Facebook is, through its WhatsApp subsidiary, expanding into London having picked the UK as its European headquarters, a move which is – as usual with tech reporting – causing not a little incorrect interpretation and analysis. Critiquing tech unicorns is shooting fish in a barrel and unworthy of us, but this move is highlighting an interesting notion about Facebook and financial services, payments especially, which is worth delving into. As the Yahoo Finance report ends:
The company’s chief executive Mark Zuckerberg has said WhatsApp’s move into facilitating payments via the app will be rolled out in several countries this year.
Recruitment has already begun, with senior engineers who were among WhatsApp’s founders reportedly sent to London last year to begin the search for talent.
It comes as new data shows investment in the UK’s tech scene holding up, despite a year of huge uncertainty over Brexit’s impact on Britain’s economy.
European investment in UK tech firms even hit a record high last year, with funds based in the EU piling £1.89bn into Britain’s tech sector in 2018.
Our main subject is how Facebook’s latest attempt to pivot its business model to payments isn’t at all new and isn’t without issues, but we’ll get to all that in a moment. But I can’t resist, and I hope readers will indulge me a little, in taking a side-swipe at the entire underlying premise of Facebook’s strategy. Yahoo Finance is an unrepentant tech sector booster and reluctant to get into matters of politics, but I have no such qualms here.
Firstly, I want to knock any notion that, post-Brexit, the UK (or, London as the UK’s financial centre, to be specific) can be a “Singapore on Thames” on the head as it is just silly. It’s merely the so-called “Swiss model” by another name – and the EU27 not only have said “no more Switzerland’s”, they’re not even happy with the existing Switzerland arrangements and are trying to wind those up via pressure on the Swiss. Let alone another one being created. The Swiss model, for those lucky enough to not have come across the term previously, refers to a notion that the UK can leave the EU without a Deal, but can, rather, come to individual arrangements for trade in particular areas. This is the arrangement which Switzerland has evolved with the EU.
So why can’t the UK copy the Swiss model? Because the EU has – rightly – concluded it was a form of cakeism which it should never have agreed to in the first place. While “thin end of a wedge” arguments can be logical fallacies, in this case, it is a valid argument because Switzerland has ended up with preferential access to the EU’s Single Market. It is enjoying the rights but backsliding on the responsibilities. The EU has had enough.
Now, the EU27 might not have everything all its own way in this, the deferral of the final decision in December last year gives a hint that the EU27 could still find it difficult to replicate the wide, deep capital markets which Switzerland hosts. The reasons are complex and aren’t the focus of this post but briefly, the unwillingness, in aggregate, of the Eurozone to run large trade deficits precludes a substantial pool of euros held outside the Eurozone itself which would then be available for reinvestment via the capital markets. They have, at the risk of a gross oversimplification, quasi-dollarised the Eurozone, at least where capital formation is happening. This gives an opportunity for non EU27 markets like Switzerland and the U.K. to muscle in. The EU27 is limited by an inviolable truth which is, while governments can restrict or even outright end international capital flows and commerce, they cannot force capital or commerce to flow merely by trying to order it to do so. Nationalisation is an option, but destroys pricing signals. If you kill price discovery, there’s no point anyway in having capital markets.
But the EU27 has signaled a clear, unmistakable direction of travel for Switzerland. It’s very hard not to come to the inescapable conclusion the Swiss model’s day’s are numbered. Yet this is supposed to be the exact same model which the EU27 will bestow on the UK? Maybe guests at the Mad Hatter’s Tea Party could believe this is likely to be a happening event, but even Caterpillar sitting on the magic mushroom smoking something pretty strong in his hookah would say “fat chance”.
So forget any fantasy about a post-Brexit U.K. financial services industry being granted the same or similar arrangements. Or, thus, any silliness about London being a Singapore on Thames, free to do whatever wheeling and dealing it takes its fancy to then selling it into the EU27 via sector-specific or market segment-specific deal-ettes.
Moving on, as we’ve more sensible things to look at.
Facebook is trying to set itself up as a financial services provider. But the latest attempt is not its first rodeo. Facebook first tried this in 2015, without any noticeable success. In late 2018, it had another go, to an overwhelming outbreak of apathy among both users and financial services providers. Try as they might, they can’t gain a foothold, yet still industry watchers keep predicting that Any Day Now, Facebook will suddenly manage to become a force in payments.
Why do analysts keep over-optimistically predicting how Facebook (and not just Facebook, other tech unicorns are given the same undue latitude) is just about to “disrupt” the payments system?
The payments system is an example of something that is superficially simple, because it replicates a previously simple system (handing over cash in settlement for a debt) with something else far more complicated (all the gubbins that go into keeping the payments system working). And because it has evolved organically over nearly 50 years of development, it is comprised of a largely-hidden framework of technical (IT systems), national law (regulation), private law (contracts) and commercial product components — all of which are designed to work together seamlessly and symbiotically.
So when system users hand over their credit card or use their PayPal app, they mistakenly think the credit card is the system or the app is the system.
Industry-watchers then make a category error in assuming that, if someone like Facebook comes along and offers a credit card or credit card-like product, or a new or replacement app, or a “pay a Facebook Friend” feature within their Facebook account, Facebook has created a new payments system. No, it hasn’t. Its tacked a teeny tiny new appendage onto the huge edifice which is really holding it all up.
Ah, but, say the analysis, what about the start-ups which have created an entirely new payments ecosystem in China? What the likes of Alipay (which belongs to Alibaba Group) or Wi-PAY in China have done is – at huge investment and with the massive advantage there were no incumbent players to fight them off, oh, and state sponsorship, too, which limits competition while they build a critical mass – to create from scratch the entire end-to-end payment system.
It is essential to understand how important the role of the Chinese government is in not only helping what are, in effect, State Owned Enterprises like Alibaba build out their financial services products and payments systems in the first place but also protect them from external competition while they establish their monopolies or oligopolies. As Forbes noted:
Since the early days, Alibaba, has been supported by the Chinese government which used Alibaba’s Taobao and Tmall sites to do billions of dollars of transactions between various government agencies which allowed Alibaba to post eye-popping revenues and growth in the early days.
The Chinese government still conducts a lot of trade between its various agencies using Alibaba platforms so as to ensure the continued scorching growth rates that Alibaba has been able to post year in and year out.
With China’s murky and archaic ownership structure laws and the fact that the government of China and/or the China Communist Party has huge control over almost single thing in the Chinese economy, companies and even society, means that Alibaba is the “golden child” at the moment.
Which is not at all what Facebook are doing, nor easily can do, because the Too Big To Fail (TBTF) banks, the card networks, the regulators, the merchants etc. are all quite happily using the existing system, so Facebook will need to either usurp that or agree to coexist with it, cooperatively. The former requires deep pockets, with no guarantee of eventual success. The latter precludes Facebook from establishing its no doubt intentional end-state: a monopoly with its toll booths around it.
Perhaps Facebook will, then, try to spend its way out of trouble and make the required investment to create a new, parallel, payment system? Then everyone can simply migrate their money transmission and transaction settlement onto Facebook’s new-fangled replacement. It doesn’t work like that. Payments is what is known as a “vertically integrated” system. You can’t establish an alternative to it incrementally. You have to replicate all the components and switch over all the user base in a big-bang implementation.
It’s no use, for example, launching a payment app if the people you get signed up for your payments service can’t use it with the existing merchant Electronic Point of Sale (EPoS) terminals in stores. You need to launch (with sufficiently wide coverage) the new EPoS hardware and have it available at the same time. But couldn’t Facebook make backwards-compatible or inter-operable EPoS terminals, ATMs, and eCommerce modules to embed in websites which work with both? This creates a complex and difficult to maintain software stack and hardware requirements because the existing payment system players set their own rules (here’s Mastercard’s as an example, all 130+ pages of it). If they don’t like anything about how Facebook’s EPoS equipment or processing apps work – they can refuse to licence them and block all transactions from such unauthorized channels. Facebook might be tempted to then cry foul and go running to the courts about restrictive practices.
But the incumbents are well used to getting lawyer-ed up and would like nothing better than to subject Facebook to a five year or more legal war of attrition. US courts in particular are very slow to get embroiled in cases which have even the merest hint of Godzilla-like company A trying to get the legal system to give them a competitive advantage over Mothra-like company B, with the courts expected to intervene and figure out who is right and who is wrong.
It is probably superfluous to add that, if Facebook’s existing business model is so great, why does it feel the need to try, try and try again to break into various aspects of financial services? Of course, financial services is, in effect, an administered income stream for the lucky TBTF banks which are the beneficiaries of their status as essential cogs in the economic machine, which need to be tended like exotic plants and given precisely the right conditions to be kept alive and (reasonably) healthy. Facebook’s current core income stream and operating model isn’t so lucky. Given Facebook’s many and varied woes, you have to at least consider the possibility it is living on borrowed time. In that position, becoming like a TBTF bank has its obvious attractions.
Addendum: readers may already be aware, since I wrote the copy for this post yesterday, and too late for Yves to have chance for me to update it and still edit it before publication, WhatsApp has ‘fessed up to a security breach allowing eavesdropping https://www.bbc.co.uk/news/technology-48262681 which was trigger-able remotely without any user activity whatsoever.
And Facebook expects us to trust it with our (real) money when it can’t, demonstrably, be trusted to look after our privacy? I wouldn’t post a picture of my mother-in-law’s cat to Facebook or WhatsApp never mind give it any access to or any role in my financial affairs. It can move fast and break things if it likes, but that will never, ever extend to my money.
Thank you Clive for the clarity and depth of your takedown.
Will somebody please start the popcorn popping?
I second your response, and, though I’m a teetotaler, I’ll even provided the beer.
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Thanks for this Clive, very clear and informative as always.
To add to the above:
There are only two possible payment systems. Centralised/cleared or distributed. Currently we have the former, via banks that act as intermediaries (be it in Visa/Mastercard, or as account holders for PayPal etc.).
If you accept banks as the clearing system, you can build an equivalent of PayPal – something that “moves” cash from bank A to bank B. But what you’re still doing is riding on some sort of existing bank infrastructure, nothing new.
And you still have the problem of persuading the users (payers and receivers) that your system is better (safer, cheaper, faster) than the current one to justify the cost of running two parallel systems (because no-one will drop the existing one for an untried one) with all that it entails. PayPal managed it, because the US banks liked to squeeze their domestic customers, at the time when most of the world had seamless electronic money transfers available to retail at trivial/no cost.
Apart from bitcoin (or similar), there is no distributed system (a system that moves money from account A to account B is not distributed, it still uses the bank infra). Bitcoin, despite now close to a decade of hype, is still a solution looking for a problem. As a payment system, it’s the equivalent of wheelbarrows in Weimar.
As a business, it does not make sense to accept BC as anything but PR, because you have no idea whether the payment will give you incredible margin (because BC moved from 6k to 8k), or huge loss (because it moved from 20k to 16k).
Ergo, all this “payment system” is just a fluff.
That said, I’d be careful before killing it all. Gadgets as jewelery was what really sold Apple, not because it would really be the best HW/SW around. It’s possible that someone will figure somethign similar for payment systems (I know of at least one startup that was assuming putting your transactions on web sort of like financial Instagram would be cool). Though I doubt it will be FB (although they may buy it).
Precisely, which is why I simply don’t understand the big rush by all the tech bros to come up with a new payment system. Or more accurately, I don’t understand why anybody would feel the need for these types of services – the companies that set up these payment systems do it because that’s where the $$$ is and they want to siphon off as much as they can for themselves.
My company deals with many of the start ups trying to become the next big thing in payments. Most of them are awful, do nothing new, and their own AP departments can’t seem to make an accurate and timely payment to us, which is the one thing these companies tout that they’re able to do.
They are just more middlemen inserting themselves unnecessarily into the payment process, taking a cut and making everything slightly more expensive. They are simply parasites looking to stick their blood funnels into every transaction they can get away with.
Cash is still king.
I’m really really dubious there’s any sort of innovation possible in payments services. You can do slicker/easier interface for the end users, and that’s about it.
Otherwise, it’s always about moving some tokens from A to B. Those tokens you either “own” (distributed, cash) or someone else holds for you and B(bank), or you move tokens from C to B with A owing C (credit).
You can come up with a lot of ways for the last bit, although I’d say most of them are not really helpfull to society (some are, credit is a useful invention), but there’s not that many things you can do to the first two.
Bitcoin tried – but it’s value-unstable and waaay too energy expensive/slow. Someone may be able to solve the latter, but w/o a government backing the value stability is IMO impossible. Which beats the “distributed” reason.
Since China’s banks are owned in common, the Finance Ministry can (and did) simply tell them to allow new payment systems in.
FYI, 100 million Chinese borrowers increased online bank assets 169% YoY and net profits 71% in 2018.
Thanks, Clive, for the lucid, thoughtful post: much to ponder here.
I largely share the analysis, assuming that Brexit doesn’t become a hard outright divorce (i.e. no “soft Brexit”, no permanent customs union). If that happens, then the EU’s wishes become less relevant.
I would also note that despite the tough talk, the financial services industry has already started to establish carve outs from Brexit on the basis of “regulatory equivalence”, whatever that actually means. So the EU might talk a tough game, but when it comes to finance, the talk is just that. The argument seems to be that nobody wants to risk a financial discontinuity, so let the beasts of finance do what they like. I doubt anybody will call Big Finance’s bluff.
Yes, I wanted to hedge my bets with the EU in respect of Switzerland and this also applies to post-Brexit carve outs. It was telling that (as indeed it was with the Brexit Exit Date extensions) the EU could have brought down the curtain on the Swiss access to the Single Market arrangements, but opted for, yes, an extension. The same was true of the LCH access — given a limited mini-deal but only for a year (if the UK had left on the 29th March).
As you say, its the same forces at work. The EU doesn’t like any of it, but transitioning away to EU27-only solutions isn’t going to be pain-free. I don’t doubt that the EU will stick to this approach in the long term, hence my conjecture that the Swiss model is on borrowed time.
However, if the Eurozone wishes the euro to become a US$-like reserve currency, it won’t be able meet its other aim, EU control of €-denominated capital markets — and all operated in the EU27. The US is willing to cede an awful lot of control of the US$ to facilitate its role as a reserve currency (you could argue the reserve currency). It (the US$) is on a long, long leash — and the US is holding the end of it — but what the EU seem to propose for the future of the Eurozone is something which far more resembles a choke chain.
Its not my area, but my suspicion is that the EU has decided that the best way to eat the City’s lunch is by slowly squeezing it while building up its own regulatory infrastructure and only letting the axe descend when they are good and ready.
As a small example, the Irish Central Bank was deliberately obstructive last year at London companies trying to set up copperplate offices in Dublin on the basis that they simply didn’t have the regulatory expertise to deal with them (they did learn at least some lessons from the 2009 crash). But having just moved in to very large new offices, the Irish Central Bank is now looking at expanding into yet more offices nearby, which strongly suggest to me that a blank cheque has been issued by the irish government (no doubt with EU blessing) to build up that regulatory structure as quickly as possible.
I think that is definitely their (the EU’s) theory but capital markets are global, not regional. The EU27 can — by some measures, have — created alternatives to Switzerland and the UK, but the more League of Gentlemen (“these are EU markets for EU people; there’s nothing for you here”) they try to become, the less they can attract global liquidity.
The more, say, the CJEU hands down judgements in favour of the EU because of a wish to promote greater integration within the EU27 (and rule against, say, US business interests where they are attempting, whether by accident or by design, to reinforce US superiority), the more that helps, well, EU, integration and solidarity but the more, in the long term, this works against attracting capital flows from outside the EU.
It’s a trade-off and it’s not a binary choice, so the EU has a lot of latitude in where it chooses to draw its red lines and how firmly or otherwise those red lines are written.
I think it’s a bit more of “depends”. US courts tend to heavily favour US corporations, yet it’s still a sizeable capital market even for non-US companies.
But that comes with dollar-as-reserve-currency, which as you say comes with current account deficit (either via trade or investment). Which doesn’t seem to be a policy that the current EU would favour.
It’s bad enough Amazon knows what I’ve bought or might buy, but Fbook wants that info too? I don’t think so. I deleted (yeah, sure) my Fbook account two months ago…don’t want them using my grandchildren to develop their facial recognition software.
I do not trust my BANK knowing what I do with my money. And so, like Richard Stallman, I take out cash and use that whenever I can. So I would never use Facebook, and even less so now that their What’s App backdoor has been exposed.
They are all middle-men (people?), each taking a cut, so they love these systems on systems on systems.
New motto: WWRMSD?
“So when system users hand over their credit card or use their PayPal app, they mistakenly think the credit card is the system or the app is the system.”
Silly Con Valley counts on this lack of knowledge about how systems (and power) work.
A lot about what happened to the media and music biz is wrapped up in similar misconceptions – a “confusion” about the content creators and the medium of delivery.
Not sure how to exactly explain it…
Did Facebook ever have a business model? It seems to have staggered into and through monetization without having a clue.
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Facebook should just buy a Bank, and put an app payment feature in the code in Smart Phones.
I suspect they’ve considered this, but becoming a bank holding company entails complying with a ton of regulatory compliance and reporting requirements. Not to mention oversight by which ever state arm of the Federal Reserve (e.g. the New York Fed) they register in. Regulation is still,woefully inadequate, but it’s stronger than the go-go days of 2007 so whatever nasties Facebook has in the woodshed might risk being dragged into the sunlight.
In one respect, then, Facebook’s attempt to get into banking or bank-esque services without actually becoming a bank is yet more attempts at regulatory arbitrage.
They can try to be a payments bank like Airtel in India
Not allowed under US regs. There is a clear separation between banking and commerce. The only exception I can recall is that Ford for a while owned a savings bank and I can’t recall what sexual favors were exchanged for that to have happened.
How is accepting payments different from become a Bank?
As I understand it, an institution become a Bank when accepting deposits.
Yves – I know Walmart tried to get a banking license 20 or so years ago and I think they ended up with an “Industrial Bank” which apparently is a very limited banking license.
The now departed Schwegmann’s grocery store chain of New Orleans fame had an in house ‘Schwegmann’s Bank.’ I used the one in the Schwegmann’s Veterans Boulevard location several times when I first moved to New Orleans.
Something from Schwegmann’s Bank history: https://casetext.com/case/schwegmann-bank-tr-v-bank-of-la-1
Something else: https://research.fdic.gov/bankfind/detail.html?bank=25139&name=Schwegmann+Bank+and+Trust+Company+_31
Google truly is execrable now.
Data mining. Essentially finding out what is in people’s souls, and selling it.
Clive’s last line …
” Given Facebook’s many and varied woes, you have to at least consider the possibility it is living on borrowed time. In that position, becoming like a TBTF bank has its obvious attractions.”
Amazon and Google are pretty well ensconced in gov services. Facebook could could find itself outside of the walled garden…
reply to albert @ 11:20am
“…Facebook could could find itself outside of the walled garden……”
It couldn’t happen to a nicer bunch of folks.
I guess my question is “Did Zuckerberg actually have a plan when he started FB?” My guess is no. He stumbled into a gold mine without a pick and shovel.
FB can continue to be a tool of the gov’t in the propaganda business. If only they could figure out a way to monetize -that-.
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One Ring to Rule Them All, or it’s modern incarnation The Borg of Star Trek.
The US deep state objectives also keep circulating in my head, but I’m not certain of their position in history. Post WW II, but when?
Thank you for this:
The Swiss model, for those lucky enough to not have come across the term previously…
I hardly understand everything on NC. Qualifiers like this are invaluable for a rube like me.
From the point of view of the user, who wants more complexity?. I have a pay pal account which I check regularly, like the bank account (although pay-pal movements appear in the latter). Adding a whatsapp payment account would require more attention checking payments and would make it more difficult to me to identify them. To avoid such complexity I decided long ago that I would never use my phone as a payment system and will stick to this decission. For instance, i don’t use taxi/uber/other transport services if I have to pay them via phone or exchanging credit card data through it.(In reality I almost never use taxis and the like)
Complexity? Think “Security”. Anything you can do to avoid exposure on the airwaves is a good thing. This includes wifi as well as cell phone usage. For banking and online purchases, a legacy desktop running Linux from a Live CD with direct a Ethernet connection is a good idea.
Even though there will never be perfect computer security, keep on not doing what you’re not doing. It’s a good start.
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Thank you Clive. As usual you are very interesting. Your expertise on the payments system is always so mind boggling. And the extra layer of complexity now with “apps” and FB’s elbowing its way in (who’s next?) to make a profit from services that were never meant to earn profits at the expense of the users is like an act of desperation. FB never had a business plan. Not even a toll both – just a potential toll booth. The best thing about the banking industry is its ability to make transactions run smoothly so the business of living and progress can get on with it. The last thing we want to do is screw that part up. It’s always possible that we could go the Chinese way in the midst of our climate emergency. But I doubt we’ll contract anything out to FB. Very interesting stuff.
Re: “Industry-watchers then make a category error in assuming that, if someone like Facebook comes along and offers a credit card or credit card-like product, or a new or replacement app, or a “pay a Facebook Friend” feature within their Facebook account, Facebook has created a new payments system. No, it hasn’t. Its tacked a teeny tiny new appendage onto the huge edifice which is really holding it all up.”
I understand and believe all of your points as to why this isn’t what they want people to think it is.
But I what I was also getting at earlier is that they don’t have to create a new payments system any more than they “created” any other service or business. They just have to be assured the hype machine will help convince everyone else they have invented a new payment system and wait for anybody that knows the difference…well, wait for them to die…
Great explanation of this story Clive. It almost makes me cheer for the Big Banks. I can see Facebook trying to set themselves up as a bank by “moving fast and breaking things” to discover that this would be a quick way to financial oblivion by getting into a fight with the banking world. From reading your article, it is like Facebook are saying “assume a back-end”. They must be listening to too many economists.