be tapped from Mainland China’s growth, global integration and capital account liberalisation,’ the report noted. ‘As well as maintaining its position as the leading renminbi offshore centre, the authorities have a strategy of developing the asset management industry, encouraging corporate treasury centres to domicile… and enabling the healthy development of fintech without compromising consumer and investor protection.’

Hong Kong has seen the introduction of novel banking and payment technologies, including data analytics that track consumer credit and spending patterns, peer-to-peer payments and biometrics authentication. ‘These have generally enhanced user experience by shifting banking and payment services to be more accessible, efficient and personalised,’ says Professor Arner.

The government has sought to strike a balance between encouragement and interference with fintech development in the city. A year ago, its Steering Group on Fintech, chaired by Professor KC Chan, the Secretary for Financial Services, released a report proposing a number of recommendations to further Hong Kong’s development as a fintech hub.

The report noted that 48 of the 100 largest fintech companies in the world already had an operational presence in Hong Kong, citing the cluster of local, Mainland and international financial institutions, financial services talent, co-working space, accelerator programmes and innovation laboratories as draws.

Government institutions were also keen to create a favourable fintech environment, with the Hong Kong Monetary Authority (HKMA) leading the way. Last year, the HKMA, Hong Kong’s de facto central bank, launched its Fintech Facilitation Office (FFO) to encourage the development and promote Hong Kong as a Asia-Pacific hub.

Working with the ASTRI, the FFO opened an R&D facility, the HKMA-ASTRI Fintech Hub, to support research into and the adoption of fintech. ‘The Hub is a place where various stakeholders can collaborate to innovate,’ Howard Lee, Senior Executive Director of the HKMA, said at its launch.

There, industry players such as banks, payment service providers start-ups and the HKMA itself could get together, Lee pointed out, ‘to brainstorm innovative ideas, try out and evaluate new fintech solutions, conduct proof-of-concept trials, and gain an early understanding.’

Minimising structural risks

As with all new technologies, fintech comes with risks and challenges. The introduction of novel banking and payment technologies has generally offered more efficient and convenient banking and payment services for customers in Hong Kong and reduced costs for banks and payment service providers.

‘On the other hand,’ notes an HKMA statement to CSj, ‘one has to be mindful of the potential risks and threats associated with these innovations’. The HKMA, as a regulator, says it ‘has put great efforts in striking a good balance between promoting the use of fintech for people to enjoy better banking and financial services, and making sure that public interests are properly safeguarded during the course of fintech development.’

In May 2016, the HKMA introduced a three-pronged Cybersecurity Fortification Initiative, comprising risk assessment, a cyber intelligence-sharing platform and a professional certification. ‘We hope this initiative will encourage the fintech sector to attach importance to cybersecurity resilience and eventually increase public confidence in using innovative payment services,’ Professor KC Chan told a recent conference.

There are also risks for members of the HKICS. A 2015 guidance note, Technology and the Company Secretary, notes that there is no fixed degree of responsibility for technological issues applying to company secretaries. The guidance note emphasises, however, that technology cannot be ignored.

As fintech becomes more complex, the company secretary’s responsibility is broadening from the company’s own information technology issues – such as procurement and upgrades – to include issues such as cybersecurity and data protection, as well as anti-financing of terrorism and anti-money laundering (AML) measures.

‘Equity crowdfunding poses a lot of investor protection issues,’ says Professor Arner. ‘At the same time, this highlights the necessity for regulators to understand and influence technology in order to address risks, with blockchain and AML being a prime example.’ He adds that the key to reducing risks is the subset of fintech known as regulatory technology, or ‘regtech’. ‘The regulatory changes and technological developments following the 2008 global financial crisis are fundamentally changing the nature of financial markets, services and institutions,’ he argues. ‘Regtech is at the juncture of these two phenomena.’

So far, Professor Arner notes, regtech has focused on automating formerly manual reporting and compliance processes, which has reduced costs for both financial services providers and their regulators. ‘However, the potential of regtech is far greater,’ he says. He believes that regtech has the potential to enable real-time regulatory regimes that identify and address risk while also facilitating far more efficient regulatory compliance.

Integrating innovation

The HKMA expects Hong Kong’s financial sector to absorb fintech’s implications with minimal disruption. ‘The banks in Hong Kong have been the major developers and users of financial technology,’ the authority’s statement notes. ‘They have been leveraging on new technological advancements in their operations and delivery of service to reduce operating costs, improve operational efficiency and enhance customer experience.’

A growing number of financial institutions have already adopted innovative technologies, such as biometrics authentication, optical character recognition and artificial intelligence. ‘There are increasing numbers of banks setting up their own innovation labs and digital teams to embark new creative projects,’ the HKMA notes.

Fintech will automate the delivery of more financial services and client on-boarding and, as a result, financial institutions will need authentication and fraud control technologies that are more automated, yet equally or more secure. More advanced cybersecurity technologies are needed as more investors share their personal data with fintech platforms, creating cyber and data privacy risks. Fintech platforms and business models often thrive on their ability to make use of the cloud, further spurring the need for cloud security.

Hong Kong’s government acknowledges that technologically advanced newcomers could disrupt established financial sector participants. In the Mainland, internet companies such as Tencent and logistics firms such as SF Express have entered the consumer finance market.

‘The more open market ecosystem has lowered the market entry threshold for start-ups and non-traditional market participants,’ James Lau, Deputy Secretary (Financial Services) of the Financial Services and Treasury Bureau, told conference last year.

The Securities and Futures Commission (SFC) has established a dedicated liaison platform called Fintech Contact Point to enhance communications with the industry. The Office of the Commissioner of Insurance has also set up similar entities. The HKMA has the most comprehensive fintech approach (although the SFC receives more queries).

As well as a liaison platform, the monetary authority also launched its Supervisory Sandbox, which live-tests fintech applications and other technology initiatives without requiring full compliance. ‘Since its inception in March 2016, the FFO has also held informal thematic regulatory dialogues sessions from time to time to share requirements and policy stances with fintech start-ups,’ the HKMA statement notes.

The office is also conducting a survey that involves banks, fintech firms and stored-value facility issuers to gauge their views on the current regulatory landscape. ‘The pro-active stance of regulators in developing sandboxes could facilitate the transition from one regulatory model to another,’ says an upbeat Professor Arner.

Blockchains of the future

Despite such efforts, and the growing investment in Greater China, Hong Kong is currently ranked only the fifth most important global hub for fintech, behind London, Singapore, New York and Silicon Valley, according to a recent report by Deloitte, the US accounting firm.

Professor KC Chan has noted that Hong Kong has a way to go to maintain standards and achieve global leadership in fintech. Last year, Cyberport – much maligned because of its status as a luxury apartment complex rather than an innovation hub – launched its incubation programme, which will provide support to 150 fintech companies over five years, and a dedicated fintech co-working space.

But buildings are not enough, Professor Chan concedes. ‘Apart from infrastructure building, we have to encourage entrepreneurship and provide for a conducive environment for start-ups to put their novel ideas into the market,’ he noted last year, adding that collaboration was the key.
Under Hong Kong’s 2016-2017 Budget, several of the Fintech Steering Group’s recommendations are to be implemented, including the establishment of a dedicated team under Invest Hong Kong, the government’s foreign investment facilitation arm, to organise international events and help start-ups, investors and R&D institutions to establish a Hong Kong presence.

As technology develops, the government and regulators may struggle to keep pace. ‘Speed of change and new entrants mean that developments can progress to significance much faster than previously, with exponential growth,’ Professor Arner observes.

Indeed, fintech is poised to move out of banking and e-commerce into insurance, stock-trading and investment management. ‘With big data analytics, we can study huge data sets to reveal untapped trends, patterns and correlations for forming trading ideas, credit scoring, and even predictions on the financial markets for fund managers to refine the execution of their investment strategies,’ says Mr Lau.

Hong Kong regulators try to apply rules broadly and fairly without singling out new technologies, says Bénédicte Nolens, Senior Director and Head of Risk and Strategy at the SFC. ‘Like most global securities regulators, the SFC is technologically neutral,’ she says, ‘which means that it is open-minded about licensed corporations and new entrants deploying technologies that achieve the right results under our rules and standards.’

With fintech poised to create a new paradigm among institutions, investors and regulators, how open-minded that proves to be remains to be seen.

George W Russell