Ant Financial: The World’s Largest Financial Services Firm
Plus: Retail Stock Trading, Banker to the VCs, Private vs Public
|Marc Rubinstein||Jul 24|| 10||7|
Issue #10 of Net Interest and welcome to the 135 new readers who have joined us since last week. Every Friday I distil 25 years of experience looking at financial institutions into an email that explores key themes trending in the industry. If you’re reading this, but haven’t yet subscribed, join nearly 2,500 smart, curious people by signing up here:
Ant Financial: The World’s Largest Financial Services Firm
A little under three years ago I took a train down the east coast of China, from Beijing to Hangzhou. I was going to visit Alibaba Group and its affiliate Ant Financial to learn how the two were shaping the Chinese payments industry.
Their presence was everywhere.
In Beijing I had been shown how easy it was to do online shopping using their payments functionality, and I experienced for myself how easy it was to do offline shopping using a phone and QR code. My kids were marginally excited by the souvenirs I brought home; I was much more excited by the way I bought them. At a restaurant in the shadow of the Simatai Great Wall I even ordered and paid for a meal all within my phone after waving it at a QR code in the restaurant window.
I was reminded of my experience this week by two events.
First, having never used a QR code since, I used one again to order and pay for a pub lunch on the banks of the River Thames.
Second, Ant Financial announced its intention to go public. Since my trip the company has grown in all corners of finance to become an all-singing, all-dancing fintech super app. It’s IPO is expected to value it at US$200 billion, placing it up there with the largest Chinese banks and bigger than most Western ones.
The two events together made me wonder: can a company like Ant Financial ever emerge in the West?
What is Ant Financial?
“Today the world’s largest financial service firm is China’s Ant Financial with over one billion clients—without any branch. A decade ago it was Citigroup with 200m customers.” — Bank of England Future of Finance report
Ant Financial – now known as Ant Group – was founded in 2004 by Jack Ma five years after he founded Alibaba. Ma had identified a problem of trust which was impeding growth in his e-commerce business. Given relatively weak consumer protection laws in China and deteriorating consumer confidence around quality control, people were reluctant to buy goods online. So Jack Ma established Alipay as an intermediary that would keep the buyer’s money in escrow until satisfactory delivery was made, after which the money would be transferred to the seller.
It was like PayPal, but with a much lower threshold for adoption given the paucity of alternatives. Some of the most valuable innovations on the internet solve for trust—Google for information, AirBnB for character; Alipay did the same for commercial transactions. It unlocked huge growth in e-commerce activity in China. A few months after my visit Alibaba did RMB168.2 billion (US$25.3 billion) of sales in a single day over its Global Shopping Festival.
At the same time as Alipay was helping Alibaba grow, it was able to cultivate its own ecosystem. China’s payment infrastructure was relatively inefficient with cash usage still very high. Alipay expanded outside the Alibaba footprint to facilitate other online transactions. By the end of 2006 more than 300,000 merchants were accepting Alipay as an independent payment method including gaming companies, travel websites and online stores. User numbers rose quickly and in 2010 the payment method received official government endorsement, allowing it to develop largely free of compliance costs and regulatory restrictions.
Today Alipay has 1.3 billion annual active users. The majority are in its home market of China, but the company also has over 300 million users via nine local e-wallet partners in India, Thailand, South Korea, the Philippines, Bangladesh, Hong Kong, Malaysia, Indonesia and Pakistan. It has a 54% share of the Chinese third-party payments (i.e. non-bank) market which in total did volumes of RMB226 trillion (US$33 trillion) last year. The next biggest player is Tencent with 39%.
Those volumes capture a lot of stuff, not just retail consumption. They include peer-to-peer payments of the sort friends make to each other, transfers between a user’s own accounts, and payment for financial services and utility bills. But within retail consumption, third party payments make up a large chunk of total volumes—a little over two-thirds. Much of that is online, in keeping with Jack Ma’s original goal, but a lot is increasingly offline. The number of QR code payments has rocketed in China even since I was there, helped by promotions mounted by the payment companies. Going forward, offline will get a further boost from new technologies built around facial recognition.
From Alipay to Ant Financial
While it created huge value for Alibaba, Alipay didn’t capture much value for itself. Even today, Alipay takes a heavily discounted fee on the payments it executes for Alibaba, and peer-to-peer payments are free. In an interview in March the company’s CEO said that 50% of daily transactions are free.
To capture value it needs to retain funds within its ecosystem. Alipay suffers an upfront cost every time users upload money to the system—a 0.10% fee levied by the user’s bank. To amortise that cost it needs to retain the funds for as long as possible. In the early days Alipay could earn a spread on funds left on account. However, the Chinese government gradually removed that opportunity, requiring Alipay to park funds in a low interest custodial account within the banking system.
Now, the opportunity is in financial services. Alipay built its financial services strategy around two resources: access to data and access to customer funds. In 2014 it restructured as Ant Financial and raised private capital (Alibaba retained a profit share but converted that into a 33% equity interest last year). It obtained a license to operate a new banking business, MyBank, and promoted the money market fund, Yu’e Bao, it had launched a year earlier.
For most banks the current (or checking) account is the anchor product—they start with savings and move into payments as an extension of that. Ant Financial did it the other way round. Its path was made slightly easier by the relative unimportance of payments income to Chinese banks. They made most of their money from spread income, generating very little from payments fees, and so did not consider Ant much of a threat.
Initially Ant Financial toyed with the traditional in-house model, creating and offering its own products. It managed its money market fund, Yu’e Bao, internally (technically, via a subsidiary, Tianhong) and retained loans on its own balance sheet or else funded them via securitisation. However it soon pivoted to focus primarily on distribution, partnering up with other financial service providers to offer their products. This reduced the direct level of competition with traditional firms and allowed the company to leverage its key strengths – data and access to customer funds – without using its own balance sheet. In order to emphasise the shift, the company cutely began referring to itself as a “techfin” rather than a “fintech”.
Leveraging customer funds
Today Ant Financial manages over RMB4 trillion of customer assets (US$560 billion) in wealth management. Approximately a quarter are managed in-house as part of the Tianhong Yu’e Bao money market fund. Once the largest money market fund in the world, it gained popularity as a place to park residual cash at an enhanced interest rate via a few clicks on a phone (Yu’e Bao translates as “leftover treasure”). Initially it offered an interest rate of 5% at a time when banks were offering only 2.75% on deposits. Since then rates have come down and, subject to increased regulatory scrutiny, the company imposed a cap on investment amounts. Now, Ant Financial provides access to a range of funds managed by ~120 different firms via its wealth management platform, Ant Fortune.
The company makes money by taking an annual sales fee from its asset management partner. On money market funds that fee is around 0.17% of assets under management. Compared with the average management fee on a money market fund of ~0.26% that represents a pretty good share of the economics. Indeed, Ant Financial is a demonstration of just how attractive the economics can be at the front-end of financial services. As an aggregator of what can be very small amounts across a large market (minimum investment is one yuan) it is able to exert considerable market power.
Leveraging customer data
Ant Financial’s second key resource, data, is harnessed through the company’s credit scoring service, Zhima Credit (or Sesame Credit). The service generates credit scores based on public data but also taps into alternative data such as relocation trends, money transfers, shopping activities and social relationships. The score is useful not just for obtaining credit but to give customers access to car rental or hotel booking services, and to borrow umbrellas and portable phone chargers from local stores, all without a deposit. A good credit score even exempts customers from having to apply for a visa if they want to visit certain countries like Singapore (they’d need a score of 700 for that, in a range 350 to 950).
The credit score provides another lever on top of payments functionality to enhance customer retention. But it is not a profit centre in itself. Rather, its value comes via Ant Financial’s lending business. Here the company is focused on small ticket loans to consumers and small businesses, which it is able to offer quickly.
On the small business side, the company’s commercial banking subsidiary, MyBank, lent money to 21 million customers last year, which equates to around a quarter of all the individually-owned businesses in China. It offers loans through its 310 lending app which promises borrowers a three minute loan application time, a one second approval time, all with zero human involvement. The rate of non-performing loans has historically been around 1% which compares favourably with an industry rate of over 3% in 2019.
On the consumer side Ant offers two products—point-of-sale loans (via Huabei) and personal unsecured loans (via Jiebei). Both are considered attractive assets by the small regional banks which fund them. Ant Financial gives these banks reach beyond their footprint, providing them with asset diversification. They also like the risk overlay Ant Financial provides. As the company’s lending dataset grows – both across consumers and across time – its underwriting performance should improve, enhancing the value of the loans it originates.
As well as loans and mutual funds, Ant Financial also offers insurance products via its partnership with ~100 insurance companies. As the latest product to be added, insurance revenue contribution is currently likely quite small. But high margins give it upside. Huize is an independent online insurance platform and it charges 75% of first year premium on life and health policies and ~40% on property and casualty for distribution. (In life and pensions the company receives further annual fees so that over a five year period it’s fee take comes to around 110% of first year premium.) Upside also stems from the current low levels of insurance penetration in China.
Closing the loop
In total Ant Financial offers products across five business areas—payments, wealth management, credit scoring, lending and insurance. Its cross-selling has been near-perfect. According to the company, “the vast majority of Ant Group’s digital payment users were also digital financial services users.” The company has also said that 80% of customers use three or more financial services, and 40% use all five services.
In the twelve months ended March 2020, digital financial services generated more revenue than payments. This may not be much of a surprise given the balance of the economics; the payment functionality drove value first within Alibaba and then additionally within financial services. However, that’s not to say payments are a loss leader. First, there’s further opportunity in the offline market—the company has 40 million active merchants with QR code capabilities, but their digitisation rate is only 10%.
And, second, Alipay is employing more aggressive tactics to keep users inside its ecosystem. It charges customers a fee (of 0.10%) to pull money out over a certain lifetime amount. As more customers hit that amount Alipay will either capture more revenue upside or will retain more funds. Seven day customer retention is currently ~85% so there is upside there. In addition, with two players controlling 93% of the market, third party payments could capture some pricing power once the market matures, from the merchant side.
From Ant Financial to Ant Technology
Ahead of its IPO, Ant Financial has rebranded itself again, into Ant Technology. It released a three year plan in March centred on opening up the ecosystem to a wider selection of partners, not just financial institutions. Its new app incorporates local services like food delivery, transport and medical services. The app’s homepage is individualised to the customer and promises sufficient functionality that users won’t have to leave it. Somewhat ominously, a company spokesman once said, “The idea is people are living their lives through this platform”.
In this latest iteration, Ant Group is further barricading its ecosystem. Although this benefits users in the short term, it may harm them in the long term if the platform becomes so systemically important users can no longer abandon it. Regulators have tended to lag behind fintech developments in China in the past. For example, the government had to intervene in 2016 when peer-to-peer lending growth got out of control.
This time the response could be more strategic. There is some speculation that the new Digital Currency Electronic Payment (DCEP) being developed by the People’s Bank of China is partly to encourage the emergence of alternative payment channels, reducing the reliance on Alipay and Tencent.
Competitors may already be preparing. As Ant tries to muscle into the business of other platforms, they are beginning to muscle into Ant’s. Ride-hailing company Didi Chuxing, e-commerce platform JD.com, smartphone maker Xiaomi and others have all begun to offer financial services products including loans, wealth management and insurance. According to Caixin, “with hundreds of millions of users, these tech giants are hoping they can replicate the success of Ant Group.” What they don’t have yet is a third-party payment platform.
Can an Ant Financial emerge in the West?
There are few fintech applications that Ant Group doesn’t do. It’s the ultimate mashup between Stripe, PayPal, Apple Pay/Android Pay, Venmo, FICO, and any of the multiple fintech companies in the US that offer lending, savings and insurance products. Its emergence in this form was entirely path dependent in a way that does not seem replicable in the West.
Although its payments model offers many benefits over credit cards, there are some drawbacks. One of the features that got it off the ground in China was its low cost to merchants. Yet it is the relatively high cost to merchants in the US that make credit cards attractive there. That cost funds reward programmes which keep consumers tied in. Credit cards also offer 30-day interest free grace periods and on the debit card side they can allow overdrafts. As Ben Thompson of Stratechery has said, “Once a job is done – and credit cards do their jobs very well – it takes a 10x improvement to get users to switch, and, in a three-sided network, that 10x is 10^3.”
Even in cash payments, the West has an advantage. The highest denomination banknote in China is the RMB100 bill, worth roughly US$15, making it a less efficient form of exchange even offline. (The highest denomination bill in the US is US$100 and in Europe it’s €500.)
The question then becomes how important a third-party payment platform is in developing a full-service fintech operation. Other businesses could achieve the same endpoint from a different starting position as Didi Chuxing and JD.com are trying to do in China. It’s no secret that Apple, Amazon, Facebook and Google also have aspirations in financial services. Just this week Amazon launched an insurance product in India. However, although they have data, they don’t have access to savings – they don’t sit on the money – which limits their scope to dominate financial services.
What’s more, having happened in China it’s less likely to happen again elsewhere. One explanation as to why there isn’t another Facebook leans on network theory; another is that knowing what they now know, regulators wouldn’t let it happen. The shutdown of Facebook’s own payments initiative by regulators in Brazil is testament to how cautious regulators are being. So fintech companies may be able to pick at some of the pockets of financial services, but the opportunity to build another Ant Financial has likely passed.
More Net Interest
Retail Stock Trading
Charles Schwab hosted a summer business update this week which put some sunlight on retail stock trading trends in the US. The company executed 1.6 million trades per day over the second quarter, up 126% on last year. It welcomed 213,000 households as customers, described as being “new-to-retail”. These households skew young—56% of them are under the age of 40. In total ~28% of its customers are now younger than 40, which compares with ~16% ten years ago.
What the lifetime value of these clients is, though, remains to be seen. Over in Europe IG Group, which offers leveraged trading opportunities, has historically had to win new clients to cover the dormancy of old clients. In the year to May 2019 new client revenues weren’t sufficient to offset lower revenues from existing clients; in the year to May 2020 existing clients were more active, but most of the revenue growth still came from new clients.
On the call, the Charles Schwab CEO acknowledged, “individuals who trade tend to have great success when the market goes up and of course tend to have challenges when the market goes down… And so I think the best thing for all of us to do is to watch it evolve over a longer period of time than just the—maybe the 4 months that this phenomenon has really been at work.”
Banker to the Venture Capitalists
Silicon Valley Bank estimates it has a 50% banking share of all US-backed technology and life science companies. So it knows what’s going on in venture capital. In his quarterly shareholder letter its CEO highlights a few trends. VC fundraising and investing activity both remain strong, but the bigger players are the beneficiaries. On the fundraising side established funds are having more success than first-time managers and on the investing side late-stage deals are attracting more funding than first-time financings.
In addition the bank has been surprised by investor support for early-stage companies. In past cycles these have been the source of most charge-offs, but charge-offs remain low. The company identified two loans that became non-performing as a result of Covid, but it has seen few others. On its earnings call the Chief Credit Officer elaborated:
“And generally speaking, coming into this downturn, venture-backed investor-dependent companies had, on average, more liquidity and were, I think, in a better position to weather a storm. And then a number of things have happened to make that liquidity situation better still, right, PPP loans, our programmatic deferrals, payment deferrals. Companies were pretty quick to reduce expenses. That helped as well. And then finally, investor support has been much stronger, frankly, than I recall seeing in the last downturn. And the combination of those things have, I think, on average, put quite a bit of runway in front of the average investor-dependent company. And you see that, of course, reflected in the lower losses that we experienced in the second quarter.”
Private vs Public
There’s often a disconnect between public markets and private markets. It’s something that private equity firms exploit to reduce the volatility of their marks. As Dan Rasmussen pointed out, when the energy sector was down 52% from December 2012 to September 2015, Private Equity funds from the 2011 vintage were marked up on average to a 1.1x multiple of money invested.
But it’s not often that the two markets are on opposing legs of the sine curve. Blackstone reported earnings this week and its President highlighted a bifurcation.
On the one hand, “in the public markets, there was that brief window which proved to be attractive, and we were fortunate to take advantage of it and move a significant amount of capital. And depending what happens on markets, that seems less likely, I think, to see that kind of dislocation, again…”
On the other hand, “In the private markets, it takes more time. So a company that has limited capital, will obviously utilize that capital to get through a difficult period of time. And at some point, they may hit the proverbial wall… I think the real opportunity still lies ahead of us in the private space.”
Perhaps it's a reflection of the reduced signalling power of valuations in an environment of zero rates, but a set-up in which public market valuations have recovered while private market valuations have yet to correct is an unusual one.