UBS & Credit Suisse Merger Talks, and Klarna Now Worth $10 Billion
Today, we’re joined by Lex Sokolin to talk through a few interesting developments in the world of fintech.
M&A is a continued trend in fintech, with the most recent candidates reported to be UBS and Credit Suisse, the latter of which is also in the news with a new digital bank. Will their effort somehow be different than the abortive attempts of their international peers, including JP Morgan Chase in the US and RBS in the UK?
Klarna raised $650 million at a $10.6 billion valuation, making it the most valuable private fintech in the world. Why is Klarna successful where OnDeck and, arguably, Kabbage weren’t?
Lastly, we venture into Lex’s realm of digital assets, with MasterCard’s fun new toolkit to help countries test Central Bank Digital Currencies and Kraken’s newly granted Wyoming bank charter.
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Thank you very much for joining us today. Please welcome, Lex Sokolin.
Full transcript:
Will Beeson:
Lex Sokolin, welcome to Rebank.
Lex Sokolin:
How's it going, Will?
Will Beeson:
It's going great. Thursday morning in Brooklyn. Life is good. How about you?
Lex Sokolin:
Thursday afternoon in London. Nice fall day. Very crisp, but beautiful as well.
Will Beeson:
Excellent. Well look, lots of interesting stuff actually that we wanted to work through so we can dive right in. Firstly, maybe just a higher level exchange around mergers generally, and kind of how the broader industry, and I guess the financial services industry in this context, the technology plus financial services industry. What's happening from an M&A standpoint?
Lex Sokolin:
So there's so much to unpack there because the underlying question is why are we seeing all this M&A stuff now? And you can even point a couple of years back to FIS and Fiserv consolidating banking platforms with payment processing, merchant acquiring, and really creating these, at least for the West, mega companies of $50, $80 billion banking payments technology companies. And then we've seen a wave of Schwab & TD Ameritrade, and Morgan Stanley & E-Trade as the fees that power these industries, the broker industries, started to get eaten away by the free trading on Robinhood.
Lex Sokolin:
Again, we see large consolidation there. And now we've got rumors at least of UBS and Credit Suisse flirting with each other for a combination, which would make a fairly chunky private bank, European private bank with a global footprint. And so the question for me is, is this just regular industry stuff? Is it regular churning in terms of the economics of these businesses or is it COVID and the new environment and the pressure on bank branches and terrestrial footprint, or is it the fact that Apple's the biggest bank in the world, and we just don't know it yet? And I think all these lenses can color how you interpret the consolidation place. What do you think?
Will Beeson:
So I love that and I think you're right in that there are a lot of drivers, I think you're right in that it's not a coincidence. And my gut feel is that it has everything do with software and technology. It's a defense mechanism against a changing world. Not only the core banking plus payments, but also the kind of banking at scale. You've talked about UBS and Credit Suisse specifically. I mean, if banks are increasingly challenged in the product creation space, increasingly challenged in the product distribution space, what attack vectors remain? It's effectively fractional reserve lending slash capital, slash balance sheet. And how do you get economies of scale? You get a bigger balance sheet and a very quick way of doing that is M&A.
Will Beeson:
It's tough to think of two banks that feel more similar than Credit Suisse and UBS. And I imagine are kind of impacted by some of the same trends. Both of those when we were coming out of college were pretty big investment bank hirers, at least in New York, or especially in New York maybe. That industry, it is changing if not going away in some sense, at least in terms of head count and potentially deal flow. And those companies' business models I think have changed significantly.
Will Beeson:
It's tough to think of either of those companies as the same type of genuinely diversified financial services company that perhaps it was pre financial crisis. Now, I think as you rightly characterize them, they're kind of private banks, right? They have fantastic private clientele and no doubt business clientele in Switzerland and Europe and I'm sure they follow some of those customers globally, but they just don't feel like the global powerhouses independently that they once were. And therefore, in this increasingly competitive, fast paced technology and software driven world, how do you compete if you're either one of those banks? You aggregate balance sheet and you do the bank thing and you do it at scale.
Lex Sokolin:
Yeah. I think look, we can pause a little bit on what exactly is melted down for these kind of high-end institutions, I think that's worth talking about. It's still spectacularly lucrative to put on a suit and be a managing director in any of these companies. It's still high prestige and a thing that people want to do and where people can build careers and move around global finance. So, I don't know if even on a revenue basis, if we were to do a comparison 15 years back, how much worse off these companies are. But then people really live, many people live in the future and they look at growth and they look at what is the potential for this stuff, the decade forward. And so if you look at institutional capital markets, for example, the cash equities business is under attack in a bunch of different places with fees collapsing and the electronification of markets more generally moving revenues from brokers to market makers, right?
Lex Sokolin:
So to the market making activities of companies like Citadel or Virtu and others. And you still have large institutional clients, but at the same time the monetization is potentially changing. If you look at the debt capital markets there, the fact that trading has really gone to electronic systems, not all the way, but increasingly again, is driving price compression and spreads and makes it a less human business, even though it's less so than on the equity side. Then if you look at the... I mean, the other part about institutional capital markets is that proprietary trading, which used to sit inside of investment banks, has been kicked out of the investment banks after 2008 through regulation. So people are not taking large proprietary risks on balance sheet. They're doing that through hedge funds externally. And then you look at investment banking and deal-making, and it's again, still a place where you can make a lot of money, but there are now more and more direct listings and tech companies don't want to be intermediated necessarily because the demand for IPO's is so embedded and high.
Lex Sokolin:
And then we talked about, right before our conversation here was recorded, about the acquisition vehicles like SPACs or the private equity money on the sidelines that is an alternative source for liquidity, for shareholders. So you don't necessarily need to IPO. And a lot of the time you don't do it for a long time and it's harder and harder to make a deal based business. And then finally, you get to wealth management, which is the key jewel that you think is the stickiest clients and so on and high net worth clients require a lot of hand holding and servicing from other fancy people in suits. And the truth is coming out that that's not really true. And that a lot of folks love their phone for their financial advisor in many different ways. And at the least the fees that you generate from money management and advice have been decreasing as has the trading nature of those relationships.
Lex Sokolin:
And when you take all of that together, what you see as the brightest example for me is Goldman Sachs. Goldman Sachs was in these businesses and Goldman's pivoted back to retail, which I've said before, I think is really strange for the brand, but Goldman's pivoted to balance sheet, to lending, to tech enabled distribution, to platforms for financial advisors that are open and accrue platform benefits and so on. And you just, you don't have that same vibe yet from the sort of the next tier of the industry. And just to cap all this off, again, these are very cashflow generating companies, but we're at a moment in time where Apple is trading at $2 trillion in market cap. We know where the value is going and it's not more investment banking, it's more Apple and more Amazon and more Facebook. And so I think to your point, scale is the defense that these teams have in order to create economics that at least allow them to continue to generate the profits that they're used to.
Will Beeson:
Yep. I think the other relevant point here, or at least related point around Credit Suisse, is the news that they're launching a digital bank. And it's tough... It's been tough for me to kind of parse what's noise versus what's fact, because as soon as anyone says incumbent launching digital bank, where my mind goes, and I imagine many of our listeners minds go, is to Finn and Bò and UBS SmartWealth and Investec's Click & Invest robo offering, all these digital offerings from incumbents which have basically been giant money pits, and have been very quickly wound down.
Will Beeson:
Maybe this Credit Suisse thing is different, maybe it's smaller scale, maybe it's more targeted. But it certainly didn't sound like that from the news that I was reading, and then just from kind of tapping into our network for thoughts, it sounds like there's kind of some first-hand reports of Credit Suisse bankers being... Private bankers being kind of pushed to engage less with their clients face to face and kind of push them toward these digital channels as part of this push into the quote unquote digital bank. Which... I mean, we could spend an entire episode, we probably have in the past, talking about why culturally these things just don't work.
Will Beeson:
It's about incentives and alignment. But if indeed there's a genuine push toward a digital bank at Credit Suisse, and if indeed the traditional private bankers are being pressured to cut face time and push high net worth clients through digital channels, it just feels like a train wreck in the making.
Lex Sokolin:
Look, it's easy to be critical. And so I think it's inevitable and a great development that every single financial institution has a digital offering. I don't think it needs to try and be Revolut or to try and be Robinhood. It just needs to be a channel for customers to be able to engage with a financial institution in the way that they want. And so I think that's a positive, at the same time, Apple just released a new feature, which is going to allow parents to send money to their kids through a text message. And so I'm like, there's a Credit Suisse app on your phone, or there is your texting inside of Apple. And which one am I more likely to use to move money around and to think about money? And over time, that answer just becomes more and more obvious to me.
Will Beeson:
But hasn't send money by iMessage existed for a handful of years now in the US?
Lex Sokolin:
It has, I think this is something to do with setting up a family household unit and using the watch as a way to do it or something like that. So you're right, it has existed. I think there's a new spin for kind of setting up the household and you can think of that connecting to themes around the smart home and account management. And then my finance mind goes to, well, if you're setting up a household that sets up household reporting for multiple accounts, from a financial perspective, like joint accounts and performance reporting for all those assets. So I'm hand waving a little bit. I don't mean that there is a direct line between iMessage and the Credit Suisse neobank. It just isn't something that for me opens up the innovative frontier at this point, it's 2020 and folks have been building these apps since 2006, really.
Will Beeson:
Yep. All right. So let's switch gears a little bit and pick up some other interesting pieces. Klarna is in the news raising $650 million or thereabouts at something like a $10 billion valuation, which is basically double its most recent evaluation. They are reported to be considering an IPO in the US. Buy now, pay later company. What are your thoughts on that one?
Lex Sokolin:
So this news came out right after PayPal announced a similar feature, right. A competing feature, that was just a couple of weeks ago, right?
Will Beeson:
Yep.
Lex Sokolin:
So, there's definitely something in the air about this theme. And more broadly, it plugs into the venture theme of embedded finance that is... It's very strongly articulated. I think you might've had Matt Harris, from Bain, talk about this theme and sort of the opportunity of brands or just anything to monetize through financial products like this, like lending embedded into your commerce. I'm a big fan of Klarna.
Lex Sokolin:
I think they've done a fantastic job executing on their theme. I'm I guess a bit surprised how unscathed they've come out of COVID, in the sense that we've seen a whole bunch of other consumer and small business, lending businesses, really suffer from exposure to the space. So I do wonder why Klarna's model's been unaffected by that. But otherwise I think they're a leader in the space, they're going to have to compete with a lot more fintech players doing the same thing like PayPal, but it makes sense for them to join this club.
Will Beeson:
Yeah. So you're right, I did talk to Matt recently and Mike Massaro, CEO of Flywire, about embedded finance. And the point Matt made around embedded credit, which really stuck with me specifically, point of sale finance, AKA buy now pay later, is that it's effectively a way to, in many cases, remove adverse selection and even create positive selection around lending. So if a bank is an institution that lends you money when you don't need it, and doesn't lend you money when you do need it. This sort of adverse selection of, "Hey, I need money." Suddenly it's not a good time to lend it to me because if I'm in financial distress to any extent then I'm not a good borrower. This goes away if you're not saying, "Hey, lend me money."
Will Beeson:
You're saying, "Hey, I want a TV. Hey, I want a sofa, Hey, I want luxury product." And of course it depends on the brand and it depends on the merchant. And if your client, depending on how you built your business, depending on the merchants that you're working with, you can create positive selection, i.e, products from brands that skew toward more credit worthy purchasers. And therefore, in the instance in which you extend them credit at the point of sale, more credit worthy borrowers. So potentially this explains some of the success that Klarna has had despite the COVID crisis. Perhaps stimulus checks also played a role in bouying their credit portfolio. I guess the question I would have, and it's a shame on me for not understanding Klarna's business any better than I do...
Will Beeson:
The other point Matt made was about building software conduits for loan origination, as opposed to the kind of quote unquote traditional model, at least over the past 10, 20 years, where the fintech goes out and secures a bunch of wholesale funding lines and then originates its own lending. And if we look at the OnDeck example and the Kabbage example, both of those feel to me more like wholesale financing, or even just debt funding to go out and build a balance sheet.
Will Beeson:
And those outcomes weren't successful, albeit SME lending, as opposed to consumer lending, but OnDeck, as you've described a number of times, was kind of a total disaster and Kabbage too recently, I guess the deal hasn't closed yet, but in the process of being acquired by AmEx at what sounds like less than a billion dollars or max a billion dollars also just doesn't... It doesn't feel like a positive outcome. This is a company that's what, 10 years old now, or at least, going on 10 and has built a very strong brand in the SME lending space, originated tons and tons of small business loans. The billion dollar exit seems like not a great outcome.
Lex Sokolin:
Yeah. I mean, it's better than $90m, but look, it's live and learn. I think, what do I have that's interesting to say about Klarna? I can take an aside and I don't know for sure that this is what's powering their growth. And I don't know for sure that this is what's driving sort of the Silicon Valley approach to embedded finance because end of the day, how new is this right? In the '80s, you can get financing on your air conditioner when you buy it from RadioShack. So these are just human behaviors that are old, that are now being digitized. But one frame that might be novel is to say since 2012 we... Broadly speaking the technology industry, has been benefiting from the implementation of neural networks and machine learning.
Lex Sokolin:
And before 2012, there was 50 years of math that was done to conceptualize and ideate how a neural network can predict behavior or create a probabilistic estimate of some behavior. And since 2012, we've been implementing this stuff to do facial recognition, to do underwriting, to do... The brightest example of this is TikTok, to recommend memes and media to teenagers without them having to press a button. And so, you could look at something like Klarna and embedded point of sale lending that's tied to an object rather than one that's tied to broadly some abstraction around an individual. When you can say, "We've got data across every merchant, and we've got data across every single product. And because we have all this data, we can at a really granular level have models that derive from the thing that people buy as well as who the people are, as well as how they get there and all these other variables. And we can do it through a machine learning approach."
Lex Sokolin:
And this is merely a derivative of the artificial intelligence theme, rather than the old model of, you go into a bank branch and you get a loan for funding your business. This is a big data model, which sits with all of commerce. And I think maybe that's a frame that colors it a little bit differently. And if that frame is correct, then the answer is it's a winner take all market. And the company that sits as the buy now pay later solution everywhere has increasing returns to scale the way that Google has increasing returns to scale of the most people using the search engine and clicking on stuff, as well as Facebook has increasing returns to scale from getting all human beings in it and getting more conversations. And so perhaps that's how to think about why a company like Klarna would out-compete a company like an OnDeck.
Will Beeson:
So, because you talked about neural networks and other super fancy, heady stuff that you understand and people like me generally don't, I feel like you were priming us for a few interesting developments around CBDCs and crypto, which again, fall into categories of things that you understand and I largely don't. So MasterCard is reportedly rolling out some sort of service to help governments, I guess, test their central bank digital currencies.
Lex Sokolin:
Sure. Smooth transition from AI to blockchain.
Will Beeson:
It's all the same, right? Blah, blah, blah converging technologies.
Lex Sokolin:
Yeah, right? It's just the nerds doing it... Which is true, they are. So, the MasterCard news, I think it's somewhat difficult for me to interpret because... So CBDCs, the concept, is digital currencies that are in some way issued by a central bank. Monies are generally issued by central banks, so this is just a digital money. We know in China, this stuff's already live, it's already been previewed in various bank mobile apps. And so Europe and the US, among lots of other countries, are thinking and racing towards what the right answer is here. And with CBDCs in particular, there are different types, so some are retail, so for every human being out there, some are wholesales, so every intermediary, every bank that then provides bank accounts to individuals and lots of different infrastructure that supports that. So I think what MasterCard is doing is it's signaling that a network provider like MasterCard has a role to play in the world of central bank digital currency.
Lex Sokolin:
I think that's the core premise. And I think there are different things in a CBDC architecture. Some of those things are, are you running this on Ethereum? Is it public or private? Are you running this on Corda? Are you running this on IBM's Fabric? Is this the Chinese Business Services Network? There are different architectures for it. And then number two is there's this sort of financial use case they are on top of it. How is it tokenized? The currency. What's the wallet? How does permissioning work? And I think MasterCard wants to play a role and have this conversation with central banks. And this isn't a new concept. I don't remember the name of the company, but a few years back, they did an acquisition of a company that was involved in building out European faster payments, which is kind of the prior generation of payments infrastructure upgrades that happened and government subcontractor stuff.
Lex Sokolin:
And so I think it still remains to be quite a big opportunity. Related to that, there was a leak from, I believe, the European Commission. Yes. So there was a leaked version of rules governing digital assets, i.e, crypto, from the European Commission. So 27 nations, that just leaked this month. And it's largely about a stable coin regulation, about regulating monies that are on blockchain networks, but that are tied to euros or to dollars, and bringing them into essentially under something like MiFID, where there's a perimeter. And there are certain rules and entities that are engaged in the business have to have certain licenses. And so I think this is a super productive step. And the third leg of the stool is Wyoming. So largely through the work of Caitlin Long, and then a few other, let's say crypto lawyers, which would be an unfair way to paint them.
Lex Sokolin:
But folks who have a legal hat and a regulatory hat, but also are engaged with the blockchain industry, have been working on getting regulations in place so that you can have a crypto industry, which is not just sitting on the sidelines waiting for some permission, but is quickly integrated into everything else. And so Wyoming's got a new charter for banks, specialty for those handling crypto assets. And so the crypto exchange called Kraken, which is one of the larger ones by volume and it's been around for quite a while, so it has a lot of users. So Kraken, the crypto exchange got approved to become a Wyoming bank.
Lex Sokolin:
So this is not like they're applying for a license. It's not like maybe one day it's we now have a bank, which is also a crypto exchange, it's in America and it can take customers. The primary thing it can't do is fractional reserve banking. So it's not going to hit up the federal regulations. It's going to focus on being just a Wyoming bank that-
Will Beeson:
A vault, basically.
Lex Sokolin:
Exactly. Yeah. It's a bridge between crypto assets and regular dollars that can travel on the ACH system. But this is a huge step, it's a really big step for the Blockchain industry. I think Europe is going to mirror this stuff with the commission rules that I described, and I think it's really chunky institutional progress.
Will Beeson:
Wow. So I don't even know where to start in terms of unpacking all of this. I mean, I guess the question that leaps out for me is, is this Kraken thing Wyoming as rogue state with small population kind of doing something maverick, or is this a bellwether of either new stuff happening in different states or any sort of progress at a federal level around your kind of normalization of crypto in the traditional system?
Lex Sokolin:
Yeah. I think that's a very fair question. I just looked up Kraken on CoinMarketCap and it looks like 24 hour volume of about 6 billion USD. So it's again, real business there, lots of folks using it. How should we think about a state being used for regulatory arbitrage? I highly recommend everybody check out Caitlin Long's Twitter, where she's got a thread on the process of how long it took to get this license in place. And in fact, she talks about working with Delaware about three, four years ago, and trying to get Delaware to adopt more digital asset rules. And if you remember, there was for a while, the idea of a blockchain based Delaware registry for corporations. And I think Delaware is the place where most corporate law resides in the US, it's a super efficient jurisdiction.
Lex Sokolin:
And I think that... I don't know if that hit a roadblock where there was just a more willing state, but there's definitely benefits to being first, because what you're going to do now is attract lots and lots of other institutions to that state. And New York in large part failed out through the BitLicense by making it so onerous for digital asset businesses to stay in New York City, which scattered internationally into Europe, into Singapore and to Switzerland, and to all sorts of other places. And so if you don't have this in place, you lose the innovation. And if you do have this in place, you accrue some business benefit from doing so. I don't think there is a web of interconnectedness that's going to come out necessarily from the Wyoming example. But I do think the way that Utah ILCs aren't everywhere else.
Lex Sokolin:
But I do think that it's an example. It's a tangible example that other states can copy because it's already written down. And I think there are now individuals in regulatory positions that have had industry experience inside of places like Coinbase. And those folks are working at the SEC and they're working in other regulatory bodies. And so to me, it's just a matter of time before this erodes, the barriers that we have in the US but I do worry that there's not enough time and that China is already today, so far ahead in normalizing blockchain as a technology, whereas in the US, a lot of people are still stuck in the sand.
Will Beeson:
Yeah. Well, look, I think we could easily continue this for another hour or so, but I think given time constraints, we need to wrap up. But look, fascinating conversation, lots to think about here. And would definitely encourage anyone listening to reach out with thoughts, especially around this Kraken thing in Wyoming, and what, if any, implications there are. Lex Sokolin, thank you very much for joining us today.
Lex Sokolin:
My pleasure. Talk to you soon.
