China’s success in financial technology inspires legions of EM fintech hopefuls worldwide, spurring them to frenzied product expansion. Private and public market investors consider EM fintech an assured tale of disruption, while traditional bankers view the gathering storm with fear and loathing. A headier concoction has rarely been found–hundreds of millions of under-banked consumers, tens of millions of under-serviced merchants, and plentiful capital to grease the over-throw of a sclerotic financial system. China stands as the shining mast of this advancing force. As the fintech narrative goes, regulators are standing by, part ignorant, part clueless, and at times even eager partners in the revolution. What can possibly go wrong?
Our travels in emerging markets have made us acutely aware of the vast opportunity this sector presents, but have also made us cognizant of the unique contextual factors that bode more sober and situational evaluation of all the investment opportunities. The success of fintech in China has provided enthusiasm to investors and companies around the world but applying a “China template” to all fintech circumstances in EM is overly simplistic. Variations in three broad factors make us question the conventional false analogs between China and EM fintech today:
- Catalysts: The driving force of fintech adoption comes from transactional use cases, which differ in intensity and characteristics across EM. For example, ecommerce penetration in many EM countries–such as India and Brazil—is much lower than it is in China. Elsewhere, ride hailing and food delivery, rather than ecommerce, are the more common catalysts, such as in SE Asia.
- Regulatory response: Regulators are stirring to taking action everywhere, with diverse agendas. In China, for example, interest income in escrow accounts was recently eliminated. In India, the United Payments Interface (UPI) weakens the walled gardens fintech platforms aspire to create. In Brazil, regulators want a centralized market for receivables, potentially changing pricing dynamics in a unique and lucrative business segment that fintech companies currently enjoy.
- Competitive intensity: Fintech is no longer the surprise no one saw coming. The China story is well known to challengers and incumbents alike. This implies a longer competitive tussle in many parts of EM, and a more agile response from incumbent banks, as rival platforms vie for supremacy.
But first, China.
China’s fintech explosion – will there be another like it?
In Q1 2019, mobile payment volume in China crossed $8 trillion for the quarter, a 25% increase year-over-year1. In contrast, the US recorded just $115 billion of mobile payment volumes in the full year 20182. Research found that 95% of Chinese internet consumers used mobile payments at least once in a three-month period3, with average users transacting four times a day. That far exceeds the US where only a fifth of the population had ever used a mobile payment service, as of 20184.
Mobile payment adoption has led to spectacular expansion in adjacent market expansion China. Asset management offerings of Ant Financial, an Alibaba affiliate) and Tencent reached over $250 billion in assets under management (AUM) at the end of 2018, representing about 12% of the total domestic mutual fund AUM in China5. These two platforms serve the lion share of users – nearly a billion people use Tencent’s WeChat Pay and over 700m people use Alibaba’s Alipay6 in China (and over 900m globally). In comparison, the most popular traditional banking mobile app in China (ICBC) attracts about 53m monthly active users7. By the end of 2017, Ant Financial claimed to have reached nearly $100 billion in outstanding consumer loans – representing a low-teen share of Alibaba’s total ecommerce gross merchandise value (GMV) for the year. Alibaba and Tencent also offer insurance distribution, credit scoring and technology services. Additionally, both companies own a bank license. China’s fintech juggernauts target not only individual consumers, but also small businesses and merchants. For example, by mid-2018, 11 million small businesses had used Ant Financial for unsecured lending (this is about a fifth of all the Small and Medium Enterprises in China), 21 million had used Ant for cash management, and 40 million had used Ant for small business insurance8.
Figure 1: Payments, Wealth Management, Financing, Insurance and Credit Scoring on Alipay
That said, the fintech story has not always been onward and upward, even in China. Regulations have tightened steadily. The creation of a centralized payments network – NetsUnion – breaks the bilateral relationship between fintech companies and traditional banks. The regulators have prohibited fintech companies from earning interest income on wallet balances. At its peak, this income stream accounted for nearly 50% to 60% of the operating profits of Alibaba and Tencent’s fintech platforms9. Issuer fees have been capped, and new restrictions have been placed on the amount of flows through digital wallets. For example, RMB200,000 is the annual upper limit for consumptions and transfers on all combined wallet balances. This is concerning for a significant portion of power users, given that the average Alibaba ecommerce consumer spends some RMB12,000 a year on the platform alone.
Yet, we can reasonably conclude that fintech in China is now too large, pervasive, and dominant to be impaired by regulatory restrictions. Even so, findings from China’s case cannot be fully extrapolated to other emerging markets, as a quick dive into three regions illustrates.
Latin America – ground zero of a new fintech war
Since 2017, Latin American (LatAm) fintech companies have grabbed over half of all the investment inflows to the region10. In 2018 alone, 1166 new fintech start-ups sprouted up in the region, up from 703 in 201711. Stone and Pag Seguro raised $1 billion each in 2018 via initial public offerings (IPOs). Recently, Mercado Libre–the region’s pre-eminent ecommerce platform–raised $1.85 billion in new funds via a public share offering as well as direct investments from companies including PayPal. Elsewhere in LatAm, Nubank raised $400m in late July 2019.
Consider the opportunities. Brazil is unique in that over 60% of purchases are made on credit, and of that, over half are routed through multiple monthly interest-free installments–with the average number of instalments being five. This indicates selling merchants must wait for cash, and a thriving pre-payment business (i.e. factoring of receivables), where fintech companies have created profitable beachheads. Annualized yields on this business can range from 20% at the lower end to nearly 40% at the upper end, depending on the bargaining power of the merchants. Powered by pre-payment revenues, fintech companies are now flexing their muscle to expand into adjacent markets. The battle for offline point-of-sale acceptance, which played out fiercely between Alibaba and Tencent from 2015 to 2018, is about to begin in LatAm with several aspirants in the mix.
Elsewhere, rampant income inequality (Brazil is the ninth most unequal country in the world, as per Gini ratios) has meant that vast swaths of people remain unbanked, and with no access to any financial product but cash. These factors create a two-sided opportunity for fintech companies. For small businesses, faster access and adoption of credit over cash is a key area fintech companies can tap into. For consumers, fintech companies aspire to roll out mobile wallet use cases, through which asset management products, insurance distribution, remittances, as well as consumer loans could flourish.
But this excitement needs some tempering. If fintech is to ride the back of transactions and use cases, LatAm presents some points of friction. Ecommerce penetration in the region varies from 4% (Mexico) to 7% (Brazil). This market penetration is rising and should benefit those who own both an ecommerce and a fintech platform, such as Mercado Libre. But logistics costs can be four times higher than they are China, partly because of rampant theft of delivered parcels and resultinghigh insurance costs for shipping. Income inequality also swings both ways–on one end, it creates the unbanked millions, but on the other, it means that the middle class and the rich have ample access to offline retail malls, credit cards, and all the trappings of convenience that have hindered the adoption of fintech in some developed markets like the US. The ecosystem of small businesses in Latam is also under-developed–there are just over 1m small businesses in Brazil with annual sales above $1 million, and many “single person” businesses (some 5 million of these). The region’s largest ecommerce platform has under 20m active consumers in any given quarter, despite a population of over 600 million.
India – too early to declare winners
Unlike most EM countries, India is blessed with a national ID and credit union infrastructure. India has the world’s largest and most sophisticated ID biometric program, called Aadhaar, which covers 1.2 billion people out of its 1.3 billion population. Its credit union, called CIBIL, has been operating since 2001, and is currently tracking 600 million individuals and 32 million businesses with a comprehensive and reliable credit-scoring system. Together, the national ID and credit union infrastructure can simplify the Know-Your-Customer process and lower retail credit cost, which are often the biggest barriers to entry for fintech companies.
Furthermore, India exhibits the necessary conditions for leapfrogging fintech. Today, digital payments represent only 15% of total payments in India, well under the 60% level already achieved in China12. There are 4 point of sale (POS) terminals per 1,000 debit cards in India, way below 13 per 1,000 POS terminals in the US13. The lack of formal payment infrastructure has propelled fintech companies like Paytm–an Ant Financial and Softbank-backed company–to come up with a mobile wallet alternative that is cheaper and more convenient to use than the traditional credit/debit cards. To date, Paytm has signed up 12 million merchants, which is 10 times the merchant base of the existing card networks. Paytm’s registered user base has reached almost 500 million with 55 million monthly active users, who generate $100 billion of transaction volume on an annual run-rate14.
That said, it is too early to declare winners in the Indian fintech space. India’s relatively open economy means that global big tech, like Google and Amazon, are serious competitors to local counterparts. In fact, Google Pay is neck and neck with Paytm in term of UPI payment volumes. Amazon India was last reported to have overtaken Flipkart with $7.5 billion in GMV in FY18 and is fully capable of leveraging its ecommerce platform to foster adoption of Amazon Pay, its own fintech solution.
South East Asia (“SEA”) – fifty shades of fintech, regional apps leading
Collectively, SEA represents a $4 trillion economy, almost two times larger than that of India. The topology of SEA is highly nuanced in terms of economic development, competitive dynamics, and regulatory directions.
The biggest opportunity in SEA is Indonesia, a $1 trillion economy, where the drive to acquire customers pushes from the two front-running fintech platforms, Ovo, backed by Grab, and Go-Jek, have expanded the fintech market significantly. As of July 2019, Grab/Ovo had covered 110 million users15. Grab/Ovo has been the payment of choice for Tokopedia, the largest Ecommerce platform with 30% market share in Indonesia, and the Lippo group, the largest offline retailer in the country. As a result, Grab/Ovo has on-boarded 400 thousand retailer outlets (versus 300 thousand for Go-Jek) and is now available in 90% of shopping malls, department stores, coffee shops, cinemas, and food and beverage outlets.
The race to payment ubiquity is relentless. Grab/Ovo’s willingness to partner–rather than doing it alone – helped put it ahead of their closest rival. That said, card penetration – including both debit and credit – in Indonesia is still less than 10%, and about 60% of Indonesians don’t have access to banks. The biggest competitor for fintech companies is their peers, or even banks, but rather cash.
Figure 2: Southeast Asia Bank Account and Credit Card Penetration
At the other end of the spectrum, Singapore is by far the most developed financial market where bank account penetration is almost 100% and credit card penetration is 35%. The Monetary Authority of Singapore (MAS) wants to promote fintech development and will soon issue five digital banking licenses. However, the MAS has made it clear it doesn’t want disruptors. Instead, it is looking for companies that can add value to the existing ecosystem. Fintech innovation in Singapore will likely be developed in partnership with or led by the local banks.
The remaining countries in South East Asia straddle in between the two extremes, with the lack of banking infrastructure inducing regulators to promote fintech development alongside or even ahead of banks. In almost all markets, customers are spoiled with choices, and consumers in SEA use an average of 3.2 digital payment platforms.
Figure 3: Average Number of Digital Payment Platforms Used by Consumers
The multilateral relations among SEA countries allow for development of regional apps, like Grab in ride-hailing (60% market share) and Shopee in Ecommerce (SEA’s largest ecommerce platform with $3.5 billion in GMV and the highest customer traffic in Q1 2019)16. Leveraging their customer traffic, these apps have been able to nurture their own fintech platforms, first as payment solution providers and subsequently as a channel to cross-sell additional financial products.
Great news for (some) banks
With the exceptions of Alipay and Tenpay in China, no other fintech company in the emerging markets can claim victory in payment yet. Outside of payment, the verdict is far from being decided, for any fintech company in any market. The two biggest drawbacks of fintech are data incompleteness and funding restriction. While fintech companies can follow transactional data, they have not yet been able to obtain the salary flows as most customers are not willing to deposit their salaries directly to the fintech platforms. Fintech platforms have also been unable to capture big-ticket purchases (mortgage, auto). The datasets for both types of purchases currently sit within the traditional banks. In addition, because of regulatory restrictions, banks are required to be the ultimate custodians of customer deposits—globally, fintech is restricted from using customer deposits for any risky balance-sheet activities.
This is great news for any traditional banks that are willing to work with fintech companies to co-develop new products or new business models. In most EM countries, more than two-thirds of transactions are still done in cash. By bringing cash into the banking sector, fintech can help banks improve deposit-gathering, which a development that allows for a higher money multiplier to foster economic development while lowering the cost of handling cash. Furthermore, with more data and an improved cost structure, fintech can enable product innovations to cater to the broader population. The net gains from having a bigger addressable market and lower expenses (operational, credit cost) should create a sizable profit pool for the financial sector overall. An example of a successful collaboration can be small-ticket sized, high-frequency consumption loans which were prohibitively expensive for banks to offer because of both high operating expenses and high credit costs. As a result of online disbursement and collection, as well as data collaboration, operating expenses can be reduced dramatically.
Figure 4: Digital Penetration (% of Private Consumption Expenditure)
While we believe in the potentials of fintech to bring about significant changes in the EM financial sector, we think there are a very wide variance of outcomes across Emerging Markets. Even within each EM country, outcomes can differ significantly between companies which have the right ingredients to succeed and those which don’t.
In most EM countries today, the fintech battles are far from being over, and the winners are most often not decided yet. Moreover, it’s important to see how traditional banks evolve in response to the rising competition in fintech.
As fundamental, bottom-up investors, we will continue focusing on understanding the business models of fintech and banks alike and we place our trust in companies which have superior economics protected by a wide moat in the long run. Ultimately, the best predictor of long-term performance is earnings, which are dictated by microeconomics not the short-term trends.
Holdings in Invesco Oppenheimer Developing Markets Fund
|Alibaba Group Holding Ltd.||6.68%|
|Tencent Holdings Ltd.||3.10%|
|Grab Holdings Inc.||1.53%|
|Mercado Libre Inc.||0.60%|
|PayPal Holdings Inc.||0.00%|
1 Source: iResearch, July 2019
2 Statista, 2019
3 As per iResearch, July 2019
4 As per eMarketer, Nov 2018
5 Media reports
6 Company disclosures
7 As per Analysys and Bernstein Research
8 All disclosures from Ant Financial, August 2018
9 As disclosed by Alibaba and Tencent, for 2017
11 As per Survey IDB and Finnovista
12 IMF, , World Bank, Nilson, Corporate reports (2017)
Blog header image: Tomas Sobek / Unsplash.com
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