The Future of Finance
12 May 2021|Jacob Schumacher
At the time of writing, it appears that the world is finally moving into a post-COVID era after a year of lockdown and an intensive global effort to develop and distribute vaccines to contain the virus. I, and I am sure you, cannot help but find immense relief at the thought that this entire event will soon be behind us.
As a financial economist and as a tutor in finance at the Hall who has just finished teaching for the term, this year has given me the time to reflect on what the world of finance will look like as the world emerges from lockdown. In my view, there are likely to be three major developments that will impact finance and financial services both at large and in the UK in the very near future. Each of these developments originate from what is an increasing application of technology and innovations in both the economy at large and within financial services itself.
Social Media in finance
The rise of social media has fundamentally transformed many areas of our daily lives and society. Huge networks of virtual communities have allowed people to interact with one another at a speed and scale unmatched in human history. Given the power of social media generally, it unsurprising to posit that it will transform the world of finance as well.
However, social media actually affecting the world of finance has also been unexpectedly surprising. At the beginning of this year in January, users using the social media platform Reddit orchestrated a coordinated “short squeeze” of the stock Gamestop. This occurred some members noticed hedge funds borrowing and then selling huge amounts of the stock on the hope they could buy the stock back at a cheaper price and profit off the difference. By buying the stock and holding it, users were assured they could profit as the hedge funds were forced to buy the stock at higher prices than they had sold it at. This resulted in a huge spike in the price of the stock from under 50 dollars a share on January 21st 2021 to a height of 350 dollars only 6 days later. The subsequent fall in the share price and other volatile movements in the price in the days since have led to fierce debate and even congressional hearings in the US. The saga is still ongoing as users of the forum continue to promote the stock and to discuss ways to identify other targets for similar investing activities.
Gamestop is but one example of how social media is transforming finance and financial advice. Investment advice ranging from the general to the specific can be easily found in a casual search on YouTube, podcast platforms, Twitter, and even Facebook feeds. Some investment advisers such as Cathie Wood have relied heavily on the internet to promote their fund and investment ideas leading them to become in online platforms with hundreds of thousands of followers. Even in my own teaching of finance at the Hall and at other colleges during this past term, I have had students ask me directly about specific advice provided by some these advisers and if it is good advice!
It is clear that we must have a better understanding of the role of social media in finance as it is already a mainstream way people try to find answers for their financial questions and problems. What is likely to be important is to explore how social media is changing the business of finance, what drives people to use such platforms instead of traditional methods, and what role both policy makers and academics can play in improving financial literacy and to reduce potential risks such platforms can expose to investors.
If social media has transformed how people talk about finance, new financial technologies (collectively identified as “FinTech”) has similarly transformed the way in which people obtain financial services. Traditionally, services such as payment and settlement, savings and lending, and brokerage were offered in person and by well-established financial firms. However, widespread adoption of computers and mobile devices has led to a huge growth in non-financial firms providing traditional financial services through such platforms. All matter of financial services are now offered on fintech platforms in one way or another. It is entirely possible to only use online platforms to buy and sell financial instruments with minimal cost and effort. Recent research has strongly suggested that this growth in FinTech has come as a consequence of the ability of such firms to resolve problems the traditional financial firms have had in provisioning financial services efficiently.
At present, the UK is a major player in the FinTech space. The UK represents over 10% of total global market share in FinTech industries. The UK has become a European hub for FinTech firm establishment and operation with some of the largest worldwide FinTech firms based in the UK and providing services such as payment and transfers, banking, and credit. The recently released the Kalifa Review of UK FinTech, identified that the UK is well positioned to be a major Hub for FinTech operations in the future and it is clear from government policy that the future of FinTech is indeed bright.
As people have come to rely on the internet and other IT technologies due to the COVID-19 pandemic, it is likely that FinTech platforms are likely to become the primary way through which financial services are offered. Which firms will emerge to become dominant players in various areas in the industry remains to be seen. Moreover, as traditional financial firms shift towards a more online presence, this raises significant concerns regarding the availability of finance in regions that have historically been underserved by the financial system. Given the current position of the UK with respect to this growing industry, it is entirely possible it can take a leading role in both establishing and shaping the industry for many years to come as well.
Environmental, Social, and Governance (ESG)
Another way finance will be transformed is through the push to use financial tools to address climate change and other social issues. It is clear from the science that climate change is a pressing, existential threat to humanity with a rise in global sea levels, increased frequencies of environmental catastrophes, extinction of many animal and plant species, and shortages of food and water due to crop failure and desertification due to a single degree increase in average temperature since 1906. It has been argued that the only way to avert climate disaster is to have economies around the world shift to a post-carbon based economy as quick as possible. The UK is also attempting to lead this shift by targeting green house gas emissions to net zero by 2050.
To affect such rapid change, policy makers, think tanks, and others have suggested that finance will need to play an important role. There have been calls for institutional investors to shift their investments away from firms based on the carbon economy and into green and other sustainable industries. While some models suggest that Green investments may not be the most optimal with respect to expected returns, the utility of consumers is maximized and the reduction in the cost of capital for green firms incentivizes adoption of Green technologies more broadly. There are signs that finance is beginning to take this task seriously with many green and sustainability funds established to meet this challenge.
However, full divestment or even an actual shift to investing only in green/sustainable companies remains to be seen. One of the worlds largest institutional investor has significant holdings in fossil fuel companies and the prospect of lower returns has made it difficult for some firms to put money where their mouth is. Increasingly, the pejorative term “greenwashing” is being used to describe financial firms who give the impression they are doing environmentally sound investing without actually doing so. Regulators have come in to try and set standards to make it more clear whether funds are actually meeting the sustainable investing standards they say they are.
Other approaches to tackling the issue have focused on changing how corporations behave through affecting change in how they are governed. Funds have also been established with the goal of investing in companies that only meet high standards of social welfare and governance. The idea is that a company that takes a longer, stakeholder view can better address the climate issue and other social issues more generally. Recent moves by the US have shored up the application of ESG standards to corporate behaviour with the new Biden Administration. However, the difficulty of managing companies generally and the separation of ownership from control raises questions as to how much day-to-day operations can be changed from such a top-down approach.
Where do we go from here?
There is much going on in the world of finance at this moment. It is very likely that the landscape of what finance is will be very different in the future than what it is now. However, it is an open question whether these transformations represent something completely different than what we have seen in the past or if it is simply just a simple evolution of traditional finance into its more modern form. What is clear is that a serious discussion of these developments is needed. Academics need to be receptive to focusing on these new innovations and to try to understand why they have emerged and what their likely effects will be.