PLACE FINANCIÈRE & MARCHÉS — Fonds

Contribution - Alfi

Fintech: overview, threats and opportunities



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Jérémie Schaeffer, partner et head of corporate implementation et Olivier de La Guéronnière, director corporate implementation, chez Atoz Tax Advisers. (Photo: Maison Moderne)

A lot has been said over the past few years about fintech, blockchain and crypto-assets, and about the consequences of these technological disruptions on the financial sector and on fund distribution.

Where do we stand today, what is Luxembourg’s position in this landscape, and what threats and opportunities should be anticipated?

A bit of history

10 years ago, Satoshi Nakamoto issued a white paper explaining the functioning of a new type of asset: the bitcoin.

The underlying technology, the blockchain, still went relatively unknown until 2016 when major companies realised the disruptive potential of the technology and invested massively into it.

Accordingly, initial coin offerings (ICOs) were practically non-existent until 2017, when figures skyrocketed: from 50 ICOs in 2016 worth USD100 million, a total amount of USD3 billion was raised in 2017 as part of 200 ICOs.

2018 followed the same pattern, with a year-on-year increase of 238% of the number of ICOs and 130% of the USD amounts invested.

This sudden worldwide interest for blockchain and tokens created turmoil at the level of national regulators and international institutions.
Jérémie Schaeffer

Jérémie Schaeffer,  partner et head of corporate implementation,  Atoz Tax Advisers

This sudden worldwide interest for blockchain and tokens created turmoil at the level of national regulators and international institutions.

This resulted in the issuance of many warnings by central banks, the European Banking Authority, the European Securities and Markets Authority, as well as many of the world’s national regulators.

Some regulators even resolved to reject some ICOs: for instance, the new Cyber Unit of the American Securities and Exchange Commission resolved to file charges against PlexCorps and its founder Dominic Lacroix, as part of the company’s ICO.

Luxembourg’s position

The Luxembourg regulatory authority, the CSSF, issued two warnings on 14 March 2018, reminding investors that tokens are not currencies, are not regulated and do not benefit from any guarantee regarding their value, hence a very high investment risk.

The CSSF recommended, in a business-friendly and constructive approach, that any person willing to exercise a business related to tokenisation should submit their project to the CSSF who could then determine any applicable regulation.
Olivier de La Guéronnière

Olivier de La Guéronnière,  director corporate implementation,  Atoz Tax Advisers

However, the CSSF recommended, in a business-friendly and constructive approach, that any person willing to exercise a business related to tokenisation should submit their project to the CSSF who could then determine any applicable regulation.

This openness of the regulator, together with other major initiatives such as the setup of the Luxembourg House of Finance and Technology (Lhoft) and a strong will from the government, helped achieve significant milestones:

- The government inserted a new article in the Luxembourg Law of 1 August 2001 concerning the circulation of securities, in order to consecrate the principle of technological neutrality by expressly allowing the registration and holding of securities by way of “secure electronic registration devices, including distributed electronic registers or databases”;

- Tokeny assisted in the first-ever token fundraising representing a fraction of the rights of a luxury real estate asset located in Belval; evidencing how blockchain makes it possible to split the ownership of an illiquid asset, render it accessible to smaller investors and liquid due to the greater ease of disposing of a token;

- Bitstamp and bitFlyer, which allow consumers to buy and sell currency tokens, based in Luxembourg and have been authorised by the CSSF as an electronic payment institution;

- The new European super calculator, EuroHPC, will be set up in Luxembourg;

- The label “FutureHub” was created in order to recognise schools that invest in new technology training;

- LuxTrust is being used at European level, either by other European cities, or by the European Parliament itself which used it to electronically sign a legislative act on 25 October 2017;

- The CSSF further announced that it is developing artificial intelligence tools in order to improve the supervision of the fund industry.

Opportunities for the financial sector

As the second largest fund centre, with EUR 4.065 billion in assets at the end of 2018, Luxembourg’s financial centre would strongly benefit from the various applications of fintech.

Nasir Zubairi , CEO of the Lhoft, also mentioned that due to the nature of Luxembourg’s activities and the ever-increasing European regulatory burden, regtech (fintechs specialised in regulatory aspects) “makes sense” to decrease back-office work and costs.

In addition, customers are asking for more direct-to-consumer distribution, and as a consequence are increasingly sensitive to transparency, costs, user experience and the ability to connect and manage their assets anytime, anywhere, on any device.

Investment in fintech and blockchain tackles the above challenges:

- Fast sharing of secure and verified data between the various actors (funds, investors, regulatory authorities);

- Easier transferability and traceability of assets through the use of asset tokens;

- Theoretically inviolable register, enabling strong ownership evidence;

- Digital signatures and cryptography strongly and quickly increase security of transactions, while immediately identifying suspicious operations.

Expected consequences are reaching faster and secure payments, ownership transfers and record-keeping, strongly decreasing costs and back-office burden, and increasing transparency with respect to the involved actors, their role and costs.

The rise of smart contracts, which automatically execute their terms and conditions, would also allow for reduced time, costs and discussions over the implementation of an agreement.
Jérémie Schaeffer

Jérémie Schaeffer,  partner et head of corporate implementation,  Atoz Tax Advisers

The rise of smart contracts, which automatically execute their terms and conditions, would also allow for reduced time, costs and discussions over the implementation of an agreement: for example, by automatically enforcing “defaulting investor” provisions if an investor doesn’t settle his commitment on time.

These new available technological solutions and the possibility to automate traditional checks (compliance with AML regulation, eligibility checks for restricted investments, roles of the transfer agents, paying agents and custodians) means that disintermediation is to be expected in the fund distribution environment.

What are the risks?

As with any new technology, benefits are only realised if some risks are taken.

Regulatory risks: There are challenges regarding the legal classification of a token: is it a payment token, a utility token or an asset token? Do rules applicable to traditional securities and public issuance apply to tokens and ICOs?

Many national regulators have resolved to apply the same laws to tokens as to traditional securities.

The CSSF stated that due to the dematerialised and cross-border characteristics of token transactions, a national regulation would have only little effect: a European or international regulation would be welcome.

Many warnings have also been issued with respect to money laundering and the financing of terrorism (it is estimated that half of bitcoins are used for illegal activities).

Technical risks: Any information on a blockchain is theoretically unfalsifiable, but this also means that the initial registration needs to be correct: any mistake made during the first registration cannot be corrected.

Data on a blockchain is encrypted with a public and a private key; the latter being kept by the user itself outside of the blockchain.

If the private key is lost, stolen or hacked, any information or token secured by a private key will become definitively inaccessible or irrecoverable.

In one dramatic example, the founder of QuadrigaCX, a Canadian online crypto-­ exchange platform, was the only person holding the private keys of his clients. Due to his unexpected death, none of the company’s 115,000 clients will ever be able to access their EUR126 million of investments.

Companies favour private blockchains for their internal use. However, this means that the blockchain contains fewer nodes. If hackers manage to control 51% of the nodes, then they can take control of the blockchain and validate transactions. This happened in January 2019 on the platform Ethereum Classic, generating a theft of EUR1 million.

The advent of quantum computing and its increased calculation capabilities generates an even higher risk of hacking.

External competition: Luxembourg is not the only country competing in this new field: England’s Financial Conduct Authority has accredited Prime Factor Capital, a crypto asset management firm, as a full-scope alternative investment fund manager.

China has made research in artificial intelligence one of its main centres of focus, and the long-serving head of the technical division of the French external intelligence agency, ­ Bernard Barbier, warned that Europe is shifting from a dependence on the US to a dependence on China.

Inaction: The biggest risk, however, is the risk of not acting.

Today, no significant impact has been made, but major disruption is at the doorstep: digital giants are slowly entering banking activities, and the World ­ Economic Forum has determined that blockchain solutions will represent USD12 billion in 2022.

Some former market titans such as Kodak or Blackberry are perfect examples of leading companies who did not adapt fast enough to changing technologies.

To take Nasir Zubairi’s view, Luxembourg’s financial sector actors are only very slowly implementing fintech, but tomorrow’s competitors may come from all corners of the world and disrupt Luxembourg’s fund distribution market.

Change is here and change will not go away. All professionals of the financial sector need to quickly adapt, or remain passive observers as current or future competitors seize their market share.

More news on the fund industry in  Paperjam’s Alfi  supplement.