Facebook’s announcement of the formation of the Libra Association, along with 26 other partners, feels to us more like a desperate last roll of the dice to stop the avalanche of EM fintech, rather than a profound change to the future of consumer-facing financial services.
After absorbing some of the press comments, and reading the White Paper, we’re struck by several unanswered questions. We do think Libra has correctly identified the problem, especially about financial exclusion and its root causes.
In the digital age, those causes should be more easily overcome. There are successful examples from Asia of how companies have used both eCommerce and social network platforms to bring about fintech solutions, eliminating many of the unnecessary layers that extract economic rent in traditional Western payment systems. There is a risk that Libra ends up just replacing banks with Facebook, with its many partners still taking a big cut.
Our key questions revolve around what we see as EM regulators’ likely inclination to not just regulate Libra, but to regulate it to death. Unlike many other fintech solutions, the new Libra currency, rather than simply allowing money to be spent more efficiently and effectively, creates an entirely new financial system with a new concept of money.
This is a DM not an EM solution
In side-stepping existing currencies in EM countries, Libra risks unintended and uncontrollable consequences that will expose the lower-income people that it is trying to empower to unknowable risk. No matter how much Libra will argue that the currency will be stable, it will not be simultaneously stable against all currencies in EMs, where the majority of the 1.7bn that they are trying to empower live.
Imagine a person in Mexico who takes a Libra-based loan from a microfinance organisation. Between last August and November, the Mexican peso depreciated by almost 12% against the USD. Such currency volatility, which is not out of the ordinary in EMs, could destroy rather than empower this individual, who likely earns in local currency.
Many in DMs assume that regulators in EMs are lax. This is not the case. We saw last year the detrimental effect on Tencent, one of China’s largest companies, when the regulator was rightly concerned on the negative impact of addiction to computer gaming. The consumer protection issue is huge, and alone is reason enough for central banks, tax authorities and financial regulators to be concerned.
Where currencies are especially volatile, consumers may flock towards Libra, threatening the supplanting of that currency, which most administrations would likely see as an unacceptable loss of control.
We wonder what would happen in the case of a default of a bank, or a government, with which Libra has lodged reserves. And what would happen if there were to be a run on the Libra – unlike with domestically-managed currencies, there can presumably be no sovereign intervention, no rescue. In EMs, due to the fragility of the financial system, bank runs can turn to riots, and EM governments would want to control that.
EM governments might be more willing to live with Facebook since they know that they can easily block it, as we have seen in a few countries recently. This will no longer be the case with Libra - suspending usage would risk paralysing a country's economy.
All these questions give us the feeling that this has not been looked at through an EM lens. The list of founding members is very thin on members from emerging markets – 22 out of 27 are developed market-based, 15 of which are based in the US.
A cast of unlikely bedfellows
The involvement of Visa and Mastercard is intriguing. The new system risks slashing the amount available to such intermediaries. While the card schemes would hope for an explosion in non-cash transactions, Libra volumes would need to compensate for the reduction in their existing business, while leaving enough profits for all the new partners.
While we don’t mean to sound sceptical, especially given the many unknowns, we believe that there’s a high chance that the Libra Association has misjudged the likely reaction of governments, regulators and consumers. It's clearly ambitious, and may be well-meaning, but we question whether the problems in the financial system can be solved by redesigning money, or perhaps it’s better to simply redesign the transmission mechanisms for today’s money. We think that solutions focusing on the latter, rather than the former, make more sense for all three groups of stakeholders.
Emerging markets are already seeing disruption and incredible leaps forward in financial inclusion. In most cases, this is because payment solutions, like Paytm in India, Alipay and WeixinPay in China, and MercadoPago in Latin America have filled the gaps left by traditional banks, and have acted as lightning rods around which other low-cost, inclusion-focused financial services products are forming. That seems to be working effectively, and in a way that EM regulators can understand, while still maintaining some sort of control.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Trinetra Investment Management LLP and are subject to revision over time. Trinetra is authorised and regulated by the Financial Conduct Authority in the United Kingdom.