A clash of ecosystems that may cause the next major financial crisis

• At the Future of Finance Summit 2019, a panel of industry experts debated on what will most likely cause the next financial crisis
• Techfins, market trust and resilience, the US dollar as the default global reserve currency, and potential risk of leverage in the markets, were pointed out as likely causes
• After a heated discussion the panel came to a conclusion that  it will likely be triggered by the loss of trust and confidence of markets in either or both of competing ecosystems

The next major financial crisis is unlikely to be caused by the banking sector as banks are fully, if not overly, regulated and severely restricted in the kind of risks they are allowed to take. This appeared to be the consensus view of an expert panel of economists, bankers, and financial market veterans.

“It is not going be a traditional banking financial crisis the way we know it. We have known financial crisis from banks before and we have regulated them so much and they are not where the threat is coming from,” said Dusan Stojanovic, founder and director at True Global Ventures.

Instead, he believes that it is the largely unregulated tech sector comprising big technology companies that are getting into financial services that will cause the greatest risk to financial stability.

“Where I see the threat is in five to 10 years when the Facebooks, Googles, Amazons, Tencents, Ant Financials, and Baidus have created a completely dominant position, not only in terms of internet, but what they call in China, internet finance, or techfin,” he explained.

The risk from techfin

David Chang, fintech advisor and vice president of the Shanghai Blockchain Association agrees. He described such techfins as the “barbarians at the gate” that will disrupt the incumbent banks.

“Traditional financial institutions are regulated by rules developed during the industrial era. Even when they are fully regulated, there have been many episodes of blow-ups. In comparison, the IT and technology industry is not as regulated, and if there is a competition with the technology players, it will be a race to the bottom and that could be the next blow-up,” he warned.

However, UOB senior economist Suan Teck Kin countered that the potential failure of a big tech company such as Facebook may not have widespread market impact.

“If Facebook fails, it closes down, it is going to bring a lot of inconvenience to users, but will it be enough to cause a crisis? It boils down to only one thing, confidence. If the market has confidence over the rest of the system, there will not be contagion, it will not spread,” he questioned.

He believes that from the accumulated experience from past financial crises, markets have become more resilient that will likely mitigate risks of major future shocks.

Increased market resilience

To illustrate the point, global markets suffered a staggering $2 trillion loss in capitalisation following the UK Brexit vote, and a $1 trillion loss in reaction to recent China retaliation against US imposition of sanctions on Huawei, without so much as batting an eyelid. This in comparison with the $619 billion loss by Lehman Brothers that ended up precipitating the last global financial crisis.

Instead, the likely causes of future financial upheavals may be from the increasing dominance and concentration of power and risks in relatively unregulated big technology companies as they expand into financial and capital markets. Unlike more traditional industrial age institutions that hold “tangible” assets, a far greater proportion of big tech companies’ assets are intangible or ephemeral.

Exacerbated by irrational investor expectations and market valuation, for example Facebook today’s market capitalisation averages around $500 billion despite the relative lack of physical tangible assets. They may be more susceptible to suffer serious systemic devaluation. The subsequent loss in investor confidence and trust should they suffer any calamitous shocks will dramatically increase the probability of financial market contagion.

Thomas McMahon, CEO at Dillon Gage Asia, is concerned about concentration risks arising from the market dominance of these big tech companies.

“I don’t care if Facebook fails, it doesn’t do anything. But Amazon is scary, it has become an infrastructure. It has been destroying legacy infrastructure while it gathers new cloud-based ones. If it fails in 10 years, we will have a problem economically. It will be an infrastructure failure as much as a business failure,” he remarked.

He continued: “Things have changed where people had faith in real businesses that actually built things. We are now focused on investments and valuations that are in multiples into things that don’t do anything other than gather data, repackage it and sell it back to us. That is a scary prospect of concentration risk but it is also happening in the financial industry. You have fewer players today in he electronification of markets. We are heading towards a culmination of risk that will have a domino effect.”

Displacement of the US dollar

The other threat to future global financial stability is the potential dismantling of the US dollar and treasury bills as the dominant store of global reserve as they become increasingly challenged by alternative reserve “ecosystems”, created by either big tech companies – for instance, a trusted cryptocurrency favoured by a younger generation who distrusts or rejects the dollar, or by a competing currency favoured by an emerging super nation or regional bloc such as a member state of the non-aligned emerging markets.

Natixis chief economist, Alicia Garcia-Herrero, is not as concerned about $500 billion tech companies failing but of the greater implication of a displacement of US treasuries and the US dollar as the default global reserve currency.

“It will be the realisation that we are sitting on a reserve currency that we are not sure why we trust. It is about a world with two ecosystems. It will be very hard to think of a single reserve currency for everybody because they need to be separate. You have companies and countries being expelled or asked to leave the dollar. So, it will be much bigger than any tech unicorns.

Stojanovic concurred: “This is exactly my point. The young generation does not trust treasuries, US dollar and the traditional banking system. They trust these brands such as Facebook that are trying to introduce “stable coins” and attacking the dollar. If you then have a stable coin that fails and one or two billion people are using it, don’t you think it is a systemic risk? I think it is a huge problem.”

The threat from leverage

Another potential risk is of leverage in the markets. In addition, the uneven distribution of global debts/leverage and concentration of holdings by asset owners may potentially cause serious imbalances in a dithering global financial system that may well end up pushing it over the edge.

However, the panel agreed that financial leverage is a risk that the traditional financial system has had the most experience in managing and on a net basis, sovereign leverage versus corporate leverage versus household leverage and domestic debt versus external debt levels of major economies have not reached crisis proportion.

But what may be more concerning is the idea of technology leverage whereby technology is able to create enormous value without the need of traditional capital. The inflated value of many of today’s tech unicorns are not really supported by real capital.

The next major financial crisis, as with previous crises, will likely be triggered by the loss of trust and confidence of markets in either or both of competing ecosystems. A clash between the traditional monetary/financial and technology ecosystems that will take place at a speed and scale that will be unprecedented.