Fintech: Safeguards in place to protect users against risk of failure

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on May 4, 2020 - May 10, 2020.

Photo by Patrick Goh/The Edge

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The local financial technology (fintech) ecosystem has been under enormous pressure in recent weeks as the economy has largely stalled due to the stringent measures taken to contain the Covid-19 pandemic. However, even as worries of permanent closures mount in the ecosystem, individual users of fintech platforms are protected and their funds can be recovered should the worst occur.

These fintech start-ups are operating in key financial sectors such as insurance, wealth advisory and investment as well as payment and remittance. It is important to note that ever-increasing amounts of private money are flowing through e-wallets, mobile payment gateways, insurance marketplaces and mobile-first investment platforms (such as robo-advisors).  

According to data research firm Statista, total transaction value for digital payments in Malaysia currently stands at more than US$12.4 billion (RM54 billion). The total transaction value is expected to see an annual growth rate of 10.8% over the next three years.

“Based on a survey of our members, we have found that due to the economic shutdown and ongoing negative sentiment, nearly half of our members have a runway of 12 months or less. In fact, nearly 30% of our membership have no more than half a year left in them,” says FinTech Association of Malaysia (FAOM) president Ridzuan Aziz. 

However, there are a number of safeguards and contingency plans in place to protect their users against the risk of failure of these companies, he adds. The association currently represents about one-fifth of all fintech start-ups in the country. 

Robo-advisors

According to Ridzuan, FAOM’s robo-advisory members collectively manage RM430 million worth of assets. These entities are closely regulated and scrutinised by the Securities Commission Malaysia (SC) with a view to safeguarding investors’ capital from risk of failure on the part of the platforms. 

“All robo-advisory firms in our association are licensed by the SC. As part of the licensing requirements, all funds deposited by investors as well as the securities invested are held by an independent trust company. These funds are never co-mingled with the robo-advisors’ operating funds,” says Ridzuan.

Furthermore, all robo-advisors are required to report their activities to the SC every quarter. These reports include details such as assets under management (AUM), the principal amounts and the rate and amount of returns, as well as the types of investments entered into. “Under the current circumstances, investors’ funds and securities are secure and would only be affected by prevailing market conditions, rather than concerns surrounding the viability of robo-advisors,” he says. 

These are important safeguards as robo-advisors have made significant headway in the Malaysian market within a relatively short span of time. In addition to managing nearly half a billion ringgit, these platforms have managed to attract 32,000 investors. “I expect the local robo-advisory segment to see more than 70,000 investors by 2023,” says Ridzuan. 

The local robo-advisor industry is projected to have a compound annual growth rate of 40.2% from 2020 to 2023, by which its AUM is expected to reach about US$294 million. 

Investor protection notwithstanding, these companies have seen diminished fund flows in recent weeks as investors cut back on passive investments, preferring to hold cash or divert funds to the stock market, says Ridzuan. 

“A good number of individuals who invest via robo-advisors tend to be relatively sophisticated investors and they are quite good at identifying value and are quickly flocking to those investments. This is something the robo-advisors in Malaysia have yet to be able to match. 

“Robo-advisors are considered to be long-term investment vehicles, whereas a lot of the opportunities in the stock market right now tend to be short-term. I have been approached by a number of investors who told me they would rather handle their own investments right now as they are confident of finding value in the stock market.” 

For their part, local robo-advisors are trying to come up with strategies to keep investors committed to their long-term investment goals on their respective platforms. However, Ridzuan cautions that these robo-advisors are also operating in other markets and may focus their efforts on securing these markets first. 

“The expectation [to help Malaysian investors] is definitely there, but the robo-advisors here are already charging far lower fees than conventional fund managers. Also, given that the revenue per unit cost is not all that high yet in the local market, it may make more sense for these platforms to focus on larger markets abroad and, where possible, attempt to cross-subsidise their Malaysian customers. However, it is uncertain at this point as to whether they will be able to execute these or other efforts immediately.”

Insurance and wealth planning

One segment of the fintech space has been particularly hard hit by the current restrictions on movement. “Some insurtech [insurance technology] members have shared that they have a runway of between six and nine months, assuming that the status quo persists for the next three months,” says Ridzuan.

Separately, Personal Wealth has been informed by an insurtech start-up that one of its core offerings — travel insurance — has been decimated in recent weeks. The company has seen a 30% drop in its overall business activity as a result. 

Having said that, while the business of these insurtech start-ups may be under threat, existing users and their insurance policies will continue to be honoured by the insurers. 

Insurtech start-ups have generally clustered around the distribution and advisory channels, as opposed to being the underwriters themselves. Thus, while these start-ups have had a positive cost-cutting effect on the industry, the policies will continue to be underwritten, and therefore secured, by Malaysia’s large and relatively mature insurance companies. 

“Even if the [insurtech start-ups] go under, the policyholders [who purchased their policies through these start-ups] will still be protected as per the terms of their policies. As a result, there may not be much public emphasis put on the survival of these start-ups,” says Ridzuan.

However, this would be a mistake as insurtech firms have grown to become very important cogs in the industry and have been instrumental in bringing down the overall cost of insurance, he adds.

According to Ridzuan, these firms have become very effective at managing the insurance policies and benefit notifications of their clients, a large chunk of which tend to be businesses with workforces of their own. The firms have also proved to be very effective at communicating with their base of individual policyholders. 

“These companies are incredibly effective at disseminating key information to large groups of individuals. Their messages and advisory notes are disseminated very quickly and consistently through mobile apps. In the past, most policyholders would only know what their insurance agent tells them,” he points out. 

“Insurtech companies help policyholders through the claims process because most of the time, there will be missing or incomplete paperwork or key events, in addition to elements of the policy that the user does not immediately understand. These companies provide the much-needed structure, accuracy and know-how when it comes to dealing with insurance companies.” 

In fact, now is the time when insurtech firms will really add value because they are busy facilitating Covid-19-related claims as well as effecting payouts and other key benefits to customers in need, says Ridzuan.

Having said that, he does not rule out a spate of mergers and acquisitions of certain insurtech start-ups by institutional investors, particularly in Malaysia but also throughout the region, if the situation persists.

Payment and remittance

Payment and remittance platforms, arguably the most visible aspect of the broad fintech ecosystem, have seen huge spikes in transaction volumes in recent weeks. In short, this part of the ecosystem is doing just fine, says Ridzuan. 

The elevated transaction activity has been further accelerated by ongoing government messages and awareness campaigns around the importance of social distancing and minimising physical contact. “The big rise in payment and remittance platforms can also be attributed to the large increase in overall e-commerce activity,” he says.

Given just how busy the various e-wallet and remittance service providers have been since the outbreak of Covid-19, Ridzuan does not see a significant risk of failure to these services for the time being. As a matter of fact, these players have been on a rewards spree of late, offering various discounts, rewards points and freebies to further encourage users to perform transactions on their platforms. 

Needless to say, this portion of the fintech ecosystem is regulated and scrutinised by Bank Negara Malaysia. Like their robo-advisory counterparts, all payment and remittance platforms are required by the central bank to keep user funds in a separate trust account, which are inaccessible to these platforms and cannot be co-mingled with their operating budgets or business accounts. Thus, customer funds are protected in the event a licensed e-wallet company goes under, says Ridzuan. 

Bank Negara is explicit about the handling of user funds on these e-wallet and remittance platforms. The funds can only be refunded to the user or drawn down to pay for a user-generated purpose. There are no exceptions to this and any deviation is tantamount to a criminal offence on the part of the service provider, says Ridzuan. 

Bank Negara also requires that individual user records be maintained and updated daily to prevent any potential fraud or risk of mingling with business funds. These records have to be kept in a specific format designated by the central bank and linked to the regulator’s own records by means of an application programme interface (API). 

Fintech firms call for support 

According to Ridzuan, despite being relatively new to the economy, fintech companies employ some of the country’s brightest talents. Additionally, the segment is building new technologies and pioneering innovative best practices that will eventually become an indispensable part of the economy. 

Hence, he is calling on the government to support the fintech community through what he refers to as “Shelter Programmes”. “This is a temporary programme that would last throughout the Covid-19 pandemic, whereby qualifying fintech companies would be taken under the wing of various government agencies, government-linked companies and government-linked investment companies.”

These fintech companies would then be tasked with building out various key digital financial functions and tools for the long-term benefit of these entities. “It would be a great opportunity for government entities to significantly improve their technological capabilities while providing a financial ‘safe harbour’ to fintech companies during this difficult time,” says Ridzuan. 

He cites the example of a recent initiative undertaken by an international bank prior to the outbreak of Covid-19. “This bank, as part of its ongoing digitalisation efforts, offered our members a total of 200 APIs to build — no strings attached. As long as our members built APIs that added significant value to users at large, the bank undertook to license the APIs from them, thus providing invaluable revenue streams.” 

However, with the onset of the pandemic, the bank was forced to hit the brakes on this ambitious plan. This is the sort of solution that could work very successfully under the association’s proposed shelter programme, albeit with government entities leading the way, says Ridzuan.

“Let’s take a government entity in charge of disbursing Covid-19-related financial aid to a segment of society. Right now, there is a delay of at least a few days between the announcement of these much-needed relief measures and the eventual delivery of aid to the target demographic. Our members could create a number of APIs to connect the Ministry of Finance to any number of key government agencies in charge of disbursing the aid (whether in the form of direct financial assistance, wage subsidies or insurance premium subsidies).

“These agencies could then quickly and effectively deliver the aid to the bank accounts, e-wallets or insurance accounts of the target demographics. With the help of our members, this entire relief delivery process could be built to take place within 72 hours.”