Get ready for major industry contraction, warns CFA chief

The Hong Kong-based head of the financial services industry’s main educational organisation says the industry faces radical change in the next 10 years. And so does its reputation. For the better.

Paul Smith, global chief executive of the CFA Institute, said the industry should prepare for a massive contraction and a culture of ‘capitalism with purpose’ driven by a new generation of responsible investors.

Speaking to AsianInvestor following the CFA Institute’s annual conference in Hong Kong last week, Smith said the association’s big research project for 2018 is to look at the future state of the investment management business. Although it’s too soon to know the final conclusions, he suggests the industry should prepare for massive disruption.

Smith said at the very least it will create more options for investors “and hopefully over time it creates more consistency and a lot better value for money.”

Notwithstanding the contraction seen since the global financial crisis of 2007-2008, the financial services industry has grown fat at the expense of investors over the last 30 years and its share of GDP and gross margins are unsustainable, he said. 

“The last 30 years has seen financial services accrete more of GDP to itself, to the point where we are now an overblown industry,” Smith said. “Roughly, we will move from 24% of global GDP back to about 16%. So the industry is going to contract by around 33%.”

BETTER CLASS OF PERSON

The outsized profit margins that banks and other financial firms have grown used to will also soon end, which is “wonderful news” for the industry, because it will bring about a change in why people get involved in financial services, Smith said.

“What it means is that young people who are motivated purely by money will go elsewhere. They won’t come to us and as a result we will hire a better class of person and run better businesses."

That new generation of financial professionals will be mirrored by a new generation of investors. “The client is changing with the millennial generation and women making up a bigger percentage of the asset-owning classes. These asset owners are a proxy for society in many ways and they think differently about their money,” Smith said.

The crisis of identity for financial services is the result of the industry’s mindset in recent years. “For an industry that represents such an enormous percentage of GDP, it has very little social output. That can’t be healthy and it’s just an accident waiting to happen – as it did in 2008.”

That the lessons of 2008 have still not resulted in a cleaner, more trustworthy financial services industry is at least partly because the financial sector "doesn’t acknowledge that it isn’t working. The industry needs to step up and take responsibility. Everybody passes the buck, as they did in 2008.”

Smith said the recent scandals in Australia involving AMP and Commonwealth Bank are just the tip of the iceberg: “They’re just the people who got caught, so we shouldn’t be celebrating their downfall in any major fashion.” Their downfall was a systematic failing rather than a personal one, he suggested.

“The mistake is to assume, whether it’s AMP or Wells Fargo (in the US), that the people at the top are bad people -- they’re not. They are incentivised badly; they march to a share price drumbeat and that’s the way their compensation packages are organised. That’s the way people judge success and so capitalism per se is the problem. Because if that’s the only metric we have for people, why are we surprised that they do things we find morally distasteful?”

Smith says CFA’s stance is to engage in a much closer dialogue with local regulators and like-minded associations. But the dialogue needs to extend beyond this, he said. “To assume you are going to change the world from one narrow vantage point is at best silly and at worst arrogant.” It needs to go beyond a talking shop, he said, to “make finance fit for its purpose”.

The conversation that Smith expects to have with regulators in Australia is likely to revolve around tighter regulation. But Smith said that more regulation is not the solution and that “there are other tools geared around culture and conduct.”

TECHNOLOGICAL SOLUTIONS

Taking an optimistic view, Smith believes that financial technology could help the industry.

“Technology is possibly our saviour because what it will allow us to do is be much more transparent, more consistent in our advice, much more tailored to the needs of individuals and, finally, much more effective. Over time, people will come to recognise the value people are adding."

Ultimately, though, it is the new industry players that will define the route the industry takes in 10 years’ time. Fintech in financial services is overwhelmingly being led by Chinese companies and Smith says the likes of Ant Financial will help the traditional players change their business models.

“The overwhelming thing I hope the change brings is simplicity of product,” he told AsianInvestor.

At another conference in Hong Kong last week, Smith said he attended a fintech session where a speaker asked an audience of 120 professionals how many had bought a fund via their mobile phone. "Not one of them had. So when we think about the onset of financial technology we also have to consider [that] we are right at the very start of this process and humans don’t change that quickly. But how cool would that be, if you bought a fund, you switch it on and it works, like buying an iPhone.”