Dispelling False Analogs in Emerging Market Fintech

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)

Conclusion

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%
Stone Pagamentos	0.34%
PagSeguro	0.00%
PayPal Holdings Inc.	0.00%
NuBank	0.00%
Google LLC	0.00%
Amazon.com Inc.	0.00%
Go-Jek	0.00%

Footnotes

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

10 https://about.crunchbase.com/blog/latin-americas-fintech-surge-4-lessons-for-silicon-valley/

11 As per Survey IDB and Finnovista

12 IMF, , World Bank, Nilson, Corporate reports (2017)

13 Paytm

14 Paytm

15 https://www.entrepreneur.com/article/330561

16 https://kr-asia.com/shopee-beats-lazada-in-terms-of-number-of-visits-across-southeast-asia-in-q1-2019/

Important Information

Blog header image: Tomas Sobek / Unsplash.com

The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

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Authors

Bhavtosh Vajpayee is the Director of Equity Research for the OFI Emerging Markets Equity team at Invesco. He joined Invesco in 2019, when the firm combined with OppenheimerFunds.

Tan Nguyen is a Senior Research Analyst for the OFI Emerging Markets Equity team at Invesco. He joined Invesco in 2019, when the firm combined with OppenheimerFunds.

Justin Leverenz, Team Leader and Senior Portfolio Manager

Justin Leverenz is a Team Leader and Senior Portfolio Manager for the OFI Emerging Markets Equity team at Invesco.

Mr. Leverenz joined Invesco when the firm combined with OppenheimerFunds in 2019. He joined OppenheimerFunds in 2004 as a senior research analyst. Prior to joining OppenheimerFunds, Mr. Leverenz was the director of Pan-Asian technology research for Goldman Sachs in Asia, where he covered technology companies throughout the region. He also served as head of equity research in Taiwan for Barclays de Zoete Wedd (now Credit Suisse) and as a portfolio manager for Martin Currie Investment Managers in Scotland. He is fluent in Mandarin Chinese and worked for over 10 years in the greater China region.

Mr. Leverenz earned a BA degree in Chinese studies and political economy and an MA in international economics from the University of California. He is a Chartered Financial Analyst® (CFA) charterholder.

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