Executive Summary
In last week's blog post, we looked at what is shaping up to be the dominant issue for financial advisors in 2016: the rollout of the Department of Labor's new fiduciary rule, which will likely reshape not just the delivery of financial advice, but challenge the relevance of the companies that support financial advisors (i.e., broker-dealers), and the nature of how financial services products are distributed (in a world where companies will no longer be able to use big commissions to incentivize the use of their products).
However, the rest of the world is not standing still while regulatory change looms. The ongoing march of technology continues, and while 2014 was the year of the robo-advisor and 2015 was the year of robo-advisors-for-advisors, it appears that in 2016 the big issue in FinTech will be a looming war over client data - who has access to it, who controls it, how is it protected, and ultimately does the data about the client belong to the financial services firm or to the client themselves? As account aggregation is increasingly used not just to track a client's household data but actually used to facilitate money transfers - not to mention companies beginning to leverage the information for big data insights - the question of who has what rights to financial data and what can be done with it is coming to a head in 2016.
And of course, it's important to recognize what may still be the biggest outright impact to the business of most financial advisors in 2016 - the Fed's new path of raising interest rates, for the first time in nearly a decade, and the consequences that may bring in the coming year. The "good" news is that at least with fixed income enjoying outright higher yields, the pressure may be reduced for advisors to seek out various "alternative" asset classes in search of yield and return. The "badl" news, though, is that rising rates can adversely impact bond prices, and even risks cracking the stock market as today's P/E ratios and market valuations may not look as appealing once bonds are paying more. Yet ultimately, some of the biggest consequences of higher interest rates may be the secondary effects, from improvements in the pricing of long-term care insurance, to higher payouts and better guarantees from deferred annuities, and a potential explosion of earnings growth for RIA custodians (with some estimates that Schwab's total earnings could triple in a normalized rate environment!)... not to mention the ripple effects across the entire economy with changes to the cost of capital and the discount rate used in most financial models.
An Emerging FinTech War Over Access To Client Data – From Privacy To Cybersecurity To Big Data Insights
In this increasingly digital world, every bit of our financial lives is being turned into bits of data, from our cashless transactions using credit and debit cards (and now just hold your iPhone near the register!), to the fact that most investors who own stocks and bonds today have never even held a physical stock certificate or bond debenture.
This digitization of our financial lives over the past decade launched the concept of the personal financial management (PFM) website – an online tool that connects directly to other financial services providers to pull in and aggregate one’s financial information into a single location. Suddenly, it became possible for households to get more financially organized, without actually doing anything – beyond connecting their financial accounts, so the data could flow automatically.
Yet what started out as just a solution to help people get themselves more financially organized, has begun to morph, as the value of interconnected financial data is not just the potential for consumers to see it, but also to use those data flows to do something. First it was financial advisors adopting account aggregation to automate the data inflows to continuously update financial plans. Then it was using account aggregation to monitor, track, and even manage and bill on, ‘outside’ investment accounts. Last year, companies like Betterment took account aggregation one step further with its "SmartDeposit" feature, which uses account aggregation connections to see available dollars to invest from other accounts and, accompanied by a standing letter of authorization to engage in transfers, made it possible for a third-party to pull money out of a bank account where it lay idle and over to a Betterment account where it would be invested.
Beyond just facilitating processes from advisor billing to automated transfers, though, there’s a growing realization that there’s value in the data itself. “Big data” has been recognized for the potential to yield “big” insights that can be deployed by businesses, and getting access to the raw data is believed to be the primary driver for why Envestnet was willing to spend half a billion dollars acquiring Yodlee when it could have merely licensed the company’s account aggregation capabilities for a miniscule fraction of that price. What opportunities might a company like Envestnet find by deploying these big data insights in its business?
Yet notwithstanding all these opportunities in data, there is a dark side as well. The fact that our financial lives are being reduced to nothing but 0s and 1s in a computer has drawn the interest of hackers and cyberthieves, who now have the ability to steal money not by robbing a bank at gunpoint, but just by using email to convince the new employee at an advisory firm to facilitate an ‘urgent’ but fraudulent wire transfer to the thief’s bank account. The cyberthief can try a million times – sending fake emails is free – and only has to succeed once. And of course, there’s also the outright danger that a hacker gains access to an advisor’s computer systems directly, to engage in even more directly nefarious activity – a concern highlighted by the fact that both the SEC and FINRA are reportedly making cybersecurity a top priority for 2016.
But even beyond cybersecurity concerns, I believe the biggest challenge that is emerging in the world of financial services “big data” is over who should ultimately control and have access to it. When account aggregation was used as little more than a ‘dashboard’ for the convenience of the end consumer, sharing data across financial institutions was fairly innocuous. Now that it’s being used to facilitate transfers away from those institutions, large financial services firms are becoming far less sanguine about sharing data – which was manifest late last fall when the big banks fired a shot across the bow by severely curtailed or outright cut off access to third party account aggregators over the span of a few weeks. As more firms find more ways to leverage big data through consumers that give permission to have their account data connected and aggregated, we are likely on the cusp of an outright data war.
Yet while financial services firms arguably do have a right to decide whether and how much of the data on their servers should be shared with others, the most controversial aspect of these looming data wars is the fact that consumers are asking for their data to be shared to the apps, websites, and tools that are using it. Unlike the use of big data in advertising – where consumers may have data gathered about them and sold to third parties, whether the consumer likes it or not – when it comes to financial account aggregation, the starting point is a request by the consumer to have the data shared to facilitate a process, from having a PFM dashboard with Mint.com or Personal Capital or eMoney Advisor, to sharing it with an advisor to expedite the financial planning process or oversight and management of outside accounts, or whatever the data may be used for next. Which means if and when large financial institutions start cutting off access to data, it won’t just be their competitors who were using the data that complain about the spigot being turned off, but also the client/consumer themselves. In other words, what happens when a financial institution says "we refuse to share client data with other firms" and the client responds "I insist that you share my data in a way that benefits me!"
While it remains to be seen how these dynamics will play out, though, the bottom line is that access to, control of, and privacy for client data is looking to be a hot topic for 2016, as consumers simultaneously want their data protected from cyberthieves but also used in solutions that make their financial lives easier.
The Unanticipated Consequences Of Rising Interest Rates
Perhaps the most significant “known unknown” looming for 2016 is the fact that, for the first time since 2006, interest rates have begun an increase cycle (and it’s the first time rates have been “not zero” since the Fed began its quantitative easing program in December of 2008!). The increase cycle kicked off with the Fed’s decision to raise the Federal Funds rate to 0.25% on Wednesday, December 16th, although as of now another four quarter point increases are anticipated throughout 2016 as well.
There is much debate about what the potential consequences will be for the investment markets. Some have raised the question of whether the Fed is raising too early in a manner that will damage the economy. Others are pointing out that interest rate increases (from interest rate lows) are typically associated with favorable market returns thereafter. And while the potential that an interest rate increase spurs either a bull or bear market certainly has impact on financial advisors and their businesses, it is perhaps the other dynamics of higher interest rates – besides their direct impact on stock prices – that may have even more impact in the coming years.
For instance, as interest rates begin to drift higher, there will once again be “value” to hold cash as an investment (albeit still at a low yield, but at least not a 0% yield!). This is significant not only for outright investment implications, but also consumer behavior. After all, mobile banking basically didn’t exist the last time rates were higher than zero (the iPhone had been out for less than 18 months and had few banking apps, and the iPad and other tablets hadn’t been invented yet). Now, we have technology that both facilitates “shopping for yields” across banks, and transferring cash from one bank to another, all from a mobile device. For those who don’t want to do it themselves, services like MaxMyInterest have cropped up that will shop bank rates and move the money around on your behalf to get the best interest rate in a savings or money market deposit account. Expect a whole new level of pressure from clients who want to ensure that their ‘idle’ cash is getting its maximal yield – which may include refusing to hold that cash in a lower-yielding money market of an investment or brokerage account!
On the other hand, higher interest rates also creates the potential for banks to earn a greater spread on their savings deposits and money market funds. Accordingly, it was perhaps not surprising that within hours of the Fed’s interest rate increase, most major banks had raised their prime lending rates (without yet increasing their offered yields on deposits). And notably, the opportunity is not present just for banks, but also investment custodians that offer money market funds (and earn spread from the assets held in those funds); for instance, one analyst estimates that Charles Schwab could triple its entire earnings for the year in a normalized interest rate environment. Which means if you think RIA custodians have been growing already, wait until you see what they can do (and what they can reinvest into RIAs) in a higher rate environment.
The impact of higher interest rates on rate spread is also relevant for insurance companies. Fixed annuity providers, including issuers of equity-indexed annuities, generate the bulk of their profits on the interest rate spread between what they can earn on their investments, and what they must pay back out to investors (either directly, or via the options/derivatives contracts they use to provide equity participation). In the low rate environment, annuity companies have been limited in their ability to pay compelling interest rates (or offer compelling equity participation rates), because there is little left for the investor after the insurance company takes its share; as rates increase, expect to see annuity providers offering more appealing features and benefits. Higher rates should also make it easier for variable annuity carriers to improve the quality of guaranteed minimum withdrawal benefits and other retirement income guarantees being offered, and may make longevity annuities and QLACs more compelling as well.
Higher interest rates will also ease pressures on insurance companies offering other types of insurance guarantees, from universal life policies (particularly those with secondary guarantees), and also long-term care insurance. In other words, as interest rates rise, long-term care insurance premiums should stabilize, and the risk of future LTC premium increases should fall dramatically; no-lapse guaranteed universal life policies should eventually see more favorable premiums as well. On the other hand, those who purchased hybrid life/LTC or annuity/LTC policies should carefully monitor whether their policies receive increases in the crediting rate as well, as there is significant ‘risk’ that the insurers will let their crediting rates lag as interest rates rise (as doing so is a “win-win” for the insurance company over the policyowner).
And higher interest rates will also begin to change the growth rate, discount rate, and other assumptions used in long-term financial planning projections. For instance, as rates increase and the time value of money rises, it actually becomes less appealing to delay Social Security benefits (though it would take a significant rate increase to materially impair how valuable it is to delay in today’s environment). The sustainability of retirement withdrawals from a portfolio begins to look better, and creates the potential for “safe” withdrawal rates higher than just a 4%-rule baseline. More generally, long-term retirement projections can be reasonably done at higher, more “normal” rates (relative to long-term averages) once yields are no longer pegged at zero.
Of course, the caveat is that the discount rate is also an essential factor in determining the value of an investment – it’s the rate used for discounting in the discounted cash flow model for pricing a stock! – and when the discount rate is higher, it makes an investment less valuable. Which means there is still potential risk that higher rates could “crack” the stock market, as current stock market prices and P/E ratios may have looked appealing when interest rates were zero, but are relatively less appealing as fixed income yields rise. In other words, while the simple math of bonds is that rising interest rates will cause bond prices to decline, at least to some extent, there is a danger that higher interest rates could cause the value of stocks to decline as well (or even more than just the bonds). Or stated more simply, once fixed income yields “something” again, some investors may decide it’s more appealing to just get the yield, shift the portfolio to be more conservative, and step away from some of the recent stock market volatility, which can cause selling pressure that just amplifies the downside risk of stocks. It may also quickly curtail investment flows to many types of "alternatives" that have been sold in lieu of "no-yield" bonds but would be eschewed for lackluster performance in an environment where bonds once again actually pay at least some reasonable yield.
While it remains to be seen whether or how quickly some of these higher-interest-rate factors play out, though, the fact remains that with interest rates beginning their first cycle of increases in nearly a decade, the primary and secondary effects of the rate increase will likely dominate the attention of advisors and their clients for much of 2016!
So what do you think the hot topics will be for 2016? Do you think I missed something that belongs on the list for the coming year? What’s your take on the prospective impact of big data and data cybersecurity, the Department of Labor fiduciary rule and CFP Board updates to the Standards of Professional Conduct, and the potential consequences of rising interest rates in 2016?
Was told by one of the aggregators that the data belongs to the client and that they have the right to do with it whatever they like. Listed off a few precedents including Feist Publications v Rural Telephone Service Co.
Shane,
Understood, but if the institution that has the data refuses to provide an API or support it, then it’s the client’s data but effectively is dead and unusable (at least in any large-scale aggregation format).
In other words, there’s a huge difference between “institution cooperates in sharing client’s data with aggregators” versus “institution says ‘sure, it’s your data, here’s a raw data file, have fun'”.
– Michael
Very true. To do really great stuff you need API access. And the banks are holding off on that.
Here in the UK the regulators are looking at mandating open-data for financial services. Lotta foot dragging, as you’d expect!
The aggregation issue you raise is a tough one for me.
Aggregators are for the convenience of the client, and banks are under no obligation to permit third-party access to their customer’s account data, despite the attitude of the customer.
Customers who are upset with their financial institutions’ decision to block aggregator access are free to move their accounts to a different institution. Customers vote with their dollars, not the volume or frequency of their tweets.
At any time, customers can manually enter their data into any PFM solution they wish and then benefit from the PFM’s functions. Account aggregation simply adds efficiency and accuracy to the process by eliminating manual data entry.
I am in favor of account aggregation. The efficiency and accuracy it provides often leads to improved awareness of one’s financial situation and perhaps also to better advice delivered by professionals.
However, institutions bear the majority of the costs of maintaining the integrity and security of the data, and for third party aggregators to benefit from the data without supporting the costs of the source data seems unfair to me.