August 12th (The era of disruptive tech)

Greetings all,

The week has come to a close, but certainly not without a surplus of intriguing developments and stories in the Global Markets. Today's subject of choice is the era of disruptive tech that we find ourselves in currently and how it is transforming the manner in which we relate to both our digital and physical worlds. But first, here is today's breakdown of the most exciting news in the PE/VC Industry:

With two bills advanced through Congress in recent weeks, the Biden administration has stamped the federal government’s imprint on major sectors of the U.S. economy; including semiconductors, energy and health, and further dismissed the notion once widely held in Washington that private markets should actually be private divorced from government intervention. This policy shift developed out of two decades of economic crises, rising national populism, a deepening rivalry with China, and apprehension about the long-term effects of climate change. Adam Smith’s invisible hand, popularized by Ronald Reagan in the 1980s and endorsed by Bill Clinton in the 1990s, has been succeeded by a muscular arm, in which Washington deploys tax credits, tax rebates, loans, loan forgiveness, regulations, tariffs, spending programs and other fiscal tools to manipulate a market-driven economy that has proven far more volatile and uneven than many people thought it could evolve into just a quarter-century ago. Sometimes government intervention is sought after when markets disintegrate. One plausible risk is that efforts to address climate change or the threat of an emboldened China could make the economy less efficient and constrain its overall growth rate, leaving households worse off than they might otherwise be in the long run. An interrelated risk involves the over-participation of Washington in the markets through vehicles such as subsidies and grants to specific corporations, which inevitably makes the economy less and less meritocratic. “We are going to have bad growth,” said Douglas Holtz-Eakin, a Republican economist and former director of the Congressional Budget Office. He posited that the policy shift away from truly free markets has affected both political parties, including his own. President Biden’s two new signature programs add $351 billion in tax spending over the next decade, according to Kent Smetters, director of the Penn Wharton Budget Model, which monitors the impact of budget decisions. “The Biden and Trump era is one of a government that wants to play a much bigger role in what is produced, where it is produced, how it is produced and with what labor it is produced,” said Jason Furman, former chair of the White House Council of Economic Advisers under Barack Obama.

The regulatory complex of the United States has grown as well. The federal government ratified 701 economically significant rules from 1981 through 2000, according to the George Washington University Regulatory Studies Center. This figure ballooned to 1,170 between 2001 and 2021. New regulatory law-making tumbled in Donald Trump’s first year as president to Reagan-era levels, then grew each subsequent year after that and reached an annual record in 2020, according to the GWU Regulatory Studies Center. The public is of two views about these evolving economic trends: Public trust in the federal government dropped precipitously after the tech bubble burst in 2000, according to Pew Research Center. Before that bust, a majority of Americans said they trusted the federal government to do what is right always or most of the time. That percentage dropped all the way to 24% in 2021. Yet a growing number of Americans say the government should do more to solve the nation’s problems. Wall Street Journal polls discovered the percentage of Americans who believed the government should do more increased from 32% in 1995 to 57% in 2020. Pew Research found in 2021 that 87% of Americans believed the government should be actively involved in ensuring clean air and water and 64% said it should offer free health insurance for everyone and 43% said it provide provide high-speed internet access. The general trend is this: As the government has taken it upon itself to legislate more aggressively and consistently with regard to regulatory provisions, the American public has responded by 1) forfeiting their trust in the ability of the government to act in the best interest of its citizens & 2) assign a heightened level of responsibility and accountability to the government for the nation's issues.

Private-equity firms are projecting a tougher fundraising environment as market turbulence hits both their own balance sheets and those of their institutional investors. In recent earnings calls, some of the largest private-equity firms adopted bullish views about deal-making opportunities in the current environment even as market upheaval and rising rates decimated the value of their assets. Publicly traded fund managers posted significant losses in the second quarter, and at least four of the largest firms: Apollo Global Management Inc., Blackstone Inc., KKR & Co. and TPG Inc., recorded losses for the June quarter. For Apollo, it was the second-consecutive quarterly loss. However, the value of the private-equity firms’ investments fell by far less than the approximate 16% decline over that period for the S&P 500 index, which also reported its worst first-half performance in more than 50 years. And firm executives said that on the whole, portfolio companies’ operational performance is resilient. Even so, the battered stock values yielded imbalances for institutional investors’ portfolios, in what’s known as the denominator effect, which many anticipate will osbtruct the flow of new capital to illiquid assets such as private equity. Caspar Callerström, deputy chief executive of European buyout giant EQT AB, acknowledged in the firm’s last earnings call that some clients, particularly in the U.S., had already arrived at their private-equity target allocation.“As a result, new fund initiatives will take longer to raise in this market, and we expect existing clients to represent a large share of our ongoing fundraises,” he said. Mr. Callerström said the firm had raised about two-thirds toward its 10th buyout fund, which targets at least $20.60 billion, with a final close projected in 2023.

TPG Chief Executive Jon Winkelried said the private-equity firm expedited the timing of first closes on its large flagship fund, settling on an aggregate $10.6 billion for its ninth flagship private-equity fund and its second healthcare-focused fund, and lastly on $1.6 billion for its third impact-investment fund. The firm anticipates a combined $18.5 billion for the first two and $3 billion for the impact-investment fund, Mr. Winkelried stated during an earnings call. “On balance, similar to peers, TPG acknowledged ongoing extensions in fundraising timelines that have been prevalent across the industry in recent quarters,” JPMorgan Chase & Co. analysts Kenneth B. Worthington and Michael Cho wrote in a note about the firm’s second-quarter performance. Meanwhile, GCM Grosvenor Inc. CEO Michael Sacks cautioned that its latest private-equity secondaries fund, which is already 30% larger than its predecessor, may miss its original goal because of the timing of capital raising. He expects the alternative-assets manager to conclude fundraising efforts for the vehicle in late 2022. Other niche funds, he said, will continue to raise capital into 2023 and remain on track. GCM, he said, accelerated fundraising in the second quarter, adding about $2.1 billion in new dry powder.

The U.S. sanctioning Tornado Cash this week exposed technical holes in the government’s ability to prohibit criminals, national adversaries and extremist groups from using the crypto services to launder money and finance their operations, analysts said. Among the most difficult challenges is that Cryptocurrency platforms are operated by decentralised nodes or computers, rather than by individuals performing transactions, analysts said. The Treasury Department on Monday imposed sanctions against Tornado Cash, a popular cryptocurrency platform known as a mixer because it combines funds from different users and reallocates them, obscuring their origin. The Treasury Department accused Tornado Cash of laundering billions of dollars in virtual currency, including $455 million allegedly robbed by North Korean hackers. As part of the penalties, officials banned all property held by the exchange under U.S. jurisdiction and prohibited U.S. companies and individuals from transacting with it. Analysts said the sanctions would decelerate Tornado Cash’s growth by disincentivising users and major crypto exchanges from trading on a blacklisted platform. This will reduce the amount of funds flowing in and out of Tornado Cash. Circle Internet Financial Ltd., the issuer of a stablecoin pegged to the U.S. dollar, banned the sanctioned wallet addresses after Monday’s announcement, effectively suspending the use of those funds in tornado cash wallets. “It is likely that nearly all responsible registered Virtual Asset Service Providers also took steps to block customers from transacting with these addresses, or face charges of willfully avoiding US sanctions compliance obligations,” Circle Chief Executive Jeremy Allaire declared on Twitter.

Two years ago, Singapore opened its doors to crypto firms. Now, after the failure of several digital currencies and firms rooted in the city-state, regulators are attempting to distance themselves from the implosions while they attempt to rein in the industry. Crypto brokers, lenders, exchanges and blockchain companies flocked to the Southeast Asian financial hub after it adopted a regulatory framework for payment services in early 2020. Close to 200 firms applied for licenses to provide digital-payment-token services, according to the Monetary Authority of Singapore, the country’s central bank and chief financial regulator. Only 12 of those applications had been approved when the crypto market recently suffered a massive selloff, which erased the values of digital tokens Luna and TerraUSD, toppled crypto hedge fund Three Arrows Capital Ltd. and forced some crypto lenders to freeze withdrawals. The Luna Foundation Guard and Terraform Labs, the firms behind the sister tokens’ crash, were established and registered in Singapore, respectively. Vauld Group, a crypto lender that has suspended withdrawals and filed for bankruptcy protection against creditors, is also based in the country. Three Arrows, which is currently being liquidated, was based in Singapore for years and its founders, Kyle Davies and Su Zhu, continued to live and work in the country even after moving the fund’s physical presence to the British Virgin Islands in 2021. The casualties have escalated in propensity. Zipmex, a Singapore-based crypto exchange, filed for bankruptcy protection against its creditors in late July. Hodlnaut, a crypto lender based in the country, said this week it has suspended many of its services. Hodlnaut had earlier received in-principle approval from the MAS for a license. In June, the firm’s CEO, Zhu Juntao, said the firm had $750 million in assets under management at its peak, with the vast majority from users outside the country. “I am hiring 50 employees in Singapore and I’m paying taxes in Singapore. So that would benefit the government tremendously,” he said on a panel organised by Singapore Management University and The Wall Street Journal. A spokesperson for the regulator said it has revoked Hodlnaut's license approval, and that Hodlnaut’s service suspension didn’t contravene local regulations. “MAS has been continually reminding the general public that dealing in cryptocurrency is highly hazardous. Not only are the values of cryptocurrencies extremely volatile, customers’ monies are not protected under the law,” the spokesperson added.

Finally, I shall offer a brief discussion on the subject of disruptive tech:

Digital disruption is ubiquitous and has altered both the way businesses operate and the way people live. Disruption caused by innovation to firms dispersed across multiple industries, from financial services to industrial firms, business processes to payment systems, manufacturing to supply chains. However, not all innovations are disruptive. Innovations can occur as part of an evolutionary progression based on existing ideas or processes rather than as a result of a revolutionary overhaul of existing systems. In ordinary communicative usage, either type of innovation can be disruptive if it results in rapid change in business that can dramatically change the market. The global fintech industry has seen major changes since the 2008 financial crisis. Further, starting in 2012, funding has poured into technology startups. Industry analysts and experts have been talking about digital disruption in their reports for the past several years; however, it was more recent when established companies started re-evaluating their IT strategies and started collaborating with startup firms. This not only allowed startups to raise large sums of money to enter the industry, but also allowed incumbent fintech firms to start expanding their services, enabling them to offer more products to their customers. One of the most active segments in fintech industry is insurance technology (insurtech). According to the Standard & Poors Global Market Intelligence (2018a), digital lenders actively sought partners, and partnerships became widespread in digital investment management. According to the report, “incumbent insurers are avid investors in insurtech companies, and the digital agency model relies heavily, for now at least, on partnerships with established underwriters.” More than $1.8 billion of capital was raised in 2018 by insurtech startup companies. For example, Root Inc., an Ohio-based auto insurance company that uses telematics data relying on insurers’ cell phones, was able to raise $100 million in just one round in 2018. Overall, new funding of US insurtech firms reached $8.64 billion in 2018. Other financial segments that received significant startup funding are in payment systems, investment management, digital lending, and banking technology. Robo-advisories that provide financial advice based on algorithms have captured much attention since 2008 when Wealthfront and Betterment were founded as automated investment firms. Since then, large investment firms like Vanguard and Charles Schwab have also started offering robo-advisory services to their customers. The Standard & Poors (S&P) Global Market Intelligence (2018b) expects this industry to grow from roughly $181 billion assets under management in 2017 to $608 billion in 2022. The digital lending industry has also seen a solid demand for their services since 2016 and leading players in the industry saw 30% growth in loan originations in 2017. The S&P Global Market Intelligence expects the industry to have over $73 billion in annual originations by 2022. Companies started to offer multiple services like student loan refinancing, personal loans, mortgages, and small business loans. Financial institutions and startups have also introduced significant innovations in the payments industry. PayPal has aggressively grown peer-to-peer (P2P) payments with its Venmo service; the company posted an 80% increase in transaction volume to $19 billion in the fourth quarter of 2018. Twenty-nine financial institutions, including Bank of America and JP Morgan Chase, launched the Zelle platform in 2017, which offers member banks and their consumers real-time P2P services. Working with businesses is the key to the long-term success of payment apps according to Bloomberg. Zelle network handled 100 million transactions for a total of $28 billion in the second quarter of 2018, larger than Venmo’s $14 billion volume. In a survey conducted by the S&P Global Market Intelligence in February 2018, consumers expressed concerns about mobile apps specifically with regard to perceptions of security and convenience, which are two valued but potentially conflicting features of the product. Innovations that are truly disruptive, therefore, possess the following features: 1) Changes the mode or means by which consumers & businesses act purposefully 2) Unlocks the potential for further innovation in a particular segment of the industry 3) Automates/Economises some process such that people are able to invest more of their time in higher and better causes.

That concludes today's article and I hope you enjoyed!

With gratitude,

Will