Sequencing the World’s Regulatory Information (#35)

Structural Shifts with Manos SCHIZAS, Lead in Regulation and RegTech at Cambridge Center for Alternative Finance

Our guest is Manos Schizas — Lead in Regulation and RegTech at Cambridge Center for Alternative Finance at the University of Cambridge. We discuss how regulatory change is accelerating so fast that people alone can’t deal with it and how does the technological solution addressing the problem looks like. Can technology solve this problem at scale? How much innovation are we seeing thanks to machine learning? And we also discuss about the Regulatory Genome Project, a recently launched long-term project that aims to sequence the world’s (financial) regulation, allowing developers and firms to build own applications on top of the platform. Before joining the Cambridge Center for Alternative Finance, Manos also served as a regulator with the UK’s FCA.

 

It costs something in the order of 4% of turnover for a major financial institution to comply with regulation.

Ben: Manos, thank you very much for coming on the Structural Shifts podcast.

Manos: Thanks for having me on the show, Ben.

[00:01:22.05] Ben: Maybe let’s start by you talking about your background because I think it’s useful for our listeners to know that you’ve seen this interplay of finance, tech, and regulation from many different angles. So, if you don’t mind, Manos, just tell us kind of, you know, how you started off in this world?

Manos: Sure. So, I first got involved with writing and reading about regulation back in 2008. At the time I was a very, very junior lobbyist at an association for accountants — the ACCA. And because I had their access to finance brief, inevitably, around that time, I had to feed into the discussion around Basel III, and the implications for financing of small businesses. But before long, I was talking and writing primarily about FinTech and regulation. At some point, I made the jump over to, I guess what I thought at the time was about the dark side. So, I joined the FCA — the UK regulator — I spent some time there leading their work, at the working level, on things like crowdfunding or their approach to small businesses, surprisingly, political and fraught topics. And then, I moved on to a London-based RegTech startup, where I was their Head of Regulatory Content Operations and also had the product brief for a short period of time. And then, of course, the rest is history. I joined the Cambridge Center for Alternative Finance, where I lead their thought leadership practices, as well as their applied research program on RegTech and machine-readable regulation.

The pace of change and the volume of data has really long outstripped the ability of firms to just throw humans at the problem — human brains and human bodies.

[00:02:53.10] Ben: We’re going to come back to the Regulatory Genome — the project that you’re working on — but before we get there, I think we should zoom out and talk a bit about the whole terrain of regulatory compliance and why it faces so many challenges? So maybe let’s start from the point of view of a regulated financial institution. Why is it so time-consuming and expensive for banks and other financial institutions to comply with regulations?

Manos: Well, alright, let’s start from the top line if you will. It costs something in the order of 4% of turnover for a major financial institution to comply with regulation. Again, that’s turnover. That’s not, you know, breaking margins, that’s not profit. It’s colossal amounts of money on a global scale. And why does it cost so much? Well, I guess, there hasn’t been a time in very recent memory when financial services weren’t heavily regulated. But since the financial crisis, in particular, there’s been an explosion in regulation, that has seen the amount of regulatory notifications rise, I think about seven or eightfold between 2008 and 2018. So, I guess the key point is, the cost is driven primarily by how demanding the regulatory framework is and the pace of change. Now, it’s not the same for every part of the regulated sector. So, a tier-one bank will probably recognize the pace of change as I describe it, whereas let’s say, you know, a smaller asset manager might not, but by and large, there’s been an explosion in regulatory requirements. At the same time, there’s also been an explosion in the sheer amount of data that firms hold, not just the ones that they have to hold for regulatory purposes, but the ones they hold for commercial purposes. You know, only recently — I think it was HSBC — one of the major banks was creating a data lake that was in size exactly the same size as the entire internet had been four years earlier. It gives you a sense of perspective of what we’re talking about. The pace of change and the volume of data has really long outstripped the ability of firms to just throw humans at the problem — human brains and human bodies.

Manos: There’s also other elements related to the way you manage institutions like that. So, you know, many of these major firms are matrix organizations where it’s actually, in the time of change, quite easy to lose visibility as a senior manager of why you’re complying the way you’re complying, what exactly the outcomes you’re achieving are, and so on and so forth. And at the same time, regulators are hardening their stance on the personal responsibility of senior managers. You know, you’ve got senior managers regimes in the UK, in Singapore, in Australia, in Hong Kong, and in an increasing number of jurisdictions. So you’re in this kind of the opposite of a sweet spot, if you will, or the sweet spot for vendors, where the key decision-makers are facing increasing scrutiny on a personal level, and at the same time, are losing visibility. So if you’re a vendor, this is a good time to come in and try to sell them technology.

[00:06:12.08] Ben: What about if we look at it from the point of view of regulators because it sounds a bit like, you know, listening to you, the regulators are really driving the agenda here — which I guess is true to an extent — but the regulator doesn’t control the pace of technology change, which is driving innovation; and the regulator also only can really affect its jurisdiction. And I think one of the things that’s become more apparent over recent years is there’s a lot of competition between jurisdictions to attract new financial institutions and also new FinTech companies. And so, does the regulator also see the need to do things differently in this space?

Manos: Sure, I guess there’s two types of regulations depending on where they come from. So, there are rules that are fundamentally quite harmonized across the globe. AML, for example, prudential requirements — at least in banking and insurance. And for those, the rules come down from Mount Olympus, from the G20. They cascade through the standard-setting bodies and then finally into national regulators. Now, if you are a regulator working in that kind of subject matter area, then your key concern is, am I fundamentally compliant with international standards? And have I found the most efficient way to comply with them? AML is the usual example here because if you’re not compliant, that’s a big problem. The whole country can get graylisted or blacklisted, and you just don’t want to be there as a regulator. But you know, even when the stakes aren’t that high, regulators want to know that they are compliant with international standards. Then there are other areas of regulation which are closer to the matter of technological change that you mentioned earlier, where good practices are bubbling up from the bottom up. So areas like, I don’t know, cybersecurity, data protection — you know, there is no single unifying force or no single cascade of standards from the top. But everyone wants to know how they compare to the jurisdictions that they see as competitors. So, if you’re in Malaysia, you’re the Securities Commission, you will look at what MAS is doing in Singapore. If you are in the UK, you’ll be looking at what the Europeans are doing post-Brexit. Pre-Brexit, obviously, you just have to comply. So this process of regulatory benchmarking is actually one of the factors driving regulatory change internationally. When at the CCF, we surveyed regulators from 111 jurisdictions around the world. They told us that nearly every exercise of review of regulation in relation to FinTech had involved some benchmarking exercise. And, in more than half of these circumstances, it was the benchmarking exercise that had prompted regulators to change how they do things.

if anything, regulators are under more pressure. So when we say something like, you know, the pace of regulatory change has increased sevenfold since the financial crisis — well, you know, firms’ compliance budgets have not increased sevenfold. But regulators’ budgets have not increased at all, not in real terms anyway.

[00:09:11.06] Ben: What about COVID? Has that had much of an impact on the pace of regulatory change?

Manos: Well, that’s what our research tells us. So, we have just come out of a significant project to basically carry out a rapid impact assessment of COVID on the FinTech and RegTech industries, as well as the regulators responsible for them. And obviously, what you hear from regulators is that COVID fundamentally changed the way they approach some areas of their work — not just their rulemaking, but also their hands-on supervision. But I guess what regulators tend to see here is some megatrends that have accelerated — so trends towards you know, more or less material financial services, more online banking, more app-based financial services and so on and so forth, but also greater demand on their resources, so that they can do more with fewer touchpoints with industry. And then, of course, COVID also came with some of its own, if you will, pathologies. So, regulators told us, for instance, that they were much more aware and worried about fraud in a COVID environment where a lot of things have had to be put on the cloud or have had to be done remotely at relatively short notice, or where firms have had to deal with stuff that previously were very closely held in-house on a remote basis. So, of course, the focus of regulators has had to change.

[00:10:48.17] Ben: So, Manos, if we were to try to summarize what you’ve told me, you’re saying that the pace of regulatory change is accelerating to the point where financial institutions can no longer just throw, you know, human resources at this problem because it’s an exponentially changing situation so it requires a technology solution to it. But would you also argue that the regulators need to be putting more technology at play here? Because presumably, they also want to know how regulations are changing and being implemented, and they want to make use of the data to make sure that they’ll keep up with the potential rates of innovation, put that to good use in terms of financial inclusion and everything else. So would you say that the need for new technology applies to both the regulated and the regulators?

Manos: Yeah. I mean, if anything, regulators are under more pressure. So when we say something like, you know, the pace of regulatory change has increased sevenfold since the financial crisis — well, you know, firms’ compliance budgets have not increased sevenfold. But regulators’ budgets have not increased at all, not in real terms anyway. And so, regulators find themselves in these very interesting challenges wherever there’s this use of data involved. Like, to give you a simple example, the first touchpoint with technology around regulation and compliance for most regulators is reporting. And if you talk to an emerging market regulator — not the poorest countries in the world, necessarily; just, you know, significant emerging markets — they will say, “You know, firms report data to us and by the time we’ve validated the data and made sure it’s not garbage, it’s three months old.” Now, let’s go back to that COVID discussion we just had. If you had three-month-old data on the robustness, the financial stability of firms, as a regulator, it would be useless. It’s a snapshot from a completely different world. So you can see how COVID can really create an issue for regulators there and waken some of them to the challenges. But even if you think of more normal times, you know, the FinTech revolution has created a very big fringe of very small, very marginal firms that fly sometimes under the radar of regulators, and sometimes just above. And so, for instance, when the FCA took over payments, for instance, the population of firms that they were supposed to supervise more than doubled overnight. Now, their resources did not increase at all. So, what exactly do you do when faced with a situation like that? You have to find some way of prioritizing your human resources. And the only way, really, to get to a point where you can do that is to invest in technology that allows you to prioritize better by getting insights more cheaply, more efficiently, where the risks are proportionately smaller.

in the AML space, every year there’s a new estimate of what percentage of the illegal flows of funds are actually intercepted by AML controls. And it’s usually always in the low single digits. So, you know, you have to keep wondering, like, is this really the best we can do?

[00:13:49.05] Ben: That’s happening, is that not? So, we are getting thousands of new entrants into this space, new technology companies, new RegTech companies are entering this space to solve these challenges that regulated companies have, and regulators have. I was reading before this podcast that I think collectively, over $10 billion of new venture capital has gone into this space in the last 10 years. So, are we solving this problem at scale?

Manos: Well, it’s interesting. I mean, obviously, throwing more firms at the problem doesn’t necessarily solve anything. It is a good indicator of how valuable the prize is, I guess, for whoever wins the race. Just to be clear, just the number of RegTechs really depends on how you define this sector. So, you know, you will hear estimates from 800 all the way to the 2000 number that you quoted, but the amount raised is almost always estimated the same way because most of the fundraising is concentrated in a handful of large firms. So, this is one of the first things I think we need to keep in mind in the context of this discussion. You will hear about RegTech growing very fast as a sector, and all of the success stories, but the typical firm in the RegTech sector — we did our own research on this — has raised somewhere in the order of $1.5 million. Now, it sounds like a lot of money if you give it to me to buy a car or a house even. But how much runway does it buy a technology company? Like, less than a year. And to put it into further context, how long does it take from the moment, let’s say someone at the bank shakes your hand and says — well, they can’t shake your hand anymore, but you know, looks you in the eye virtually, and says “I love your product, we will definitely buy it” and the moment when you first see any money from them? Usually about 18 months. So, you have to put these two numbers together, like, how much runway do they have versus how long it takes for them to actually convert prospects to paying customers. So, most of this sector isn’t particularly successful financially. And so, the sector is kind of ripe for consolidation. Quite a few of these people are competing in very, very crowded segments. Also, of course, in our own research, what we’ve seen is that there was a golden era of new market entry between let’s say, 2013 and 2017. And the pace of market entry has slowed since then, quite significantly. So, this sector is now growing more from the center than from the margins — so, big firms getting bigger, as opposed to new firms joining.

I’m skeptical about the pace at which we can move towards machine-readable and machine-executable regulation, where we treat regulation as code.

Manos: Now, to your question, though, the actual question was, you know, are they solving this problem? I think the first thing to bear in mind is that the sector has been around for like 20, 30 years, depending on how you define it. So, you know, you had regulatory intelligence applications 20 years ago, you had BPM and GIC applications 20 years ago; they’ve evolved since then, yes, but the fundamental kind of offerings were already being imagined at the time. What firms are now much better able to do, I would say, is, first of all, they can scale a lot faster and deal with smaller institutions because their services can be delivered through the cloud and by APIs. It’s much easier for them to work together, so, hooking up different applications via APIs is now much more realistic than it used to be. And so, what that means is that ideally — and we’ll have to come back to this point — you know, no one firm has to build everything, end to end your entire kind of compliance factory. So, that obviously helps. But there are areas where RegTech has yet to make a significant impact. If you try to map where most of the effort has gone — AML, reporting, risk particularly on the prudential side — between those three areas you’ve probably captured 80–90% of the activity that we’ve seen; probably a lot more if you count it by funds raised. And then there are other areas, notably on conduct, for instance, that are kind of less tangible and quantitative areas of compliance, where, you know, you don’t see the same level of success. And, of course, even where the RegTech sector is making inroads — good on them — you still have to ask yourself, how much success do we have to show for it? So, in the AML space, every year there’s a new estimate of what percentage of the illegal flows of funds are actually intercepted by AML controls. And it’s usually always in the low single digits. So, you know, you have to keep wondering, like, is this really the best we can do?

[00:19:02.21] Ben: And listening to you, it sounds a bit like, you know, even though lots of money has gone into this space, and accepting that, you know, most of it has flown to a few big firms, rather than the long tail of smaller suppliers, it sounds like there’s still a lot of duplication of activities in this space, and also potentially, like, there’s not complete coverage of the regulatory space, i.e. people keep shooting, I guess, for the areas with the largest addressable market. So, would you say that they’re two of the challenges that still persist, that the RegTech community is still duplicating a lot of its own efforts, as well as, you know, perhaps don’t have complete coverage yet of all the areas of regulatory compliance?

Manos: Absolutely. And I’m not sure that any one firm has a particularly good overview of its entire competitive environment, just because so many people are trying this and many of them are still under the radar unless they’ve done two or three funding rounds and you start seeing kind of headlines about them. But I think it’s also important to say that compliance, in general, involves a colossal duplication of effort. If you think about it, the regulations are the regulations. They are what they are. But there’s thousands of financial services firms, each developing their own mapping of rules, you know, against their own internal systems. And you think, “Well, how much of that is duplicating effort? And is there really a business reason to duplicate this for each firm to do it on its own?” Because compliance in itself does not confer a competitive advantage. Being able to manage risk better does. Being able to understand customers better does, of course, so there are some things that firms will always want to keep close to their chest. But compliance in itself does not. So the duplication is quite substantial and not very rational.

[00:20:54.08] Ben: In terms of technology change, you mentioned cloud, you mentioned APIs? What about AI? Because it seems to me that one big area of potential improvement here is to train models… You know, you can imagine this particularly in the case of financial crime, for example, where, you know, many actors contribute information about financial crime and one provider can train the best models and can give the best predictive analysis about where financial crime might arrive, or stop financial growth based on patterns seen in the past. So, are we seeing much innovation and headway being made thanks to AI in this space?

Manos: We are. And I guess we’d better because the amount of processing power we can leverage these days is colossal. So, you know, in the first AI spring, in the ’50s and ’60s — I’m not reminiscing, I wasn’t there — back then it would take about seven minutes for a computer to parse one sentence or one paragraph worth of text. And now we can do, like, billions of them in the same amount of time. You know, obviously, that helps. Having said this, applications of AI mostly end up with a trade-off. So, think of it a little bit like an industrial process, where, because at the end of the day, most of the applications of AI that you’ll see in compliance come down to statistical models. You’ve got error rates, you’ve got false positives, you’ve got false negatives. And the whole kind of quality assurance process is around saying, “Well, how many false positives and false negatives can we tolerate?” And particularly, like, “How many false negatives can we tolerate?” Because that’s where you get fined or put in jail. And so, usually, what happens is firms, certainly in compliance, are very, very reluctant to accept that there will be a consistent level of errors in a compliance process, particularly around things like AML. And so, you know, many will seek a level of certainty that is just not possible. Some of them will tolerate redundancies and duplication, just to make sure that they are covered. And particularly in the larger firms, often you will have a duplication internally. If you’re a tier-one bank, there is actually a decent chance that you’ve licensed software that duplicates things you’ve built in-house, that you have licensed software from two different people that overlap. So, the strategy around incorporating AI in this area is still not fully fleshed out.

to get from the messy regulatory language to something that humans can work with, you have to have some kind of mental map of what regulations are out there, a kind of taxonomy of regulatory obligations and concepts. That’s one side. And you have to have a corresponding mental map of what the firm looks like — what matters to the firm. So a firm doesn’t see itself as a collection of compliance obligations. It sees itself as a collection of products and functions and locations, and yes, even processes and controls and policies, and so on, and so forth. So, you have to have both of those maps, and then get them to talk to each other — so create linkages between the two sides of the equation.

[00:23:41.02] Ben: What about this whole area of machine-executable regulation? So, you know, certainly, I’ve been reading about a lot of companies that are working on, you know, basically turning regulation into code, which can then be executed by the machine. And this seems, you know, at least prima facie, like, this is the most elegant solution to this problem, right? Because if regulators can put out very precise regulations, and they can be turned into code, not only can that code then be executed immediately, but it will be executed exactly as the regulator intended to be executed. So that seems like the holy grail here, would you agree? And do you believe that this is realistic and that we’re making progress in this direction?

Manos: I mean, it is the holy grail. And it’s interesting because it’s one area where software developers and lawyers kind of lead in the middle. Both sides think like machines. They want very precise and consistently worded inputs and outputs. But in reality, most regulation doesn’t work that way. So, the hype around machine-readable, machine-executable regulation is what it is because some of the earliest use cases for RegTech and SubTech are around reporting. And reporting use cases involve heavily standardized data — I say heavily standardized, but if you see them upfront in their raw form, they’re not always that good but they involve much more standardized and much more quantitative data, more structured data as well than most other RegTech use cases. So, if you’re only really interested in reporting and adjacent use cases, actually machine-readable and machine-executable regulation will happen. You know, it’s already happening in some domains, and it will happen in most others. Enormous amounts of money, enormous amounts of attention, and standard setting effort has gone into those. But then there is a lot of regulation where this level of standardization, of quantification and of structure just doesn’t exist, partly because that’s not how it’s been designed and it’s very expensive to redesign it from scratch, but partly because regulators want it that way, or legislators want it that way.

Manos: So, to give you an example that’s close to my experience: let’s say consumer credit regulations in the UK do not include any indication of what criteria somebody should meet in order to get a loan. Not because they couldn’t come up with, you know, a good sense of what credit worthiness looks like, but because legislators and regulators want firms to have the flexibility to come up with their own answer to the question. In other cases, the point isn’t flexibility, but responsibility. So, very often, what the regulator wants is for the onus to be firmly on the firm to find a way to reassure the regulator that the outcomes are as the regulator expects. And so, you can imagine a situation at the limit of this road towards machine-readable, machine-executable regulation where the regulator just releases their code and they say, “Okay, plug this in, connect it to your data lakes, and out will come compliant outcomes.” If something goes wrong, who’s to blame? The only person left to blame now is the regulator. That’s not a very comfortable place to be, certainly not if you’re an independent regulator. Like, if you become a sandwich between industry and government, that’s the sort of thing that would end up with the regulator being crushed. So, there will be a natural resistance in some areas of regulation against this level of mechanization. But even in reporting where this is supposed to work well, you know, if you hear the noises coming out of some of the kind of leading regulators in the world — not least the FCA here in the UK — what you will hear is that there’s enormous amounts of data standardization that needs to be done before the promise of even that use case — which is the most promising RegTech use case of all — can be fulfilled. So I’m skeptical about the pace at which we can move towards machine-readable and machine-executable regulation, where we treat regulation as code.

Treating regulation-as-content where we say the regulatory language is what it is and the job of RegTech isn’t really to turn it into push-button executable code, but rather to turn it into workflows and business rules.

Manos: Now the opposite, which does work, but is more human in the way that it does work, is treating regulation as content where we say the regulatory language is what it is and the job of RegTech isn’t really to turn it into push-button executable code, but rather to turn it into workflows and business rules. And so, the idea is that to get from the messy regulatory language to something that humans can work with, you have to have some kind of mental map of what regulations are out there, a kind of taxonomy of regulatory obligations and concepts. That’s one side. And you have to have a corresponding mental map of what the firm looks like — what matters to the firm. So a firm doesn’t see itself as a collection of compliance obligations. It sees itself as a collection of products and functions and locations, and yes, even processes and controls and policies, and so on, and so forth. So, you have to have both of those maps, and then get them to talk to each other — so create linkages between the two sides of the equation. If you’ve done that, then effectively you can get either one application or multiple applications talking to each other by APIs to do this interesting kind of relay of regulatory content. So regulatory content comes in, it gets labeled according to where it has to go, what it’s related to, and then it’s passed on to the appropriate application, to the appropriate subject matter owner with an instruction that implies what kind of workflow is expected afterward. So, that’s messier, it’s more human, but for the same reasons, it’s bulletproof. Eventually, someone will make sure that the system works. Whereas end-to-end machine-readable and machine-executable regulation will usually break down.

[00:30:19.28] Ben: You know, if we think about the idea of machine-executable regulation as being… You know, if we were to be on the Gartner Hype Cycle, it would probably say machine-executable regulation in brackets for reporting, right? And then it would be somewhere quite early in the hype cycle, because, you know, this is probably being hyped, and we’re going to go to the trough of disillusionment. Where are we with the alternative approach, which is, you know, using, I guess, AI and classifiers, and so on, to be able to classify regulatory text at scale, and to serve it up, as you said, into workflows. So this seems like the more promising approach and where are we in the hype cycle with that kind of bridge?

Manos: Just before we move on from machine-executable regulation, I think the key moments in the hype cycle for that, you know, probably, the key moments would have been the FCA and bank of England’s digital regulatory reporting pilot. So that was definitely a hype point in the hype cycle. And if you’ve read all of their lessons-learned reports, you actually feel yourself sliding down the hype cycle. It’s hard to read those and think, “Oh, this was this was a slam dunk.” But then you look at things like, you know, ISDA’s Common Domain Model that basically gives you a way of making both machine-readable and machine-executable a lot of the contract terms around derivatives. And you think, “Well, that’s quiet there. But actually, that seems to be working reasonably well.” And the whole kind of cause of machine-readable and executable regulation has been given a new lease of life with the Saudi-led G20 sandbox, which really is focused on these types of applications. So, you know, I think we’ve still got some time of hype left in the machine-executable side of things.

Manos: But as you said, I think there’s a lot more to be said for regulation as content and the other side or the less ambitious kind of side of RegTech. And there, I guess, the level of maturity is very good. So, when we looked at the market last — you can probably name something in the order of 25 to 30 platforms or tools that are in the regulatory intelligence space, that are really making significant headway in organizing regulation, according to their themes and topics and using things like natural language processing and machine learning to automate that so that they can read rule books at scale. Now, where you want to go eventually is that there’s one kind of virtual front end to every rule book in the world. We’re not there yet. But equally, I think, as long as you’re thinking of private standards only, we’re not that far either. I mean, there’s very significant work done and you can already name three or four firms that are way out ahead of anyone else — I won’t name them here. Now, what you don’t have, though, is some way of reconciling all these proprietary standards into one language of regulation. And that’s quite hard for someone on the purchasing side because what it means is, if you’ve done a lot of work to onboard one of these suppliers and mapped all of your internal systems and controls and processes to their dictionaries and their map of compliance, what then happens if you want to change the supplier? You know, or what has to happen if you want to onboard some other compliance application that needs to talk to that first one, but just doesn’t know the language? That’s the bit that we don’t yet have a very good answer for and there’s no clear kind of commercial incentive for firms to create that.

[00:34:18.08] Ben: Which is the segway into the Regulatory Genome Project, because that is at least partly a public good, right? And it’s aimed at solving exactly this problem of creating common standards and interoperability, right? At the level below commercial applications.

Manos: That’s correct. So let’s start with a little bit of background on the Regulatory Genome Project. So, at the CCF, we were approached in 2017 by what is now Flourish Ventures and was then part of the Omidyar Network with a very specific use case. So these guys were impact investors, they invested in FinTechs mostly in emerging and frontier markets, that were kind of mission-driven to improve financial inclusion. And what they said was, “Look, our portfolio is doing quite well. But one of the things that usually get in the way of growth and manifests itself in the kind of growth plateau at a time that is not really helpful for our firms is that if you want to grow beyond a certain point, then you have to expand at least on a regional basis.” So let’s say you start off in Kenya and you want to cover all of East Africa. Very reasonable. So, when the firms reach that stage in their development, it’s actually quite hard for them to grow because different markets, even within the same region, even if there’s a certain level of integration, have different rules. And so, a lot of time and money, and lawyers fees have to go into making sure that you get market entry just right from a compliance basis. And there’s no obligation for regulators to be consistent with each other or to make life easy for you.

Manos: So, they came to us with that question, saying, “You know, you have access to resources at the university, you know, cutting-edge research on NLP, you know, machine learning engineers — isn’t there something that you could build, that would pass regulation across jurisdictions and make it comparable?” And we thought at the time, well, look, this is a nice applied research program. Of course, we would be interested in looking into this. But what we found as we went along and created a pilot application and tested it, and saw they worked reasonably well, we thought, well, we’ve only covered one domain in this area. We came up with an AML model. We’ve only covered one domain and anyone we tried to take this to as a potential user would say, “Well, what about this other area of application?” So they might say, “Okay, AML good. What about cyber? Or payments, great. But what about insurance?” And it seemed to us that we were going down this rabbit hole of mapping out all the regulations in the world in order to create this one product.

Manos: Obviously, there was also a kind of existential question — you know, the university isn’t really a RegTech vendor, we didn’t want to be permanently in the business of building applications. And it’s a busy space out there, right? Other people have done this longer, and they know this better. So, we thought, what is it that we feel is really needed? Is there a public good that our research can produce? Now, that is consistent with the mission of the university. And so, we thought of an analogy to, I guess, the life sciences. And, at the time, because we were dealing with people who had been involved in the Human Genome Project, it kind of triggered this thinking of, is what we’re trying to build really kind of parallel to the Human Genome Project? And is this pilot application we built, something analogous to an application like 23andMe? And then, from that kind of thinking became the genesis of what we now call the Regulatory Genome Project.

even if you’ve already gone quite a way and had a lot of success in implementing RegTech within the organization, the appeal of interoperable applications and open standards, I think, should be quite significant.

Manos: So, we basically thought we need to find a way to fund and resource and guide a long-term project that maps all regulation. And then, to make sure that it’s available to people truly as a public good, we have to not only make the marked-up rules, I should say — the classified rules — as open data or as near as open as we can make it, but also, we need to find a way to release some of the pent-up innovation out there, by allowing developers and firms to work on this map of regulation, this global map of regulation, and build their own applications. And that way, we don’t have to be, you know, the guys who build everything. We can tap into the creativity and technical skills out there.

Manos: I think what’s really important also, just to bear in mind is the skill sets on the two ends of this journey are just very different. So, building a map of regulation requires a certain amount of technical expertise in the areas of regulation, it requires very strong ties with regulators — which the university has. Whereas, building applications on what we call ‘the right-hand side’ of this journey requires very different skills and a deeper understanding of how the institutions work internally as organizations. So, what does it mean to keep the machine kind of running? And so, to expect somebody to cover all of that is actually quite hard. That means that most people who have innovative ideas in RegTech, either coming from one end or the other end, can’t really deliver the whole thing. So, I guess this is a long way of saying that the key principles behind the Genome Project are, first of all, regulations should be available in machine-readable form as a public good. This is stuff that firms are required to know, by law. They’re made with public money. There is no reason for it to not be open data in a machine-readable format. That’s principle number one. Principle number two is, all of this information must be available to developers in such a way that people can build applications around it. And finally — and this is a key point — both the representation of regulation and the resulting application need to be interoperable. You need to have one common language of regulation. It’s true, different jurisdictions regulate in different ways so, you’ll never get to the point where you say, “Well, this requirement in Brazil is exactly equivalent to that requirement in Mongolia.” But what you do have in the middle is a kind of regulatory Rosetta Stone that can map regulations from any given country against a common framework. Think about, I don’t know, the Dewey Decimal System, right? If you go into a library and you’re a librarian from anywhere in the world, of course, the books are going to be different, but you know that nonfiction is going to be there and you know that life sciences are going to be there. So, that’s the level of interoperability we want to get to.

[00:41:27.18] Ben: And how do you get there? How do you sequence the genome of regulatory information?

Manos: So, let’s get as practical as we can. So, it starts with a paper exercise — I mean Excel exercise — whereby you create almost a hierarchical list of regulatory concepts and obligations. You usually do it by domain. So, you might say, “Here’s my taxonomy of AML concepts and obligations, here’s my taxonomy of cybersecurity, and so on and so forth.” And you know, some of these taxonomies are what you might call horizontal — they cut across the entire financial services industry, so the two examples I gave just now — some of these are vertical. So you might have payments, for instance, insurance, crowdfunding, which was one of the areas of the Center’s particular attention and expertise. And what you do is you create these hierarchical lists of obligations. So for instance, you might say, I don’t know, let’s say you’re dealing with investments, right? You might have client categorization and within that, the definition of an accredited or professional counterparty. You know, perhaps not the best example, but the point is that you always move from a higher level, more general obligations or families of obligations, to more specific ones. Now, at the end of each of these branches, if you will, you will have an end node. You will have the most detailed level of classification of regulations that the genome can manage.

Manos: Now, in theory, there is no limit. You can keep making them more specific, and more specific, and more specific. But remember, the genome as a public good is about making regulations comparable across jurisdictions. So there is a natural stopping rule. You want to stop at the point where the regulatory requirements at the end node are still comparable internationally. So, for instance, client categorization, yes, that’s comparable. You know, the distinction between professional slash accredited investors and more ordinary retail investors, yes, that’s comparable. But if you go all the way to saying, you know, ‘treatment of local authorities for the purposes of client categorization’, you are getting now so fine to the weeds that you’re going to draw blanks for most jurisdictions. And then for everyone who’s subject to MiFID, you will just have this note that says, actually, in most cases, these people are retail clients. So you can guess what the stopping rule is. You go as many levels down as you can until you reach a point where international comparability is compromised. So, that’s how you build that.

Manos: Up to this point, you’re still kind of in the paper world. You can still be doing that in Excel. But then, once you’re happy with the structure you have created, then you can start using machine learning. And machine learning relies basically on collecting large amounts of data from a diverse sample and teaching the machine that a specific example corresponds to a specific node. So, for instance, let’s say you have rules around credit worthiness assessments of consumer borrowers in different jurisdictions. You basically say to the machine, “This is a credit worthiness assessment-related obligation. This is as well. This is as well. This isn’t.” You repeat that over and over and over again until you can train basically a statistical model — which lives as code and we call ‘a classifier’ — so that model can now take in unfamiliar text, and take a stab at what category it fits into. So the next time around you feed regulatory text that you’ve never seen before to the same classifier, and it can say what the probability is that it is about credit worthiness, and you set yourself a cutoff and you say, “Well, if it’s above, let’s say, 70%, 80%, we’ll mark that as a one.” And so, what that does is, if you try to imagine now the machine-readable version of the same regulatory document, that paragraph or that piece of text now carries a tag, an electronic tag that says, “This corresponds to this type of obligation.” And any other application that knows the universe of tags that you’re working with — your taxonomy — can now read this and say, “Oh, okay. I know that this paragraph now is about this.” And that’s how you might be able, for instance, to run queries via an API; you might say, “Can you bring me all the text that’s tagged as credit worthiness assessment?”

[00:46:13.17] Ben: How difficult is the tech there? It sounds almost like, you know, provided you train the classifiers with enough data, then the results will get better and better and better. So, would you say it’s more of a challenge to get the data than it is to get the tech, or am I oversimplifying?

Manos: It’s a good question. I mean, I don’t want to downplay how difficult it is to get the tech. Like, the colleagues who we have working on this are obviously at the top of their game. Having said that, the technology comes with its own significant challenges. What do I mean by that? You know, there isn’t an enormous amount of regulatory tax out there. Now, this may sound really funny bearing in mind what I said earlier.

Ben: Yeah, the sevenfold increase you mentioned earlier. Yeah.

Manos: That’s true. But, you know, from a machine learning point of view, if you look at what kind of corpora people are working with to train machine learning models, they will usually use, you know, all of Twitter for the last three years, or, you know, the entire text of Wikipedia, or the entire internet if it comes to that. So, you know, in comparison to things like that, the amount of regulatory text out there is not enormous. And so, a lot of the challenge is around making sure you have enough samples to actually build good models. The other thing I guess, which people need to appreciate is that the returns to just having more samples start to diminish reasonably early. So, you know, the models don’t get exponentially better as you double or triple the amount of data you have access to.

Manos: Where this becomes really challenging, is, first of all, when you look at really new or niche areas. So, let’s say tomorrow, you know, one of our regulators came up with a very, very specific type of obligation in relation to making, let’s say, AI auditable. So it says, “If you implement any AI applications as a firm, you have to make sure that they are auditable by a regulator — whatever that means. You know, in the early days, only one regulator will have any references to that. So your sample is going to be tiny, right? That is a problem because it means your model runs the risk of having blind spots and you have to find ways of bootstrapping the small sample that you do have, in order to make sure that the classifiers work. I’m not saying that’s not possible, and obviously, my colleagues are working on things like that, but it is challenging. And it’s also challenging when you look at non-English techs because if you create a classifier for AML obligations written in English, that’s going to be completely useless if you’re reading documents in Spanish. But the problem is, if you want to replicate that process in Spanish, your corpus of documents now becomes a lot smaller. And Spanish is, you know, a major global language. Try doing that in Japanese, try doing that in less widely-used languages, that are not the language of business for many people. That is another major issue in that area. But I guess the final issue will always be with these things — and I’ve already mentioned it once already — is that, at the end of the day, there will be errors. And there’s a question of, you know, how much liability should the parties accept for these errors, and who does it sit with?

[00:49:45.07] Ben: If we move beyond the tech and the data — although I think this is a bit related to the data — to this idea of the chicken and egg problem because it’s not difficult to foresee a time when the genome exists and therefore if you’re a RegTech provider, you would build any new RegTech application on the genome because you then don’t need to do all of the mapping of taxonomies yourself. You can just query the public good, right? But between now and then, you’ve basically got to convince software providers to build on the genome, you’ve got to convince regulators to work with you, you’ve got to convince commercial users to use it. So, how do you go about building that ecosystem around the genome to make it successful in the first place? Or, in other words, how do you solve that chicken and egg problem?

Manos: So it’s a fair question. I mean, there is a place you can start, obviously, and it depends on where your relative strengths are. So if you look at other initiatives that have tried to kind of force some level of convergence within industry, they would usually have some strength in one area or the other. Now, if you’re talking about the university’s areas of expertise, obviously, because of our work in capacity building with financial regulators, that for us is the obvious place to start. So we’ve got very strong links to financial regulators around the world and we also know that they have a very strong use case around regulatory benchmarking. So, remember what we said earlier in this podcast that regulators are always checking their homework against the guy who sits next to them. And so, these benchmarking exercises are big painstaking things — expensive, very slow. I remember one regulator saying, “You know, if I had a tool that could do this, I would have nine months of my life back on just the last project.” Which was quite intense but I sympathize with that.

Manos: So the first people to reach out to are regulators. But regulators being involved gives confidence to financial services firms. And not just confidence in the quality of the taxonomies and the classifiers because frankly, regulators will never pull out a big rubber stamp and saying, “I approve of this.” But what a firm can see is that if this is good enough for the regulator to use for their own use cases, then, you know, maybe this is good enough for us as well. I think — you know, as far as industry is concerned — this standard-setting process is also an opportunity to influence in the direction of the common good, in the sense that, of course, you know, no regulator is going to go to a consortium of firms and say, how should I write my AML rules? But giving them the tools to compare against their peers, will usually give you, as a result, better regulation, because people will now have an evidence base on which to say, what is common practice? What is good practice? How do different things correlate with market outcomes or consumer outcomes? So, from an industry perspective, even though you can’t just lobby these people in a crude way, they have been given tools whereby, internally, they can come up with better outcomes for things that you care about. So that’s another reason why industry really, you know, ought to care about creating something like this.

Manos: And then, once you’ve got a few major banks, a few major fund managers, a few major insurers on board, as well as a developer platform through which you can access these assets, then, as a developer, it becomes quite reassuring to know that you can build on this standard because you’ve got the sense that whatever else happens, there are some people who are already on board, and will use applications or will build applications against that standard. So, your investment, your one-off investment in mapping all of your internal systems to this common denominator set will not be wasted. And, as a developer, that can be quite attractive, because the alternative is that every time you onboard a new major client, you have to do all sorts of ad-hoc fixes, so that your systems talk to theirs, which is, you know, expensive work that you’re not always going to get paid for because the client, as far as they’re concerned, it pays for the actual result not for the path you have to walk in order to make sure you can service them.

[00:54:16.15] Ben: So you’ve just launched the Genome Project, and you just started to try to recruit new members, new consortium members — the private sector, the regulated users of the genome. First of all, how is that going? And secondly, if I were a large financial institution, and I had, you know, significant resources to invest in RegTech, and as you say, already had many, many existing RegTech applications and suppliers, what would be the case you would make to join the consortium?

Manos: It is true. We have been in conversation with a number of major financial institutions starting with some of the larger ones, as you might imagine, for obvious reasons, which are now starting to yield results in the form of potential collaborations. Now, that activity is not going to end anytime soon, because, at the end of the day, you want as much of the industry onboard the consortium as possible. But once the first step of recruiting firms is significantly under way, then the work begins to build out the rest of the genome, and also to recruit developers and make sure that you raise awareness of the benefits of your platform and to build the kind of tools that will help developers build applications against the genome. So, there’s a significant kind of technology roadmap, there’s a significant business development roadmap, as well as, of course, the semantic roadmap whereby we’re actually creating the genome itself. So this is just the beginning. But we’re already seeing some of the first successes. Similarly, on the regulatory engagement side. So, you know, we’ve had our first few workshops with individuals from the regulatory community who are willing to dedicate their time to review and make suggestions to improve the various taxonomies. And so, you know, I’m quite confident that if we’re speaking again this time, next year, a significant percentage of financial regulation will have been mapped — and come 2022 we’ll be in a position where people can actually start building applications.

[00:56:31.28] Ben: If I’m a bank and I want to make this case internally — because I presume there’s a price point to join the consortium — how would you convince me, practically, that it makes sense?

Manos: Yeah. I guess it’s always a very different conversation when you’re dealing with a major financial institution that actually has done a fair amount of work in the RegTech space — and pretty much all of them do. If you speak to tier one bank, they have been bombarded with proposals from RegTechs, and even from potential consortiums as well. And so, I guess the way people will usually respond this — you know, why do I really need this sort of thing? I’ve already got fairly mature solutions in-house that I’m reasonably happy with. So where is the real kind of long-term strategic value?” And I guess there’s three layers to this. The first one has to do with how procurement works effectively. It’s great that you’ve got the supplier that you’re happy with. That’s amazing. However, what it also does is it locks you in because you’ve invested a significant amount adjusting your internal systems to fit with theirs, and particularly adjusting at the semantic level — so, making sure that all of your other applications speak the same language as the vendor and can map to the same taxonomies. Now, that’s usually a significant sunk cost. And so, a firm that wants to move away from a supplier relationship doesn’t actually have a lot of good options, because they’ll have to take on the cost of doing this all over again if they onboard somebody new. And it’s very unlikely that they’ll be able to get a startup, for instance, to do that work because the startup just doesn’t have the cash and the runway with which to do it. So you end up in a situation where you’ve got a significant supplier lock-in. And it shouldn’t really be the way that a major financial institution runs compliance technology. So, that’s one part of the answer.

Manos: The other part of the answer is that usually, even when you do have really good applications, they tend to be limited in scope. So they will either be limited to a few domains that they were originally built on. So let’s say, you know, anywhere in Europe or anywhere in firms that deal with Europe in any way, people will have built ad-hoc systems to deal with MiFID compliance, for instance. You can’t then repurpose that to deal with some new type of securities law that comes in 10 years down the line. If you’re lucky, maybe you have architected that way but most people will not have. So the benefit is that dealing with a kind of de facto standard, like the genome, as and when it becomes available, builds some longevity into the applications that you do build. And obviously, it’s not just scalability across domains. It’s also, are you able to serve jurisdictions that are not in the magic circle of jurisdictions that suppliers usually target? So if you think about what most applications can deal with, they can deal with EU, UK, US and Canada, Australia, Hong Kong, Singapore — that’s your magic circle. Beyond that, you know, here be dragons in many cases. So being able to have that same level of scalability and functionality beyond those core jurisdictions is a huge benefit.

Manos: And then finally — and I think this is the more where interoperability really comes into its own — is when you deal with suppliers or partners to whom you have the cascade regulatory obligations, or with which you are tied together in a compliance pipeline. So I’m thinking of things like, for instance, product governance, where the producer of a financial product and the distributor of a financial product are tied together in a set of obligations around, for instance, identifying what the target market of a product is, identifying any applicable risks, understanding what kind of uses the clients are supposed to have for these products, reporting on whether it is sold and distributed in the way that was envisaged. Now, all of that requires that information flows between two very different firms — you know, the distributor might be a huge bank or it might be an IFA; the producer will usually be a very substantial financial institution — but they can be very different is what I’m saying. Similar things happen, for instance, when you cascade obligations in the area of cybersecurity or cyber resilience, where the two organizations — the supplier, the vendor, and the buyer — are actually very different organizations. So, if you need their systems to talk to each other, you need some common denominator to map them against each other. Otherwise, you risk, again, that kind of lock-in that we talked about earlier with regards to suppliers. So, I think the bottom line here is even if you’ve already gone quite a way and had a lot of success in implementing RegTech within the organization, the appeal of interoperable applications and open standards, I think, should be quite significant.

[01:02:03.05] Ben: Let’s assume that you build this, it gets wide usage, you overcome the chicken and egg problem, then we can imagine the network effects — the flywheel of network effects — will really start to kick in. And you know, then you’ll be able to level the playing field between regulators, regulators will get better feedback to make better regulations, there’ll be fewer barriers to entry for new vector companies. And so, you’ll see this unleashing of new RegTech innovation. Firms will be able to comply with regulation more cost-effectively, more quickly. Would you describe that as the end state, the kind of collective good that will be created, or is there anything I’ve missed?

Manos: So, no, I think you’re mostly there. I mean, what I would expect to see if this whole thing works properly, is that in the end, there is a marketplace where firms can engage developers to work on the genome — you know, they don’t need to involve any of us in any way. But also, regulators can start writing regulation that is as machine-readable as possible. So, for instance, right now, there are standards like a common torso for writing machine-readable documents at the document level. You know, you can do a lot better than that if you have a common standard for what is in an AML document or what might be in a cybersecurity document. At some point, once you’ve reached critical mass, you’ll start to penetrate a lot more deeply into how regulators do their work, and also a lot more deeply into how people build applications. And that, to me, is what success will really look like — that people start considering your standards at the outset of building their tools and applications.

Ben: Manos, thank you so much for coming on the show. It’s been great!

Manos: Thanks for having me! A real pleasure!

Digital Assets are Coming of Age (#34)

Structural Shifts with Adrien TRECCANI, CEO of METACO, the foundation of digital assets

Bitcoin is the best performing asset in 2020. There is growing institutional interest in crypto and broader digital assets. Tokenization is poised to be a huge market opportunity. In light of all this, we’re inviting you to a masterclass on all things crypto. We’re sitting down with Adrien Treccani, CEO and co-founder of METACO — a provider of security critical infrastructure for financial institutions that enables them to safely enter the digital asset ecosystem. Adrien is a leading software engineer specialized in high-performance computing and financial engineering and an advisor to banks, hedge funds and associations on distributed ledger technology. So today, you are going to learn about the difference between cryptocurrency, digital currencies, stable coins, you’ll hear about the evolution of blockchains, what will happen to commercial banks if we start seeing Central Bank-issued Digital Currencies, and more.

Full transcript

 

The next step is for the trusted companies on the market — which are the banks — to actually get in and start offering professional services around the management of digital assets. And for that, infrastructure is needed.

[00:01:24.17] Ben: Adrien, normally, on Structural Shifts we don’t do a whole lot of bio. We don’t cover a lot of biographical information, but I think it might be useful in this case. So, should we start there? How did you first enter the crypto space?

Adrien: You know, Bitcoin started in 2008 when the first paper was published by this anonymous creator called Satoshi Nakamoto. And then, for a few years, it was only the playground of, let’s say, libertarians, anarchists, passionated software engineers, and cryptographers. But, let’s say around 2011, a lot of people started getting in either for speculation purposes or because of passion for the new technology and innovation. At this time, I was doing my Ph.D. You know, when you do a Ph.D., you have a bit of free time. I don’t like to say it, but you still have some free time to look for things which are not strictly speaking related to your Ph.D. research. One of these things was cryptocurrencies. I was completing my Ph.D. in mathematical finance with a specialization in high-performance computing and Bitcoin was not so far away from what I was doing. So, reading articles about it, I saw an opportunity to speculate or invest. I did not believe in Bitcoin initially. Like, I think, everybody, initially I saw a scam or something which I could not really understand. But after a month of looking around for information, and also missing out on incredible growth opportunities — I think Bitcoin tripled while I was just looking at it — I started investing a little bit and therefore, also getting into the details of blockchain. And this is only years later, in 2015, I realized that something had to be done to support the growth of the ecosystem. The industry was not ready at all to offer massive services around cryptocurrencies, tokenization, and all of these new use cases that are appearing today. In particular, we were still facing a lot of platforms getting hacked, losing most of their coins; investors like myself losing a lot of money in these horror scenarios. And so, I thought that the next step was for the trusted companies on the market — which are the banks — to actually get in and start offering professional services around the management of digital assets. And for that, infrastructure is needed and Metaco — my company — is specialized in offering such infrastructure.

cryptocurrencies have these incredible opportunities that you no longer see on any of the markets

[00:03:41.23] Ben: And you always saw that as being the opportunity you would pursue? Because I can’t remember when we first met, but you’ve been in this space for a very long period of time and you’re an expert. And you could have done anything, right? I mean, you could have set up an exchange, you could have been a trader — why did you start a custody platform?

Adrien: I could have been trading. That’s a good point. I have these several years in the hedge fund industry as a trader, and I think cryptocurrencies have these incredible opportunities that you no longer see on any of the markets unless you do high-performance frequency trading. And so, I think that would have been a possibility. However, at that time, the markets were not sufficiently developed, if you think in terms of market depth, about liquidity, to implement many of the strategies that today would be actually very interesting to study. I missed the opportunity at that time and that was also for me a way to get back to software engineering. And discovering Bitcoin when I was doing mathematics and finance allowed me to get back to programming. And so, when I was the victim myself of losing bitcoins, having one of the exchanges I was using that got hacked and then a second exchange that I was using got hacked, I really thought that the opportunity was in building the infrastructure of this new ecosystem. And today, well, I’m not saying that since we founded the company in 2015, we had this exact precise business plan. In fact, we slightly pivoted in 2017, but we always had this ambition to provide institutional solutions for digital assets.

[00:05:18.11] Ben: Is custody, do you think, the biggest missing piece in the institutionalization of digital assets?

Adrien: Well, I think custody means slightly a different thing with digital assets than it does in traditional banking. When we think about custody in traditional banking, it’s often about storing pieces of paper, and potentially, you know, having corporate actions and not doing much about it. When we say custody in the crypto ecosystem, what we mean is much more than that. It’s obviously key management, the management of these — what we call — secret keys, which secure the assets, but it’s all of the interaction with the blockchain or the distributed ledger. It’s not just about storing and moving assets, it’s also about interacting with smart contracts and corporate actions, managing the whole lifecycle of digital assets — things which are much more dynamic than what one is usually used to with custody in traditional banking.

We’ve seen this big trend of central banks speaking about creating not just physical cash, but getting into digital cash — what is called today, a CBDC. The principle behind it that you can store and transfer a currency peer to peer, from person to person, with no intermediary is something that we see today indeed central banks are moving to.

[00:06:13.12] Ben: Many of the listeners will have different levels of understanding of all these different terms. So, if you’re okay, to maybe just take a step back and just maybe see if we can define and come to an understanding of some of these terms, and then we’ll delve in a bit more deeply. So, can we start with what the difference is between a cryptocurrency and a digital currency — or a central bank digital currency?

Adrien: Yes, sure. So, I would say that Bitcoin created this new way or proposed a new way of dealing with assets. These new ways to think about the solution were, there are less central parties. You can completely decentralize the payment network or currency, and make sure that there is no single point of trust — you don’t have a CEO, you don’t have a chairman or a company or a government that has full control over the assets or its infrastructure. And so, Bitcoin was the first to provide a scheme that actually works and that has been verified now for almost 10 years. However, what was invented by Satoshi Nakamoto in this context can be reused for many new applications. Some parts of its invention can be reused in different contexts and sometimes, almost exclusively, everything that is invented can be reused for other assets. When we speak about digital assets, we generally think about taking the blockchain technology that he invented in this context, extracting some parts of it, and using it for different asset classes — let’s say securities like equities, fixed income, and whatever, bonds or loans, real estates, arts; you know, anything that you think could benefit in being tokenized or put in a digital form on the blockchain.

Adrien: Then once you’ve gone through this tokenization process, your asset benefits from the same properties as Bitcoin itself. It can be stored and transferred efficiently, it can be divided into small particles, it can be controlled through what is called a smart contract so, sort of automated software, which can simplify the application of contractual clauses. What we’ve seen recently is that this technology could potentially also be used by more traditional assets like currencies. We’ve seen this big trend of central banks speaking about creating not just physical cash, but getting into digital cash — what is called today, a CBDC: Central Bank-issued Digital Currency. I’m not saying here that they would use exactly the same principles as Bitcoin. I think that the Bitcoin blockchain or the Bitcoin technology will not be adapted for that, it will not scale enough, it would be too open or too transparent in different ways, but the principle behind it that you can store and transfer a currency peer to peer, from person to person, with no intermediary is something that we see today indeed central banks are moving to.

[00:09:04.10] Ben: At the moment, I can pay you in Swiss francs, I can make an online transaction, it’s digital, right? So just again, what would be the difference, then, between just a digitally-exchanged Swiss franc and a digital Swiss franc?

The idea of the Central Bank-issued Digital Currency is that you can have a direct link between you and the Central Bank, but it is now digital rather than physical

Adrien: Well, think about the difference today between cash and something that you hold on your bank accounts. When you have cash, it’s guaranteed by the Central Bank that you will have some purchasing power tomorrow. So, if you have this banknote in your wallet, then tomorrow you should still be able to buy your bread in the morning with this banknote. Because it’s backed directly by the Central Bank, this claim, this promise is made by the Central Bank itself. Any other entity in between, an intermediary, I don’t know, defaulting, going bankrupt, could not break this promise by the Central Bank. I’m not saying that this is perfect. Of course, the Central Bank, we’ve seen many examples where they hyperinflate the currency and potentially, even though it doesn’t go bankrupt, you still lose all the purchasing power that you’re supposed to have and you start having packs of banknotes that are worth nothing, that are good to light the fire, for instance. But you know, this is still a claim that is direct between the consumer and the Central Bank.

Adrien: Now, if you think about banking money, that’s very different. In fact, when you have money in your bank account, this is not a promise by the Central Bank, this is a promise by this intermediary that is your commercial bank. If this commercial bank goes bankrupt, if it wants to apply special fees on every transaction, any model, any business model or risk that this bank is facing, potentially, you’re going to be subjected to it. It’s not a direct claim or a direct connection between you and the Central Bank. So, this whole chain of intermediaries, which sometimes is much more than just one commercial bank — it can be multiple commercial banks, it can be payment processors, it can be custodians in between — this whole chain could be completely reduced to a direct link, similar to what you have with the cash, but in a digital form. And so, the idea of this CBDC, this Central Bank-issued Digital Currency, is that you can have an equivalent direct link between you and the Central Bank, but it is now digital rather than physical, and you can use it to process transfers on the internet as efficiently as you would with Bitcoin — probably much more efficiently than you would with your bank transfers where sometimes you cannot transfer during the night or off business hours, sometimes you cannot transfer outside of your country, or it takes multiple days, it can be very expensive depending on where you send the money. With the CBDC, the promise is that it would be relatively similar to Bitcoin, you could send this money anywhere, anytime, frictions would be minimal, and you would have the guarantee that even if there is a complete collapse on the financial industry, as long as the Central Bank is relatively stable, your purchasing power should remain the same.

[00:11:54.15] Ben: In the event that we do see Central Bank-issued Digital Currencies, what becomes the role, then, of commercial banks?

I wouldn’t be surprised if in the future, we start seeing fine art, Picasso paintings being tokenized, so you, as an investor can finally invest in it, even if you’re not a billionaire, through tokenization, and that you can start diversifying your portfolio in many different classes of assets, that today you don’t have access to.

Adrien: Well, I think it may change dramatically. I don’t think banks will disappear. In fact, you know, some people expected that post offices would disappear when the internet was adopted. This is not what happened. In fact, Swiss posts in Switzerland are louder than ever. They just had to restructure to find new business models, new opportunities. And we see that what they used to do may have changed slightly, but it’s still relevant. I think the same is going to be true for cryptocurrencies or Central Bank-issued Digital Currencies. I believe that banks will still be relevant. If you think about it, even today with cash, you have the ability to store cash under your mattress. Now, do you do so when the amount is relatively large — let’s say if you store more than a couple of thousands — are you going to put that under your mattress, or are you going to put that in a vault somewhere and potentially with a bank? You probably will do that with a bank. Even though you don’t have to, it’s just an option, at some point, you realize that you prefer paying a professional third party that knows what it’s doing, has all of the measures, the infrastructure, the processes than doing it by yourself saving a few hundred bucks per year, but potentially being fully compromised. And I think the same thing is going to happen with digital assets. Even if you have the option to work with the Central Bank directly, it would be a very practical option to have for small amounts, you know, fast transactions to not be fully dependent and reliant on the commercial banks and payment processors. But in general, when you want to work with a trusted third party that removes some part of your fees and your anxieties, and you will get back to working with a bank. And this is pretty much our assumption also with Metaco. You know, we could see a future where banks completely disappear. In fact, we could go one step further and think about a situation where even central banks disappear and are replaced by Bitcoin, Libra — which in a way is a central bank — Ethereum, etc., and where commercial banks simply are no longer relevant. I think that’s not gonna be the case. And our approach at Metaco is that most investors in these cryptocurrencies and digital assets, will still want to work with a trusted partner that knows what they’re doing, that advises them — and for that, infrastructure will be needed.

[00:14:17.06] Ben: Do you foresee that everything will go digital or crypto and therefore they just have to find a new role than the new decentralized financial world? Or that there’ll be a little bit of a bridge between the old and the new?

If you think about a world where some of the regulations adjust to this new digitalized ecosystem, decentralization, I wouldn’t be surprised that new competitors that would never have considered getting a banking license due to the costs and, you know, frictions could suddenly become relevant and capable of operating a regulated business in this field.

Adrien: I think the transition is going to be very long, first of all. So, even though we speak about tokenization as being a hot topic today, I think tokenization is going to take years to become a new standard, and that is going to take even more years until the legacy approach is completely replaced by tokenization. Now, whether it’s going to be fully replaced at some point, I wouldn’t be surprised because if you think about it, everything is digital today, except monetary considerations. Everything can be digitalized: information, communication. You no longer send telegrams, right? You use the Telegram application, which is a messaging app; you use WhatsApp, you use Facebook; storing pictures — you used to print them — well, you no longer print them, you keep them in a digital form. So, what’s missing today is the notion of money or value of equities, which is partially digitalized but it’s still in a very centralized ecosystem, which doesn’t give you as an investor direct control over what you own. So, I wouldn’t be surprised that in the future, we start seeing fine art, Picasso paintings being tokenized, that you, as an investor can finally invest in real estate, even if you’re not a billionaire, through tokenization even if you’re not a billionaire, and that you can start diversifying your portfolio in many different classes of assets, that today you don’t have access to.

[00:15:59.23] Ben: One more question on the role of banks. So, what about things like issuents? Do you think that they just become custodians or do you think they keep some of their historical roles in, for example, issuing new securities?

Adrien: I think they will keep this role, however, they will be facing more and more competitors coming from IT. So, security firms, IT firms, or, you know, some of the big techs today: Google, Apple, Facebook, Microsoft of this world. If you think about this, it’s already the case that Apple is getting very strong in payments. Alipay, obviously, and many of these other protocols are getting traction to a point that you can ask whether banks and payment processors are going to remain relevant in this field. So, I think yes, banks are gonna keep this role and are probably going to be natural service providers in this field. However, they’ll start facing competitors that they don’t see today on the market. A big part of the reason they are still so strong in this market is because they’re protected by regulations. If you think about a world where some of the regulations adjust to this new digitalized ecosystem, decentralization, I wouldn’t be surprised that new competitors that would never have considered getting a banking license due to the costs and, you know, frictions could suddenly become relevant and capable of operating a regulated business in this field.

[00:17:16.10] Ben: So it seems that a lot of the promise of digital currencies, cryptocurrencies, Central Bank-issued Digital Currencies, is about democratization, is about making everything to do with finance cheaper, easier to access, having less friction. So, is that where you see the benefit? Do you see that finance becomes open to everyone because you don’t need a bank account — you can diversify your assets for, you know, very small holdings? Or do you think it’s something bigger? So the reason I ask that is because, on the way here, I re-read the classic article by Chris Dixon, “Why Decentralization Matters?” And for him, it’s much more than just democratization. It’s about introducing new, better incentives for digital commerce. Do you see it as big as that?

Adrien: I see it even bigger than that. It’s much more than finance, it’s much more than payments. It actually can have dramatic consequences, in my opinion, in a good sense. But beyond this obvious industry that is finance, one example is governments today or the way we operate a company. Let’s start with this simple use case. Today, a company, if you’re in Switzerland, you create your company, you say, “Oh, I’m going to inject 100,000 Swiss francs for the capital, I’m going to be the shareholder of this company, I’m going to be subject to specific laws that have been established. I can set up a shareholder agreement.” All of these things, if you think about it, they are arbitrary. It happens that through history we’ve defined that this is the way it should be in a country, and every country will have a different way of operating with companies. But in the end, it’s nothing more than a series of contracts. And all of these contracts can be fully digitalized on the blockchain. This is exactly what these so-called ‘smart contracts’ are about. They’re not just for tokenizing things. They’re also for digitalizing companies where you can have an algorithmic Board of Directors, shareholders that can vote, you can pay dividends to anonymous shareholders that you don’t know anything about, except that they hold a part of this abstract company. You can take decisions and vote as a Board of Directors, not because you all meet in the same room, and you have the law of Switzerland backing you, but because you just vote with your token, in a smart contract on the chain. So, a company is something, if you see it this way and you do the abstraction that is nothing more than a set of contracts, I see a future where this simple concept may be completely digitalized and even the government here would become less and less relevant in regulating and controlling how companies operate.

Adrien: That’s just a tiny example, but if you push this further, you can start thinking about many laws that exist today, and are enforced by the centralized governments. You know, we have a centralized government, we speak about democracy, but in the end, there are a bunch of people that vote to elect legislators, legislators create laws that do not always reflect what do people want, these laws are then enforced by judges and courts that may even interpret the law in a different way than it was written, which was different from what the people actually wanted — and you end up in a system where you have dozens of intermediaries and a very centralized system for politics, for law, for justice. And I can see a future where blockchain and smart contracts can be used to create new incentives where many of the laws that we have today become irrelevant because they are already backed by some form of smart contracts, and the protections that the law offers us today can be enforced by algorithmics, by codes, by programming, and you no longer need to have armies of lawyers, judges, courts, and politicians creating laws because it trades into code running on the blockchain. So, that’s, I think, a very exciting future, obviously very disruptive — I’m not sure regulators will be happy about it, because it takes away some of their power — but I think it also can create a world with much more certainty, where, when you sign a contract, which in this case is digital on the blockchain, you’re not fearing that law may change in the next two years, or that the courts may interpret your contract in a different way, that the counterparts in the contracts are maybe dishonest. You agree on a contract, you don’t ask the lawyers and the judges to agree with you. You just code it in a specific way and you get the two parties of the contract to agree and to let the blockchain execute it with no ambiguity.

[00:21:32.25] Ben: You mentioned Libra, right? When we think about Central Bank-issued Digital Currencies, they are decentralized to a point, but they’re not completely decentralized, because you still have, I guess, one per country, one per nation-state. Whereas, it seems that Libra is trying to do something which is truly global, right? So, do you think that Libra is therefore the best medium of payments that could be or a better form of that?

Adrien: I think the ambition of Libra is very different from the ambition of a central bank. You know, a central bank, by definition is central. Why would a central bank aim for decentralization when even its name includes the word ‘Central’, you know? A central bank wants centralization, it wants all of the power to decide on what’s best for the economy. Then, we can debate whether it actually does what’s best for the economy and I would argue that it does not. But I think there are as many opinions as there are economists on the market. The point is, a central bank is not here to decentralize. It is here to provide a service which is systemic to the economy. I’m pretty sure, although this is obviously a market that is immature today, that any platform that a central bank deploys for Central Bank-issued Digital Currencies like a digital Swiss franc, is going to be rather centralized than decentralized. What is going to provide as a benefit is that it’s probably going to be peer to peer. So, you will have the ability to store and transfer these Swiss francs person to person with no intermediary — but through Central Bank, of course — however, I don’t expect that they will build and provide an infrastructure which is maintained by dozens or hundreds of thousands of different users or companies. I think this is not necessary for what they aim to do.

Adrien: However, Libra has a different ambition, which is to provide a neutral platform, which can host, then, a lot of different initiatives. It could potentially be used by a central bank to issue its coin on the Libra network, it could be used by a private company that wants to issue its coin — whether it’s a currency, a stable coin, or whether it’s a commodity token or something else — on the Libra platform. So, I see Libra more as infrastructure or as really an open platform than it is about providing money. Of course, one of the main use cases of the Libra platform is for this consortium of private slash public companies or entities to jointly control and potentially issue a stable coin. The Libra Foundation or Association is responsible for managing these stable coins for different currencies that they announced and this can look very much like what a central bank would do. But to me, it’s just a specific use case that they could have achieved with this Libra platform. And I wouldn’t be surprised that in the future we’ll see hundreds of new use cases like this one on the Libra platform the same way we see so many different applications of smart contracts on Ethereum.

[00:24:28.13] Ben: To pick up on that, you introduced the term ‘stable coin’. What’s the difference between cryptocurrency, digital currencies, and stable coins?

Adrien: So a cryptocurrency, at least if you think about Bitcoin and the ones that get a lot of inspiration from Bitcoin, a cryptocurrency is a fully decentralized currency. And by this, I don’t mean just that the blockchain — which is the ledger that stores every transaction and wallet and balances — is decentralized, I mean that the currency itself is not controlled by any central party. So, who is responsible for creating new bitcoins on the network, managing the monetary policy of Bitcoin? Well, it’s no single person. It’s actually the whole network itself that has to agree on the terms of the next bitcoins to be created in the network. And so, the management of Bitcoin itself is therefore fully decentralized. What it means also is that there is no central party that can decide whether it would make sense to create more bitcoins today or less bitcoins today. It’s fully algorithmic. This is very different from what the central bank does. If you think about the Central Bank, it looks at the economy, it looks at the exchange rates of the currency, and based on this, it will decide, “Well, should we print more Swiss francs? Or should we print less Swiss francs?” This will be a dynamic politically-based, in a way, or economics-based decision process that defines how many Swiss francs are in circulation. So, that’s very different. This is how the central bank is capable of keeping this stable, because depending on the status of the economy, it can decide to print more or print less, so that the purchasing power and the exchange rate with other currencies is relatively stable. With cryptocurrencies, you cannot do that, because they are fully decentralized, nobody controls them, so they cannot adjust to the exchange rates. This is why you see Bitcoin rising so much or Bitcoin crashing so much, suddenly. It is not adjusting to the demand of the market. So, that’s the main difference between cryptocurrency in the traditional sense and a stable coin. A stable coin is generally managed by a central party, or has, at the least, if it’s not managed by a central party, some form of algorithmic pegging to the value of something that is stable in the economy.

[00:26:52.03] Ben: Let’s also talk a bit about blockchains, the underlying ledger. So, do you see that the Bitcoin blockchain will always exist? Or do you think that gradually, these blockchains will evolve and become more scalable, more composable over time? So, is it just the first generation or is it a blockchain that will continue to exist, that has continued relevance? How do you see the evolution of blockchains? And how many can there be at any one time, since, you know, to be secure, it needs a lot of computing power?

Adrien: I think that the alternatives that you propose are not necessarily mutually exclusive. If you think about Bitcoin, I agree it is a first-generation blockchain, by definition. It’s the first one that was launched and that actually survived. Now, it is also true that is not going to be the only one and that it’s already outdated from a feature point of view. The feature set of Bitcoin is very limited as compared to many new distributed ledgers and blockchains that exist on the market. At the same time, this is also the main value of Bitcoin, it’s its stability. It’s not changing every week, it’s pretty much the same code and the same algorithm that is running now for more than 10 years. And this is because of the stability that people and investors have so much trust in it. You know that it’s not going to break because of a new bug that nobody knew about, that was brought during an update or in some new feature implementation. You know that you’re facing the same thing as the last 10 years. So, if it was robust until today, there are good chances that it’s going to remain robust in the next 10 years.

Adrien: If you think about alternatives like Ethereum, Tezos, and the many other ones that exist on the market, their goal is not exactly the same. It’s really to innovate. And they do innovate. In many ways, they do much more than what Bitcoin can do. But at the same time, it’s also a risk, because if you’re an investor, if you’re using that in production, and there is a massive update of the platform, what are going to be the consequences on your code? Could it be that a bug is introduced, a security risk is introduced? You never know, really. And I think this is why, as an investor, you may want to also favor these stability components — and this is also why we see Bitcoin being so dominant on the market in terms of market capitalization and traction. It’s certainly not because it has the most use cases. I think that Bitcoin is pretty much nothing more than a stable deflationary — or ultimately deflationary — cryptocurrency that is therefore a good investment opportunity. It doesn’t do much more than that today, it can be a great payment protocol, but not much more. Whereas Ethereum provides all of these so-called smart contracts, which can simplify contractual relations between investors and you have an infinite degree of flexibility: you can program any arbitrary software running on the Ethereum platform which you cannot do with Bitcoin. So I think that today, the question is more, “What do you want to do with these cryptocurrencies?” If what you want to do is revolutionize the future, replace what I call, you know, companies being digitized, you can’t do that today with Bitcoin; you have to go with a more modern platform. However, if what you want is you’re looking for a form of digital gold, something which has gained trust over the years and that has shown to be something that is attractive that people like to hold, and that tends to keep its value to some degree, then I would prefer investing in Bitcoin for that. It’s really its main value proposition.

At this stage, we are at the beginning of this industry, where you still have a lot of competition — healthy competition in a way — you have a reasonable amount of different ledgers that are all credible, but you have still a very strong dominance with Ethereum for smart contracts and Bitcoin for cryptocurrency.

[00:30:21.02] Ben: If we assume that the end state or future states where we have decentralized apps, decentralized companies, or maybe digital autonomous companies, decentralized apps, decentralized finance — so we have, you know, a tendency to have a very large number of companies, and apps, and so on, the opposite of centralization. Underneath it, we still have the force for centralization of the blockchains themselves, right? Or not? Because, I suppose the subsequent question is, you know, how many blockchains do you think we’ll end up having? The permissionless ones.

Adrien: It always depends what you call centralization. You’re saying that we have decentralization that is the blockchain. It’s a bit like saying it’s centralized because we’re all on the same planet. You know, we all live on planet Earth. Of course, at some point, you have a centralized standard, if I could say, or a relatively central standard. Now, it doesn’t mean that this standard is centralized itself. If you think about Bitcoin, sure, it’s a very centralized standard. So the specification of how Bitcoin works is now agreed over by thousands of users, thousands of companies. However, the Bitcoin network is maintained by these thousands of users. So, if you want to change anything, you can’t do it by yourself. You have to convince thousands of other users. I think that this is actually a very strong value. This is the network effect. The network is more valuable as you start growing its user base, the network that it can reach. Would you use Bitcoin if you knew that only a couple of people on planet Earth would agree that you send them to them and that they sell a piece of bread to you? No. You like having Bitcoin because you know that there are millions of people that hold some, potentially you can go to a supermarket and buy a piece of bread with it. Maybe not everywhere, but this is starting to happen. And clearly, Bitcoin has value. You can exchange it for Swiss francs or something else quite easily.

You have this triangle, that you can’t get everything at the same time. You can’t get decentralization, security, and scalability at the same time. If you want two of them, you’re gonna have to sacrifice part of the third one.

Adrien: Now, having the fragmentation with dozens of blockchains, actually, in a way hurts the system. It’s great in the sense that it creates competition between these initiatives, and therefore, through competition, they have to improve to keep their momentum, keep their dominant position. However, at the same time, when you want to do something concrete — let’s say you’re a bank and you want to create a new asset on the blockchain — you immediately start asking yourself, “Where should I do that?” On Bitcoin, on Ethereum, on Tezos, on any of these other, you know, hundreds of blockchains. And therefore, whichever decision you take, is going to make some people happy, and some people unhappy, because not everybody agrees on the same standard. So, it’s always this trade-off between competition is a good thing but if you have too much competition and no standards, then it limits the innovation also. And I think at this stage, we are at the beginning of this industry, where you still have a lot of competition — healthy competition in a way — you have a reasonable amount of different ledgers that are all credible, but you have still a very strong dominance with Ethereum for smart contracts and Bitcoin for cryptocurrency.

[00:33:22.23] Ben: In the current internet era there’s a tendency for heavy concentration at the app level. I think the opposite is true in the crypto world, which is the concentration is at the protocol level. If concentration is at the protocol level, is the hardest thing, then, getting those protocols to scale? Because I remember you’re the first person I ever heard talking about sharding. So, can you talk about some of the ways in which these protocols are starting or the mechanisms that people introduce to try to get this whole infrastructure to scale better? And use less electricity?

Adrien: So, I think that’s multiple different issues. So, the first one is, I don’t know if it’s a theory, but it’s at least a very strong observation. You have this triangle, that you can’t get everything at the same time. You can’t get decentralization, security, and scalability at the same time. If you want two of them, you’re gonna have to sacrifice part of the third one. So, you could, for instance, like, Bitcoin has pretty good security, pretty good decentralization, but then, the scalability is not so good. Or you could say, “Well, I’m gonna centralize”, which is what we have today. You know, if you think before Bitcoin, we had these very centralized payment processors like Visa, MasterCard. And you can say, “What matters for me is security and scalability, so I want to be able to process thousands of transactions.” However, then in this case, it’s not going to be so decentralized. It’s going to be very centralized, actually. And having these three properties at the same time is very difficult. So, when we speak about ways of scaling the blockchain, sure, we can do much better than what we do today, but we have to be aware that this cannot be infinite. We cannot reach hundreds of thousands of transactions per second or millions of transactions per second, keeping the same level of security and decentralization. You will have to start, you know, sacrificing some of these properties.

We should not see energy consumption as the devil. It’s part of any successful industry, and I would tend to argue that securing value, which is probably the most important thing today, in a globalized free market, being able to secure wealth, secure value and purchasing power is arguably much more important than many services we pay so much for in terms of electricity

Adrien: Now, what we see happening is the capability to indeed use sharding techniques where potentially part of the network validates some kind of transactions, and the rest of the network validates other kinds of transactions, and therefore, because you don’t have every single computer of the network validating every single transaction, then you can maybe double it or triple it, depending how you shard, how you allocate this subset of operations to each of these maintainers. Now, I don’t want to get into the details, but this is typically one sacrifice because now rather than having all of the users checking everything, you only have part of the users checking some things. One could argue that in many cases, this is sufficient — and I think it may be the case that it’s sufficient for many applications — but by definition is obviously less secure than everybody looking at everything. So this is one of these trade-offs.

Adrien: Another way of scaling is to not have every transaction written on the blockchain. Of course, when Bitcoin started, it was the assumption that, you know, everybody could write a transaction on the blockchain, or at least some people believed that. I don’t think Satoshi Nakamoto himself believed that. He wrote something in one of his, I think, messages or maybe in the white paper that suggested he was aware that this would not scale forever. But clearly, it was realized at some point that you could not scale what you write on the chain, forever. You would have to, at some point, decide to write transactions outside of the chain. And so, what we see today as a possible way to scale is to say that small transactions, fast transactions that require really high frequency, but maybe do not need to be secured to a point where you write everything on the chain, they could be processed more centrally between two parties using cryptography. So, in a way, it would still be relatively secure, no way for an intermediary to steal the funds or to break the chain. But you would only rise the settling transaction, the clearing transaction on the chain after you have reached a point where the risk that you have of chain is maybe too high for your tolerance.

[00:37:16.08] Ben: Is that how you see permission and permissionless blockchains coexisting? So, just again, for the benefit of our listeners, can you define what the difference is between permission and permissionless?

Adrien: Yeah. Permissionless ledger is like Bitcoin. It is a ledger that can be used and maintained by any user. If you have an internet connection, not only can you use Bitcoin, but you can also maintain it, you can be what is called a miner — so somebody that’s going to protect the network actively — and you don’t have to ask anybody; you don’t have to ask the government, you don’t have to ask your bank. You can just participate in maintenance and use it however you wish, like any other user on the system, without any permission. That’s what we call a permissionless ledger. Now, of course, not everybody is happy with this solution. If you think about banks, for instance, they don’t like the idea very much that they would start issuing securities and have to have processes to apply compliance logic on something which is, in some way, out of their control. So, in the last five years, or maybe more than that, several initiatives have been launched to create things that looked very much like Bitcoin or Ethereum but that are not controlled by any internet user. They are controlled by a subset of pre-approved users. That could be a consortium of banks, for instance, where you take a consortium of 10 banks, and each of the 10 banks knows which are the other banks of this consortium. We can verify, therefore, that only just 10 banks are maintaining and protecting this network and potentially accessing its information. So, this is a permission ledger, a ledger that is not accessible by anybody.

[00:39:00.14] Ben: And so, you could see a situation where a consortium of companies or banks might do supply chain finance, for example, in a permission blockchain, and then write the resulting transactions into a public or permissionless blockchain.

Adrien: It could be the case. I think we’ve seen quite a few projects going that way, where a permission ledger is used a bit like intranet — you know, like, before the internet, we had more intranet — so it’s used a bit more in a private context. And when you want to settle or when you want to get back to a more public standard, you would operate on a public chain. I’m not a big believer in permissioned ledgers, to be honest. I think that although in some use cases, they have a strong value proposition, in general, they are not so much more than a very secure database. You could, in fact, implement a permissioned ledger with some SQL database with additional layers on top of it, checking the integrity of data and making sure that multiple parties have ways to audit the contents. And so, I sometimes am a bit doubtful that this can establish itself as the new standard for digital currency management. However, in some cases, we’ve seen interesting applications. In particular, when you have natural consortiums for specific applications, if you look at a specific supply chain, it may be that indeed, you don’t need to open up to the rest of the network, you just want these specific dozens or hundreds of parties to be involved. And why would you then go on a public chain where you have to pay fees, where everything is public, and therefore you have privacy leaks, and where you’re not in control — so, it’s harder to apply your governance logic on top of it. In these cases, indeed, using a permission ledger is an interesting alternative.

Cryptocurrencies in general are becoming much more legit. And we see it concretely happening with regulators opening up everywhere in the world and reputed banks moving in this field, also.

[00:40:49.00] Ben: We’ve talked about how blockchains can become more scalable. Another objection that people raise is that, you know, they’re so wasteful in terms of… You know, because trust is achieved through mathematics, and mathematics is done by computation, these need an awful lot of electricity, right? So, there are ways — proof of stake and so on — that are emerging where we don’t necessarily have to burn a whole lot of electricity to create the trust, right? So, do you mind just talking about some of those emerging techniques?

Adrien: Yeah, sure. But, before I speak about these imaging techniques, maybe there is a philosophical question, which is, do we actually care? If you think about this, governments use a lot of electricity too, and we’re not arguing that we should remove all governments on planet Earth, just because they turn on the light when they get to work. Banks use a lot of electricity. Gold mines, when you’re mining gold, you use a lot of electricity.

Ben: And there’s also, we can put electricity on a renewable rail.

Adrien: Of course, I think we’re getting there in the future. We may have actually a very efficient way for, if you think about, some of these renewable energy factories, however they do it, that don’t know exactly how to store the electricity, they don’t want to sell electricity at the wrong time during the day. Well, they could actually use this electricity to mine Bitcoin when it’s not profitable to sell it on the market and rebuy electricity later. So, I think we should not see energy consumption as the devil. It’s part of any successful industry, and I would tend to argue that securing value, which is probably the most important thing today, in a globalized free market, sort of economic system, being able to secure wealth, secure value, purchasing power is arguably much more important than many services we pay so much for in terms of electricity. You know, if you ask me, I’m a bit of a libertarian so I’m quite open-minded about this. But if you ask me, if you want to save energy, I’d say maybe fire a third of the government. Maybe a third of the administration today is not so necessary. If you think about it, we have all of these laws that are no longer relevant and that need to be implemented, that need to be monitored. Let’s save energy! You know, fire some state employees. Or maybe some banks are no longer so efficient, so we can fire some personnel in the bank. So, I know it’s a bit hard to say that, but the energy consumption is not something we should necessarily avoid. We could argue that having the most secure blockchain on the market today — that is Bitcoin — has a price, an electricity price, but this price may be the right price for the service it provides.

Adrien: Now, you’re right that there are some new initiatives. It’s been quite a few years already that what is called proof of work — proof of work is the main mining algorithm on Bitcoin, which is so energy-consuming. There are new initiatives to replace this proof of work algorithm with more modern or let’s say different ways of securing the blockchain. And although I doubt very much that Bitcoin will adjust to it — because again, the main value of Bitcoin is that it doesn’t change so much — we already know that other chains like Ethereum or Tezos have moved or will move to such a new way of securing the blockchain. Now, it’s not perfect either. It may be more ecological, you may use less electricity — actually, significantly less electricity — but it has other security weaknesses that it introduces, that we don’t know much about and it’s not clear that it’s actually as secure and as neutral that the Bitcoin system is. So I think it’s good for innovation, but I would not be so convinced that this is the way everything has to go. I think Bitcoin remaining the way it is, it’s actually a very strong value proposition.

[00:44:37.25] Ben: Because in its essence, if somebody has a larger stake then somebody else has more say over the blockchain, is that right? So it’s not as equitable or not as fair.

Adrien: Yeah. But, you know, in this proof of stake modality, which is this alternative to proof of work that uses less electricity, if I want to make it simple, the richer you are, the more control you get. So if you’re rich in terms of coins and cryptocurrency, you’ll have larger control over the network. And the assumption here is that it’s very hard for somebody to centralize so much that it has a lot of control over the network by becoming very rich. Well, this assumption is correct. If you look at history, and the billionaires of yesterday that now are worth more than 100 billion or 200 billion, you may wonder if this assumption of relatively decentralized coin distribution is valid. Of course, there are ways to counteract on that, you can create counter incentives for cheaters or abuses of the system, but is it going to be perfect? I think nobody can know for sure until this is concretely implemented.

Adrien: Now, if I want to be honest, proof of work is not perfect either. So, this existing Bitcoin protocol that secures with what is called mining, it is heavily electricity consumption is not perfect either. There is also a degree of centralization, the reason being that as soon as a company emerges and makes profitable business rounds of mining, it’s going to grow, it’s going to hire more people, buy more hardware, and is going to concentrate a lot of mining around its factory. And what we see today is that China is one of the main miners. It has several of the largest mining factories, and electricity price is one of the key drivers of where you would like to establish such businesses. Some countries naturally attract mining, other countries naturally reject or repulse mining because it’s too expensive and not profitable. And even though mining is interesting in the sense that, in theory, anybody could just turn on its computer or laptop and start contributing, and therefore creating very decentralized networks, in practice, your laptop is so weak or is so bad in comparison to professional miners that it has become unrealistic to compete with professional miners, unless you heavily invest in professional hardware. And that means that most people will not do it, and therefore centralization also appears.

[00:47:05.12] Ben: And is that centralization of mining becoming a problem? Does it make the network vulnerable?

Adrien: By definition, having excessive centralization always means it makes it more vulnerable. At one point it becomes really vulnerable is hard to say. I think we’re far from that. And even though it is relatively centralized today, it still is an oligopolistic control. And the interesting property of such protocol is that even if you have a miner that represents, I don’t know, 5% of the total mining power, and therefore, one could say has 5% of the mining power, he cannot do anything by himself. He would need to align himself and have a handshake agreement, or a contractual agreement with up to 50% of the mining power — so many other parties on the network — to finally reach a point where this is potentially dangerous for the network. What we’ve seen in the past that this sort of centralization event can happen. There were multiple times in the history of Bitcoin, where mining was so centralized that the top two out of three miners, were almost able to control the network. What we’ve seen is that naturally, without trying to enforce new rules or change the protocol, the network itself got so afraid by this amount of decentralization, that it fragmented by itself. So, some of the contributors of these mining pools, you know, these mining companies, decided to switch and move to different companies, because they didn’t want to be potentially parts of excessive centralization, that would hurt the trust and the security of the network, and presumably the value of the coin because the value of Bitcoin heavily depends on how much you trust it.

[00:48:49.10] Ben: So we’ve come a long way. So, you know, initially we had this, you know, in for me, of being a place where criminals did business, right? And then we had this sort of, Bitcoin boom. I remember Jamie Dimon said that Bitcoin was worse than tulips. And then, it just seems that, you know, as time has gone on, more and more institutions have entered this space. A lot of the negative reputation has disappeared so, I think most people recognize that it’s not a place where exclusively criminals do business. And it seems like in the very recent past, there have been a number of key masters, right? So, people like Paul Tudor Jones writing that letter where he said he was going to invest in Bitcoin, he saw it as a reputable asset, and the OCC saying that banks can now act as custodians and Renaissance Capital now being able to trade futures. Do you think we’re reaching some sort of tipping point where Bitcoin moves from an edge case niche financial product to something which is truly in the mainstream?

Adrien: I think there is no doubt about it. The only thing that’s missing is the regulatory approval in some countries — actually in many countries — and the ecosystem and infrastructure to build up so that the banks or the institutions that are moving in this field, have the technical capability to do so. What we see — our company Metaco is well-placed to know about this market because we’re in discussion with dozens of banks pretty much everywhere in the world — and we see the demand is very, very strongly increasing. It’s generally a demand that needs to start building today to be productive or operating in a couple of years. So, it’s not something that is so responsive. You’re speaking about large companies, large banks, or even smaller banks, but that have a lot of other considerations — the regulatory aspects, the risk, the reputation. The market is moving now and it’s a given, at least to me, that what we knew about Bitcoin — five, six years ago, it was the preferred currency of the dark web Silk Road markets to buy drugs, weapons and pay hitmen — is very far away now. And Bitcoin criminality, of course, is always going to exist the same way that you still use dollars for terrorism financing and money laundering or whatever criminal act — or Swiss franc or any other traditional currency. Bitcoin is not going to be an exception. Of course, there will be criminal activities with Bitcoin. But Bitcoin is becoming much more of a legit currency. Cryptocurrencies in general are becoming much more legit. And we see it concretely happening with regulators opening up everywhere in the world and reputed banks moving in this field, also.

[00:51:42.10] Ben: Did you ever have any doubts that cryptocurrencies and blockchain would become a mainstream phenomenon?

Adrien: I personally never had doubts about it, otherwise, I would have probably sold my coins multiple times in the last seven years, as the market crashed — which happens regularly. I think for me it was clear, and it still is clear. What I could never have been 100% convinced is whether Bitcoin would be the winner, or Ethereum, or something else. I’ve also made a lot of wrong bets on some of these other currencies that I did not invest in, because I thought they would never succeed. And actually, those things can be worth more than a billion today. So, nobody really knows, I think Bitcoin is here to stay and I think it’s going to be a very, very strong new asset class on the market as it becomes more mainstream. I’m pretty sure that the other smart contract platforms on the market, like Ethereum, are here to stay. They have this very strong network effect today, where they’ve almost established themselves as standards. So, a big question has always been which of these cryptocurrencies are going to survive? But I think we’re very close to having a concrete answer to that question today.

We, at METACO, focus on infrastructure, and then we work with regulated partners, which are banks, in making sure that they have the most solid and professional infrastructure to protect their assets, to start tokenization use cases, do anything that is related to the blockchain.

[00:52:53.27] Ben: I just want to maybe finish off by talking a bit more about Metaco itself. So, you recently raised a 17 million Swiss francs series A round in the middle of the COVID-19 pandemic. So, that would seem to indicate that this space, again, is hot and becoming mainstream. But can you just talk a bit about why you’re different from some of the other companies that provide custodian infrastructure? Do you think it’s because you’re principally on the side of the banks and the financial services companies?

Adrien: Yes, indeed, we’ve gotten through a Series A financing round, where we raised 17 million. To be fully transparent, we started the fundraising before the COVID. But, you know, it doesn’t change much about the outcome, which is, you know, raising funds takes more than six months.

Ben: And it was a larger raise than you were initially seeking, right?

Adrien: Oh, absolutely! We aimed to raise 8 million, we ended up with more than 20 million on the table and we settled at 17 because we didn’t want to get into a lot of negotiation about new valuations, reducing dilution, etc. But it was a very successful round. To be honest, it was not the easiest period to close such a round. It is clear that a lot of venture capital funds on the markets stopped any discussions they had not just with us, but with any company on the market because they had to focus on their existing portfolio of companies that maybe may have been suffering because of the period. I think we’re getting back to normal now but we’ve been extremely successful in also the companies that we brought as shareholders. You know, Standard Chartered Bank is one of our shareholders, Zuericher Kantonalbank — it’s massive players in the banking sectors. Standard Chartered is a global custodian, Zuericher Kantonalbank is one of the most reputed banks in Switzerland. We brought a company called Giesecke+Devrient, which is one of the security giants that is supporting central banks everywhere in the world, and that is also very much focused on Central Bank-issued Digital Currencies, which is one of the reasons for the investment in Metaco. So, incredible investments and opportunities opening up with these different new partners and shareholders.

Adrien: I think as a general comment on the company, we are very special in the sense that we are specialized engineers in cryptocurrencies, in blockchain, in security, and obviously in software engineering, but we don’t focus so much on regulated services. We actually don’t want to become a regulated company. We focus on infrastructure, and then we work with regulated partners, which are banks, in making sure that they have the most solid and professional infrastructure to protect their assets, to start tokenization use cases, do anything that is related to the blockchain. And so, for that today we have the chance of still being very much of a startup. We are agile, we can take decisions very fast, very efficiently, depending on the market conditions. But, at the same time, we’re backed by extremely solid companies, we have a lot of liquidity and that gives us all of the opportunities to scale not just in Switzerland, but in Western Europe, Germany, and Singapore, Southeast Asia, and in North America.

Ben: Fantastic! Adrien, thank you very much for your time!

Adrien: Thank you, Ben!

Creating the Wikipedia of Impact Investing (#33)

Structural Shifts with Bertrand GACON and Sylvain MASSOT, co-founders of Impaakt

Today’s guests are reinventing the way the world measures how sustainable companies really are. Yes, we do have ESG data and CSR reporting, but those measure practices rather than impact, and describe policies rather than outcomes. In this episode, the co-founders of Impaakt — Bertrand Gacon and Sylvain Massot — are sitting down with host, Ben Robinson, to talk about how they are creating the Wikipedia of impact investing. Leveraging the collective intelligence of a large community of analysts to assess the social and environmental impact of large listed companies, they offer investors and the financial institutions the data they need to allocate capital to the companies who are having the most positive impact, and also to give everyday citizens the information they need to decide who they want to work for, who to buy from, who to advocate for. 

Full transcript

 

 

ESG is about finding whether the companies are doing things right. Impaakt is about finding whether companies are doing the right thing. And that’s very different.

[00:01:39.10] Ben: Okay, so, both of you, thank you so much for coming on the Structural Shifts podcast. I wanted to start by just talking about the ESG market sustainable investing in general. Is it to direct resources away from potentially harmful industries, those that are socially environmentally harmful? Or is it about getting a better return on investment because you’re investing in things that are sustainable?

[00:02:05.23] Bertrand: Well, actually, the answer should be both, actually. This is where it all started, but there have been many different layers and approaches when sustainable investment developed over time. It all started with the exclusion of the so-called negative screening — that was actually created more than a century ago — and the main proposal of that approach was really to align your values with your investment portfolio. So, getting rid of tobacco, weapons, alcohol. It was mainly a faith-based organization that started with that. And for many, many decades, it remained something very basic in terms of how sophisticated these approaches were. And then, at the beginning of the 1980s, it turned into something more advanced, where we replaced the exclusion approach by positive screening. So, instead of getting rid of the bad guys, the idea was to start trying to measure how good and responsible were the good guys, and this is where the ESG score started to come into place. And, at that time, it was still about trying to invest more responsibly and more sustainably and it took another decade before we figured out that actually, we can have both performance — financial performance — and sustainable investments. And this is where also the impact investing appeared and went on top of those previous approaches that I’ve just described, where the idea is really to identify companies that are doing good and bringing positive impact to the world and society and the planet, while, at the same time, making sure you can make profit out of that.

[00:03:49.03] Ben: In other words, you don’t have to sacrifice returns if you want to do the right thing. Is it just sort of, you know, pressure from institutional investors and retail investors that’s driving this market, or are there other forces — regulatory or any other drivers?

[00:04:07.05] Bertrand: Well, it’s a combination of many things. In the beginning, it was really more few private investors wanting to advance in that direction. But then, once some track record has been established, investors wanted to follow through and this is now very much driven by consumer demand, possibly due to the generation shift that we saw when the so-called famous millennials that are looking for, well, this kind of alignment, but also because the regulators are following through. And we saw very recently, the EU Taxonomy, that is a whole set of regulation that is trying to establish some common language and common ground to define what sustainable investing is all about. And this, in turn, is further accelerating the movement in the financial industry, because the pressure is just coming in from all places at the same time. But I have to say, what really has been the biggest accelerator in the last three years, really has been financial performance. When bankers started to realize that the performance of portfolios actually was better when you invest according to ESG standard than not, then of course, this has led to a whole shift in the financial industry.

[00:05:26.18] Ben: Sylvain, I read that 2019 was another record year for ESG funds or inflows into ESG funds. How big is ESG investing today? In absolute terms, and also as a share?

I just came across a graph showing that the inflows in the ESG and sustainable investment strategies are almost twice as much as the inflows in more traditional strategies since the beginning of the COVID crisis.

[00:05:44.26] Sylvain: Sure, and then you have to realize that the definition of ESG is actually quite loose. So, by that, we are talking about everything starting from exclusion strategies that we were referring to — best in class — and all other legislative impacts. that our best estimates, although the data stopped to give each day is that it’s probably about 30 trillion US dollars worth of assets that have some kind of ESG strategy attached to it. So, if you relate that to this total size of the asset management market, which is about 80–90 trillions, about one-third of the total market is now exposed to ESG.

[00:06:26.21] Ben: And Bertrand just mentioned that the performance has been better than other non-ESG funds. Do you have statistics on that, as well?

[00:06:39.01] Sylvain: I think the jury is still a bit out whether you are generating constantly better return from your first few years. I mean, they’ve been factors like you know, excluding some sectors, the energy sector typically, which has been helping with performance. But what we can say for sure is it’s not a detractor of performance, which was the accusation that we had back a few years ago that by investing ESG, you were sacrificing returns.

[00:07:08.03] Sylvain: You also mentioned that the year 2015 has been an important year, because this is the year where the sustainable development goals were achieved by the United Nation, also the year of the Paris agreement, and it’s also the year of the Dieselgate from Volkswagen. And all those three events coming together have led to kind of a wake-up call in the financial industry, and some players started to remove from their portfolios those high ESG risks companies, which in turn might have also explained part of the movement that we saw, and therefore, the increased performance that happened in the next few years.

[00:07:47.13] Ben: So are we able to trace to 2015 a very big jump in ESG interest in influx?

[00:07:54.20] Sylvain: I think it has been prophesied. I mean, it’s not just like it happened all of a sudden, with people waking up in the morning and switching all of their portfolios. But part of the growth of the industry is to be able also to deal with what we call integration. So it’s not only new funds being created and raising assets, is also all the strategies being transforming to green strategies or sustainable strategies, which means that part of the assets, you know, that we had before, all of a sudden became ESG sustainable assets which also explains how we could go so quickly into trillions and trillions of dollars being invested.

we see a huge wave of transformation in the financial industry — and what used to be a niche only five years ago, is now becoming completely mainstream. So, you will struggle finding any major bank in the world not doing sustainable investment today.

[00:08:33.02] Ben: Do you think COVID-19 is also going to act as a driver for this market?

[00:08:37.28] Sylvain: Well, the first data that we saw, yes, is pushing into that direction. I just came across a graph showing that the inflows in the ESG and sustainable investment strategies are almost twice as much as the inflows in more traditional strategies since the beginning of the COVID crisis. I’m not sure there is a direct relationship to that. Maybe this would have happened anyway, with or without the COVID, but for sure, it has not been slowing down the process. And as I was mentioning, now, the performance is a topic that is no longer a reason not to go into investment, into sustainable investment. Then we see a huge wave of transformation in the financial industry — and what used to be a niche only five years ago, is now becoming completely mainstream. So, you will struggle finding any major bank in the world not doing sustainable investment today.

[00:09:31.04] Ben: That was going to be my next question, actually, which is, you know, if sustainable investing is kind of, you know, is doing the right thing and performance doesn’t suffer, we do the right thing, then, you know, others can only hold us — there’s still banks or fund managers that don’t offer ESG funds and indexes and ETFs.

[00:09:52.05] Bertrand: Yeah, of course, you find, you know, some boutiques or specialized asset managers that have very specific strategies where ESG integration is not so easy, or maybe their clients are not so interested into that. So, you see funded too but, you know, that was exactly the reverse six or seven years ago — you would only find a few companies that were really doing sustainable investment as their core offering. So now, of course, if you look at the details on that, you might find very different realities and, you know, behind the communication and marketing strategy of those different asset managers, how deep and how serious they are in the integration of ESG, then you’ll find very different situations.

[00:10:40.02] Sylvain: Yeah, if the issue is about potential brainwashing because it is not fashionable and then a lot of these assets have only a very tiny overlay of ESG attached to them.

[00:10:54.00] Bertrand: And it’s very easy to kind of green your agenda, you know, just by pretending you integrate some ESG environmental in this appropriate era. What does it mean in practice? How much your investment decision is really being affected by those criteria. Is this something you just use to slightly inform your research or is it something that triggers divestment or investment decisions, right? And this whole level of details is really why you can tell the difference between the ones that are doing it seriously and the ones that are just doing it because it’s become fashionable, as Sylvain was saying.

[00:11:28.26] Ben: Do you believe that this really makes a difference to the green agenda as compared to, you know, technology change or government action? Are we really moving the needle with ESG investing?

[00:11:39.27] Bertrand: The answer is probably yes and no. And we can see companies that have made a lot of progress when it comes to adapting their practices in terms of their processes to become more sustainable in many industries, actually. Now, all these good changes that happened — and I have to say, many companies really embraced the change have done some progress, and have made some progress in terms of becoming more sustainable in their practices, but where we are really missing the picture is that the ESG data is only about practices and it has not forced the financial industry so far to really rethink asset allocation or sector allocation, right? Because it’s being more or less agnostic in terms of what is your core business. But it does say that if you want to pick a carmaker, it will tell you which of those carmakers is more sustainable than another one, but it does not tell you whether it’s better to invest in cars than it is to invest in bikes or whether it’s better to invest in old energy, rather than to invest in renewable energy, right? It doesn’t tell you that. And this is where we probably missed a big part, a big chunk of the need we have to transform the economy in a much deeper way, by really using impact measurement, and not just ESG measurements to make informed decisions.

[00:12:57.09] Ben: Sylvain, is there anything you want to say? Because I think we’re getting into the next topic, which is, you know, the problems of the way that we do ESG calculations today, and ranking.

now is really the time to go one step further, beyond ESG. And the financial industry has a very strong responsibility in triggering that change because there is nobody than the managers and CEOs listen more to than their shareholders

[00:13:08.12] Sylvain: I guess, we look at it also from the pool of assets we which are reliable. There’s no denying that, you know, asset managers can exert some pressure on their companies, there is no denying that these large companies manage the biggest investments, you know, compared with the smaller companies. And I think with ESG we have an example like, you know, back 10–15 years ago, where governance was not necessarily very much on the agenda of the people and companies, and now the ESG governance becomes basically mainstream. So, I think it really matters to have these ESG strategies to make the world change.

[00:13:50.14] Ben: Companies care because it affects managers’ compensation, and so, they want to be ranked well, and therefore that affects the way that they invest or the kind of investments they make. So that’s how it makes a difference today through compensation?

[00:14:09.08] Sylvain: Yeah, through regulation. I mean, through competition as well. You know, there’s nothing that a manager hates more than just to see their direct competitor having a better ranking or a better sustainably ranking than they do. So, there’s a number of drivers there and I think all of that has created a good momentum in the market. We now really need to go beyond ESG because for all the good thing that ESG has brought, we are still not moving, again, the transformation of the economy at a pace that is the one we need to address the many challenges that we have and this is more than time now to go beyond ESG. It was a good way to start that, it has already led to some good momentum, good changes. I think, you know, most managers are really keen to see their rating improving over time. But now it’s really time to go one step further and the financial industry has a very strong responsibility in triggering that change because there is nobody other that the managers and CEOs listen more than their shareholders, just because of the compensation that you mentioned.

[00:15:16.04] Ben: If we really get down to the first principles, what is the issue with the way that ESG rankings are calculated today?

[00:15:27.27] Sylvain: It’s really looking at the practices — you know, whether a company has good policies in place — but it’s not going to judge whether the product and services of that company are having a positive or a negative impact on the planet and society. So, I’ll just give you one very simple example, which is an example which we’ve been exposed to, in our former life as a professional in finance. If you look at the energy sector, if you want to take to the company with the best ESG rating within the energy sector, it happens to be Repsol nothing against Repsol. I mean, it’s a very well-managed company and it’s got very good policies in place, it’s very transparent about what it does, about the reporting of their emission and so on. At the end of the day, it’s a company which is producing fossil fuel, which has a very big carbon footprint. If you take a company typically in the renewable energy sector, a smaller company, I mean, the footprint is obviously much better, but these companies do not necessarily have the same policies in place, they do not communicate as well as Repsol. So you get in front of the client, and you tell them, “You know, I selected the best company in the energy sector, so you should be happy to see that it is Repsol. It just doesn’t work if you really want to understand whether this company has a positive or negative impact on the planet.

[00:16:54.05] Ben: So even though renewable energy company scores worse than…

Sylvain: Much worse, but again, there’s nothing wrong with what the traditional ESG provider is telling me because they’re only interested in measuring whether this is a good company with good practices, good policies, and doesn’t judge the impact.

[00:17:14.12] Ben: And why has the industry focused on procedures and not impact? Is it just because it’s very easy to objectively judge procedures, but it’s hard to objectively judge impact? Is that the reason?

A pure big data approach will not enable you to necessarily understand the impact of a company, […] we still need the human brain, but one human brain is not sufficient to measure all the different aspects of impacts of a given company. So rather than just going for either an expert-model or a big data model, the most interesting approach is to use collective intelligence.

[00:17:29.04] Bertrand: I don’t think so. I think the main reason is that it was the demand at the time. ESG started 20 years ago, and 20 years ago, the idea was to say, “Okay, a company is no longer just a company that is making profit. You know, we should also care about responsibility.” And so, it was more of a question about how responsible is that company in how they drive their business, how they run their operation. So, the question was, you know, trying to find out whether those guys do things right. And this is how ESG started. So you get interested in what are your policies, you make sure you treat your employees right, or you make sure you control your supply chain, and reduce your environmental pollution. But it’s just about how responsible you are, not what is your global impact on the world and society, right? And those are two different questions. And again, at that time, we were happy with the answer to the first one, but the time has come now to move to the next one. And the time has come to go… You know, ESG is about finding whether the companies are doing things right. Impaakt is about finding whether companies are doing the right thing. And that’s very different.

[00:18:35.25] Sylvain: But let’s face it! It is also true that it is much easier to assess the practices of companies than the impact of companies which have been huge for multi-facet products operating in many different countries. It’s much easier to send a questionnaire to a company to say, “Are you having the right policy there?” than to making the full assessment of the portfolio.

[00:18:58.01] Ben: Because I guess it’s a question of both data that exists, right? So, what is the carbon footprint of the company but also how do you judge, for example, you know, pumping effluents into the river versus pumping carbon into the atmosphere? How do you make value judgments about these different impacts?

[00:19:16.29] Sylvain: Yeah, you’re touching on some of the flaws of the existing ESG methodology. The first one is that, of course, if you only are interested in practices, the best thing you have to do is to ask the company, right? So, a large part of the information is just coming from the companies. And Sylvain was right to mention that this is done through questionnaires sent to companies and companies answer to this questionnaire and this is how you calculate your ESG scores. Now, the impact, you know, is much broader and the company might not be the best organization when it comes to answering what is the global impact that you have on the planet and society. Just take the example of, I don’t know, of any tech company like Facebook, right? Facebook has much impact on the world in terms of democracy, privacy, you know, access to information, fake news. I mean, we saw many of these issues, some of them, you know, being very important in terms of scale that they can have, and the impact they can have on the world. Well, I’m not sure that, you know, Mark Zuckerberg is the best person to ask when it comes to measuring the diversity of these impacts. So, we need to have a different approach that can be a lot more open, that can look into different sources, and not just the company, and that can really look at the impacts and not just practices. And this really was the frustration that we had, with Sylvain, when we used those data in the financial industry because we were also using these ESG data, we always got frustrated to the fact that they were not measuring what matters, and they were not getting the information where it was the most important to do so.

[00:20:51.21] Ben: A lot of companies are now looking into this, right? So, a lot of companies are taking a big data approach to this. It is not a questionnaire approach, but a sort of big data approach to trying to calculate the broader impact of companies. Why is it that you are not pursuing the same approach? Why do you see that there is a gap for a different approach?

[00:21:19.15] Sylvain: I guess, to start with, you know, the problem with the impact measurement done by companies themselves, just to be clear, we’re talking here about large complex companies. It is kind of self-assessment, and doing self-assessment means that, you know, your VC has a lot of cherry-picking and these companies are going to report on what they are doing. If we take the framework of the Sustainable Development Goals, a lot of companies are now reporting what they’re doing on SDG. But then you end up with situations like Philip Morris saying that they have a positive impact on SDG 3, which is about health and wellbeing. And it’s just because, again, you know, they are cherry-picking. And the problem we have here, we’ve been talking about brainwashing, the SDGs are, you know, the set of 17 goals are different colors so now we’re talking about rainbow washing. If you really just ask the companies, again, they’re going to tell you what they’re doing well, but not what they are not doing so well, what the negative externalities from their business are.

[00:22:21.05] Ben: We now have almost like a framework that’s emerging, for us to start to be able to calculate impact, judging the broader impact of companies. So, why not just take a big data approach? Because this is the moment for you to tell us a bit more about Impaakt. You are taking a much, much more radical approach, which involves, you know, creating content yourselves, right? So, why take the approach that you’re taking, rather than just seek to leverage additional datasets and take some sort of big data approach?

[00:23:00.04] Sylvain: I guess the issue we have is that assessing the impact the company has, according to one SDG, it’s not something which can just be measured in quantitative terms. It is a qualitative assessment also to do, above that. There’s also a lack of data. As I said earlier, a lot of the data come from the companies themselves, so you have to dig to get to the data, and you have to analyze this data. So, a pure big data approach will not enable you to necessarily understand the impact of a company, as on each of these SDGs, which is the reason why we thought, you know, we still need the human brain but one human brain is not sufficient to measure all the different aspects of impacts of a given company, and which is why we thought, you know, rather than just going for either an expert model or a big data model, what is probably the most interesting approach is to use collective intelligence.

[00:24:04.19] Ben: Okay, Bertrand, tell us a bit more about Impaakt and this idea and how you’re leveraging collective intelligence.

[00:24:14.01] Bertrand: Yeah, so the idea was, as I was mentioning, was, we wanted to create a system that was really looking at impact. We knew that it would be difficult, we knew it will be challenging, so we actually looked at big data as one of the first, you know, intuitive way of doing that. And we realized, for the reason that Sylvain just mentioned that was not the right way. I mean, we still use artificial intelligence to support the work of our analysts, but at the end of the day, we still need to have people that look at data, are able to put that into perspective, are able to also confront their views, building this collectively-built knowledge around the impact of companies. And the process works very much like a Wikipedia visual where it’s not one single person telling you about the impact of the company, but it’s many brains, you know, that each of them is having a little part of the information and we find a way of not only verifying that information because collective intelligence is also an open door to distortion and manipulation, so you have to get the quality control process very strict. But when this is done, if you find a way of gathering all that data and organizing it in a structured way to the depth of it, then you can really build a very strong and robust knowledge about the impact of companies. And this is the model that we started, actually, and we refined all the time, and now we are very confident about the value-added that it is really providing in comparison with any other solution that we can find on the market.

[00:25:47.20] Ben: Was Wikipedia the inspiration? And did you not think that that was just an absolutely massive, really ambitious mission, and you didn’t think that you might be entering into something that was a lot?

[00:26:07.22] Sylvain: Well, you know, if you want to get to the moon then you have to run for the stars, right? So it is huge. I mean, we were starting to concentrate on the 1500 largest companies of the world at one point in time and we want to cover many more, but even that number of companies is a huge challenge because each of them has many impacts in many different directions and we need to document each of them, write a report — a small report — on each company and making sure that, you know, the analysis that’s being returned is entirely vetted, that you fact check all the sources. So, it’s a lot of work at the end of the day. But the machinery that we’ve been able to create is working and we were discussing that before the podcast started, our main challenge is more to review all the analyses that are being published on the platform or submitted to the platform on a daily basis, to create the content itself. So yeah, it is working now and it is proving to be very disruptive and very interesting and the sky’s the limit in a way, because the bigger is the community and, of course, the more data we will process and the more research we will use. And so, as long as we keep this capacity to attract new people to onboard the journey, then there’s no reason to limit the growth capacity of this platform.

[00:27:46.11] Bertrand: I guess, you know, then, the one issue is that we were probably a bit naive initially thinking that, you know, collective intelligence, anyone would be able to contribute, and that the amalgamation of all this contribution would get us to a good result. The reality is a bit more complex. So, in order to get people to write on Impaakt, we need to train them, which is what we do through our certification. Then, in order to make sure that they write on the relevant topics, you have to really build a framework of the most important topics, whether positive or negative for each industry. And this is what also we’re working on today, to make sure that on top of what people can come up with, quite naturally, we make sure that all the important topics are addressed for each industry — for each company in each industry. And this is where artificial intelligence gets into the picture, right? This is where we use technology to basically ease the work of the contributors on the platform, give them access to research and sources, but also being able to identify all those topics that Sylvain just mentioned, and make sure that they’re properly covered by our analysts.

[00:28:57.16] Ben: Do you think it has been harder to try to build this from Geneva, just because here we don’t have a rich group of tech companies and people that you can turn to for advice and examples of successful companies that have done this before? Do you think it was harder both because there isn’t this ecosystem that you can tap into and also because maybe there isn’t the same level of tech talent?

[00:29:29.02] Bertrand: I have a different view on that. Actually, I think that Geneva was a chance for us. First of all, because I would not describe Impaakt as a tech company. Of course, we do have a tech platform, of course, we need to get tech right, but what we do is not rocket science in a sense that it doesn’t require the most advanced tech people in the world. We do have a data scientist and CTO which is a Ph.D. in data science from EPFL and, you know, for what we need, the kind of level that we have is really good enough. But in the other way around, I think probably the idea of Impaakt would not have been born somewhere else than in Geneva. I mean, we have a unique ecosystem where the financial center sits together with the United Nations and many international organizations. So, it’s a very small city in a way, where all the finance people can meet with the Impaakt people, in a way, in less than 15 minutes of public transportation. And this might have not happened if we were based in London or New York, because just impact investing was not as mature in those cities at that time that it was the case in Geneva.

[00:31:05.05] Sylvain: And frankly, for what we are doing, we feel that the value really lies in the community we’re already in. That’s what will make better success. And the community is neither in London, nor in New York, nor in Geneva. It’s got to be really, all over the world. And what we’ve been building with our certification webinars, we’re basically recruiting people from Mumbai, to any city in Central America, or in Africa.

[00:31:36.29] Ben: I guess I hadn’t really thought about it in those terms, which is actually, the unique propositions of Geneva might actually give it this boost, because obviously, I came more from the point of view of, you know, this is a platform company, you’ve got to solve this chicken and egg problem. And, you know, hundreds of companies have done this in the United States, very few of them have done it in Europe. I was thinking about it from that point of view but maybe that’s just kind of, you know, double click on that chicken and egg problem, on how you step by step overcome it. So, talk us through that. So, you mentioned certification, you mentioned trying to build the community. How difficult has it been? How many wrong steps along the way?

[00:32:19.05] Sylvain: Yeah, I guess, you know, the first assumption or the wrong assumption we made was that, you know, people will find it easy to write a short analysis, which is really the building block of our platform — 2000 characters analysis. The reality is that there are many pitfalls. Writing about impact, as I said, it’s not straightforward. People keep writing about the practices of the company because it’s easier, they keep writing about remediation, because it’s easier to find some information about how much a company has reduced their pollution, but they still remain a big polluter. So the first issue for us was, we cannot just rely on the layman, we need to train these people, which is why we do this certification, to make sure they know how to write a good analysis.

[00:33:07.02] Bertrand: And this has turned into being probably the best idea we had because not only it developed the skills of our community in terms of the level of quality we want to see in the content we produce, but is just turned up to be the number one engine for attracting new members, right? So, probably 50% if not more of all the visitors that we have on the platform, the users of the platform — not just those who contribute, but also those that are doing the ratings and the readings — most of them have heard about us through the certification program. And this is how we build the community, this is how we create the skills, this is how we engage on some of the community because the way the certification works, is not only just a webinar you attend to and you get the nice movie for one and a half hour — then you’ve got assignments to do so you get in touch with the instructors that are working at Impaakt, and you have this ongoing exchange and discussions with them, they will guide you in terms of improving your work. And this does create a very robust and a very engaging relationship with the community that we are leveraging today in terms of making sure not only the community increases in terms of size but in terms of how active that community is on the platform. You know, it took us some time before we figured out how to do that, but I think the certification has really been one of the major steps in terms of solving that issue. And if I look at the figures, you know, a quarter of all the people that come to the platform today are regular visitors which, for this kind of platform, is a very important number. If you look at the number for TripAdvisor, you know, some people go there once or twice a year, and the vast majority only go there and then never come back. For us, we have a situation where a quarter of the community are regular users and that’s a huge achievement and this is related to the certification program very much.

[00:35:10.20] Sylvain: But in fairness, the second issue we had, which was related to the first one is that once we have the certification, and we have people doing the certification, you’ve got to wonder why are they doing the certification? And a lot of people thought, “You know, it’s great, that’s actually something I can add to my CV.” So, we were investing a lot of time in training people to become good Impaakt analysis writers, and once they have the certification, they disappear. So it was sort of a never-ending investment. And what we then realized was that for people to carry on writing, then we give them incentives. And by starting to pay contributors once they are certified, we have been able to build a community of these regular contributors, who do not just come for the certification but want to continue afterward.

[00:36:06.10] Ben: So, people come to do the certification program because they’re interested in this space, and they want to make a difference, right? And then you keep them engaged by paying them for their contributions. So, the supply side is working quite well now because people are producing things to good-enough standards and they’re regularly contributing.

[00:36:26.15] Bertrand: And it should be, you know, snowballing, in the sense that, you know, you have the people that you have trained become regular contributors, and you keep training new people on top of that.

[00:36:36.18] Ben: Got it! Okay. Then, that’s going to be a bit of a bottleneck around the review process and ensuring consistent quality. But I guess that’s solvable. Right?

[00:36:48.00] Bertrand: Yes. And by different means. I mean, we just basically replicated the success that we had with the certification program but just did the same thing for the reviewing team, right? So we created a certification for reviewers. You first have to be a certified Impaakt analyst and then you can apply for the certified reviewer program. And then, we created a similar community. Of course, it is not driven out of the same kind of incentives and the same profile of people. But we just did a community of both external freelancers and internal staff managing that. And so, we have this capability that we need as well, on that front.

[00:37:24.13] Ben: What’s the profile for people that contribute to Impaakt, and the profile of the people that review?

[00:37:33.04] Sylvain: We have not necessarily checked lately, and it’s obviously fast evolving as our community is growing very fast but I would say, it’s neither the very young nor the very old, in the sense that we thought initially we would have a lot of students but maybe they don’t have the time, they should have the interest but they don’t have the time. It’s more like, I would say either a professional or a young professional in their 30s with an interest in sustainability — a lot of people are already more in sustainability, but not all of them. Some just wanted to discover about sustainability. And, you know, a profile, which is extremely International. As I said earlier, you know, we have people from Asia, we have people from Africa, we have people from Europe and North America, also South America.

Being a social enterprise doesn’t prevent you at the same time from making the profitability which will make you sustainable over the long term.

[00:38:25.04] Ben: And you said the interest is around sustainability. What does that mean? These are finance professionals or are much more general than that?

[00:38:34.16] Sylvain: It’s very diverse. We’ve got people from very different professional backgrounds. Some of them are engineers, some of them are teachers, some of them are students, but they come from very different backgrounds, both geographically and in terms of education, and in terms of professional experience. And this is actually what we want. We want to have that diversity because we know that the collective intelligence mechanism works at best when you’ve got that diversity in the community, and this is one of the joys, to realize that we were able to attract very good people. I have to say that the common alignment in sustainability is one of the key features we want to encourage even more. And this is also one of the lessons that we learned is that we see that the quality and the insightfulness of the analyses that are being submitted on the platform to be reviewed, tend to be much better or much higher when people are really sincerely passionate, genuinely passionate about sustainability, than it’s about just people that have been attracted because a financial reward and just want to get the money. And we can tell at the end of the day that is making a difference. And so, we also try to find ways of making sure we expand the community by looking for those, you know, sustainability-aligned type of profiles.

[00:40:00.22] Ben: Getting a certain critical mass of companies under coverage before you can attract the banks and other users onto the platform. How’s that going? How easy is it now to recruit them?

Sylvain: Do you mean clients?

Ben: Yes.

[00:40:17.23] Sylvain: Okay. So I think for that we have a roadmap and, you know, there’s a lot of chicken and egg here, where you need to find in sync but at the same time, you don’t have the content. And this is what we decided we would focus on first. Right now we assume that unless you have at least, you know, 1000 companies under coverage or companies which represent the bulk of the portfolio of the large asset managers, you’re not going to be on the map. So what we are doing is we are building content first, we are working together with some, what we call pilot clients to help us understand what are the fast-evolving needs of the financial community, because you know, we both exited the industry only a few years ago, but we realize that things are changing. And it’s only by the middle of next year when we feel that we have decent coverage on the 1000 companies that we will be really able to engage on a large scale with the asset management community.

[00:41:25.00] Ben: What do you think they’re going to do with the platform? Mostly, like a very silly question. So obviously, we hope that they would use the platform to make investment decisions. But do you think that they’ll build applications on the platform? Do you think that they’ll manage their products’ information on the platform? How do you think that this will go into practical use?

[00:41:52.11] Bertrand: Yeah, this is what we hope, otherwise we would have probably missed our mission because our mission is not just to be a good data, is to make sure that the financial community is using this data to make investment decisions, otherwise, we’re not changing the world, right? So, yes, we do hope that this is going to happen. And this is what is already happening with ESG data. We mentioned at the beginning of the podcast that not all of them are using the data in a way that is sufficiently deep, but many do. And the more it goes, and the more managers are using this data, just because as I was mentioning, it’s also driving performance. So they have that interest in making sure that they really use the data to make an investment decision. So, they’re already doing that today. But what is happening is that we see an increasing number of people within the community that is starting to realize, you know, the limits of ESG data that we have already detailed. This is not already the majority, because you have to remember that most of them just discovered those ESG data only one year or two years ago. So, the level of maturity is not always the same within the financial industry. But, you know, every single week now you start to see reports or articles about the need to go beyond ESG, the limits of ESG, and why we need to look at Impaakt. And so, as the industry becomes more sophisticated, what we believe is that those that are already using ESG data to inform their portfolio management practices, they will just use Impaakt data to do the same thing.

[00:43:24.11] Ben: Do you believe there will be the same use cases or do you think that there will be different use cases? Do you believe it might go beyond finance?

[00:43:30.21] Bertrand: About the use case: the beauty about the Impaakt is that you can look at the overall scores, and then do some reporting on your portfolio, make some adjustment. But the way Impaakt is built, the platform is built in many different building blocks, which we can re-assemble in different ways. So, people may use it just to understand what is the score of the company they have in the portfolio, but they may be interested in one dimension. I’m maybe interested in gender equality, a specific topic of water, and that platform will enable them to understand other companies’ scores on this specific dimension, which I believe the existing ESG tools do not necessarily enable you to do at this stage.

[00:44:19.03] Sylvain: And you’re right. I mean, our initial focus was on the financial industry because this is also the industry we know more about, but we have companies that this data is of interest to and that brings value to many more stakeholders, you know, for consumers, for future employees who want to check about whether they want to work with that company, for governments who want to know whether they want to give out some family contract to this company or the other one. And you can even look a bit you know, from a broader perspective. You know, everything that is related to B2B activities, you know, any company that wants to engage with a business partner might be interested in knowing, you know, what is the company we’re going to work with or to work for, right? Think about the advertising business. I think the advertising companies are starting to be faced with increasing pressure about what kind of products you are actually advertising because, of course, you know, this has a huge impact on the consumption patterns and you have your share of responsibility as an advertising company promoting this product, or this business model or another one. And I think those companies just like the financial community, at one point in time, they’re going to start to be interested about, you know, should I really be taking that company as a client, and promoting, I don’t know, this new generation of electronic cigarettes? Is that something that I should be doing or not? But it’s very easy to tell when it comes to products that are notoriously toxic. It is not so easy when it comes to more complicated situations. I was mentioning the tech sector, for instance, it’s hard sometimes to realize all the impact that these products might have on society and the planet. And as the CEO of an advertising company, I’d probably want to know.

[00:46:17.20] Sylvain: And if I may add, you know, one type of focus additional client, which we do not necessarily mention, is the corporates themselves. We don’t mention them because we do not want to be dependent on our revenues from corporates who can then influence the score that we would have on the company, but quite clearly, these corporates will be interested in finding out why they are performing better or worse than their competitors. And again, the platform enables them to not just look at their overall score, but see on what dimension they are clearly not doing well. And if I may add, also, on the consumer, I think the consumer is definitely interested in. The problem there is that they are thinking in terms of brands, rather than corporates. So the one thing which we are thinking also to add at some point, you know, relate also to the analysis, not just to the corporate, but to specific brands in turn.

[00:47:19.13] Sylvain: Now, another way for us to achieve our mission is to make sure that the data we produce is being used by as many constituents as we can and, this is also why some of that information — the scores, for instance, or the basic research — is also made available for free on the platform to anyone because this is also how we believe we’re going to create that knowledge about the impact of a company. It’s also why the certification program is free. We want to give out those free to as many people as we want and we want to bring that knowledge in the hands of as many citizens as we can because we know that this is how we get the scale of change that we need to see the world.

[00:48:01.19] Ben: I can imagine going on to Amazon and being able to make a decision based on the environmental overall impact of the companies, of the brands that I would want to buy. But the question I wanted to ask you is that it’s obvious that if you get this right, you know, this is going to be a winner-takes-most like platform. And who you’re up against? Are there other competitors? Are there other companies that are trying to do this at the same time as you?

[00:48:28.21] Bertrand: Many of them! I mean, this is a booming industry. I mean, open the newspaper every day, and you hear about sustainability here and there. So everyone is interested in sustainability, everyone knows that measuring that is a complex issue, everyone knows there’s a market for that. So yeah, many competitors and I think the most serious ones actually are the established players — the same company that has created the ESG rating that now wants to go beyond. And these companies are not just sitting there, right? They know the limits of their model, and they try to find ways of improving their existing scoring to better answer the needs of the market. Now, we have the chance that those companies all face with the same issue about having their history scores that they have been selling to their clients and if they change radically their methodology then they have to explain to their client that the score they gave them or sold them a few months or a few years ago, they’re no longer valid, and then it creates a lot of problems in terms of backtesting and in terms of all the investment decisions that have been made based on those scores. All they have to gradually evolve those methodologies and then it would take some time before they can really have something that is impact-driven. Some of them are trying also to recreate a second offering, like, I’m maintaining my first series of scores based on the ESG but then I create new products based on impact. And here, again, it’s a bit complex for them to find the right marketing because they basically ask their clients to manage two different scoring systems, right? So, then most of those companies face the limits that we’ve already described around where the source of the information is coming from, the model, which is also very costly in terms of fixed cost. And there’s a number of issues with, obviously, the incumbent of the market, and why it is trying to get into that place.

[00:50:36.06] Bertrand: The other area of competition that we see is those using mainly the big data approach, as we mentioned already, and although we’ve done that — we’ve already determined — we don’t believe that this alone would be good enough to tackle the impact measurement. At one point in time, you need to make a call, you need to make a judgment, right? You can gather information about how many water sources Nestle has prioritized. But you know, who is going to make the call that water prioritization is more important than obesity, right? And which weight you should give to each of those topics into the calculation of the score of Nestle. This is where also we believe that collective intelligence has a lot to bring to the picture.

[00:51:28.27] Ben: And is anybody else taking a collective intelligence approach, that you’re aware of?

[00:51:32.29] Sylvain: To the best of our knowledge, not yet.

[00:51:35.09] Ben: Your approach clearly has very strong pursuits of it. The more contributors you get, the more the clients will be interested — banks and other corporates will be interested in using the data, and therefore, you know, the more contributors you’ll need to feed them. And so, you can see how this drives very, very strong side network effects. Do you think there are other network effects that you can achieve? You know, can you use the corporate example to contribute data or to enrich the data to make the value propositions stickier and better over time?

[00:52:09.21] Bertrand: Absolutely. So, we’re only starting to explore those new dimensions, those new accelerating effects. I think, in short term is, there’s a lot more around gamification that we’re seeing because we need also to better incentivize the people that have come to the platform, not just to write analyses, but to do ratings and just to do readings, right? So to increase this part of the community. The other snowball effect that we could trigger, possibly the one about having those corporates feeding themselves part of the information — not doing the rating themselves, of course, but you know, at the end of the day, we were saying that corporates are not the only ones that should be populating this kind of data, but they can be at least providing part of the data, and those are related directly to the impact of their processes and practices. And so, yeah, it could be a very good idea of asking those companies to write up the good part that they want to defend; it doesn’t change the fact that then it would be vetted and controlled and rated in the same process as the rest of the information.

[00:53:23.21] Sylvain: And to balance that, you know, we can also look at other constituencies. And typically, what we have in mind is NGOs with interests maybe in line with ours because of their advocacy or mission, they know a lot about companies and the topics of interest to them. So, really tap into these communities of members of NGOs, to get to know the balance to what we’re going to get from the corporate sector.

[00:53:52.05] Ben: Yours is a for-profit company. Do you think that that’s a problem or in some way might dilute the periods in admission? Or do you think that that kind of profit is essential to get the wheels turning properly?

[00:54:06.22] Bertrand: We’ve attended presentations from Wikipedia and heard the founder lamenting about the difficulty to raise money. I myself, have also venture foundations in the not-for-profit sector, and I think it’s a fact that it’s easier to raise money in the private sector. Our project is extremely ambitious. We realize that we will need many rounds of financing before being self-sufficient. And for that reason, we thought that, you know, for-profits was probably the best avenue. But we are a social enterprise. By that, we mean that we have a mission. The mission is really at the core of what we’re doing. Being a social enterprise doesn’t prevent you at the same time from making the profitability which will make you sustainable over the long term.

[00:54:55.05] Ben: You mentioned 2021 — I think is a key date to start bringing clients, buyers on the platform. What are the key milestones that you have coming up in terms of calibrating and judging the success of your mission?

[00:55:10.04] Sylvain: Our first milestone is really meet 2021. And this is the magic figure of, you know, 1000 companies, corporate. 1000 companies corporate, to give you an idea, that means, you know, having probably about 10 times more analyses per company — 10,000 — and it means having probably about 500,000 ratings on the platform.

[00:55:36.15] Ben: Did you say 1000 companies, 10,000 analyses. And that’s what you call investments. And then what’s next?

[00:55:45.01] Sylvain: The next step is that, you know, when an analysis is posted on the platform, the writer is going to give his own assessment of the impact of the company describing his analysis. But we don’t rely on one person. What we want is the community to read the analysis, and make a judgment, assess whether the impact is positive or negative, whether it’s big or small. And each of these contributions from a visitor to the platform who read the analysis, accords ratings. And, as I said, you know, we believe that you not only need many analyses for a company to form a view, but you need many people to read these analyses and form a judgment on whether the impact is positive or negative or whether it’s large or small.

[00:56:34.03] Ben: I can imagine many people listening to this will be rooting for your success, right? Because if this is truly a success, then this will change society in a profound and very positive way. So, if people want to get involved, if they want to undergo the certification process, if they want to become contributors, if they want to use the platform, what’s the best way of finding out more?

[00:57:02.17] Bertrand: www.impaakt.com. This is where you’ll find all the information. We make it easy for people to engage in the community. And, as Sylvain mentioned, we initially thought that, you know, it would be easy for anyone to write a short piece of analysis on one impact or one company. It is not the case. Not everybody is a contributor, not everybody is willing to spend a few hours, a few minutes writing up something and doing the research. But there’s many other ways you can contribute. You can just go and read the information. Just reading the information is already making a difference, because then you can use that information to decide, again, whether you want to work for that company, whether you want to invest in that company, whether you want to buy products from that company. The second very easy way is to do ratings. And to do rating, it requires you slightly more engagement, because you need to read the analysis and you need to decide, you know, based on what you’ve just read, whether the impact is bad or good, and large or small. But by doing those ratings on the platform, you also contribute to forging a collective evaluation of the impact of the company, and this is how we derive the scores. So those ratings are also very important today. And then, of course, the last step, which is the most engaging one, probably also in a way, the most rewarding one is to become a contributor. And this is very easy, in a way. This is where the certification program gets into the picture. You just register there. We do two trainings a day — two to three trainings a day, depending on the day. We now have between, 1500 to 2000 people registering to that webinar every single week, so we’re training many, many people on the art of impact analysis. If, after the training, you don’t want to keep on that, at least you’ve learned some skills, you can stop there, and it’s already mission accomplished as far as we’re concerned. But if you want to know how to use those skills and apply them and become one of those contributors to the platform, then you just start submitting your analyses, you will be reviewed and published and you make money in the process.

[00:59:04.21] Ben: Sylvain, Bertrand, first of all, congratulations on the work that you’re doing! Secondly, thank you so much for coming on the podcast!

Sylvain: Thanks for having us!

Bertrand: Thank you!

Hard Truths about Digital Banking (#32)

Structural Shifts with Leda GLYPTIS, Chief Client Officer at 10x Technologies

We’re discussing with Leda Glyptis, a self-described recovering banker and lapsed academic, who’s worked in technology implementations for the last 20 years. Leda is one of the leading voices in banking and FinTech today, she has served as Chief Innovation Officer at QNB group, she was Director of EMEA Innovation at BNY Mellon, and most recently she was Chief of Staff at 11:FS. In this episode, Leda and Ben discuss what a Chief Innovation Officer actually does, whether innovation can come out of innovation departments, what most companies miss when they talk about culture, why emotions are holding back traditional and challenger banks from making money, why selling banking services like supermarket offers doesn’t work and what banks should be doing instead. For more information on Leda, look up the hashtag #LedaWrites on Twitter. She publishes an article every Thursday.

Leda recommends

 

  1. One book: “To end all wars: A Story of Loyalty and Rebellion, 1914–1918” by Adam Rothschild
  2. One influencer: if you don’t follow Bradley Leimer already, I don’t know what you’ve been doing and you don’t know what you’ve been missing
  3. Best recent article: ‘Can empathy be the cure’, by Theodora Lau
  4. Favourite brand: Converse All Star
  5. Productivity hack: I have ‘writing spaces’ — windows of time in spaces away from my desk where I write with no interruptions, no internet access and usually with a specific time box imposed by a friend arriving to join me in a café or park at a given time or by virtue of doing it on a flight or train ride.

One should only build the technology that is tied to their differentiator and partner or buy the rest

[00:01:28.12] Ben: Thank you so much for coming on the Structural Shifts podcast! I wanted to start off by asking you how one goes from studying social and political science to becoming a banker?

Leda: First of all, thank you very much for having me. The answer to that is ‘by accident’. I have always found it extremely impressive and confusing when I hear people talk about their careers and say, “You know, when I was 17, I decided I want to do this, then I had a plan, and I did it.” I don’t know who these people are. This was not me. Mine was entirely accidental. As I was finishing my Ph.D. with a series of deaths in the family which knocked me for six, I found myself sort of delayed and frustrated, ended up getting a job in, actually, private security of all things, and was my first taste of corporate life and working with technology investments — because the company was investing in non-weapons defense technologies at the time. And I found myself quite far away from academia, in a place that was interesting but didn’t make that much sense. And I chatted with a friend one day saying, “There are parts of my job I really like, parts of my job I don’t like, but I really don’t know what to do now, where to go next.” My friend said, “Well, we’ve built some software. We want to sell it into banks, but we don’t like people and things. You like people and things. Why don’t you join us?” It was an absolute audacity of your mid-20s. I thought, how hard can this be? And it turns out, it was quite hard, but it was also quite incredibly interesting. And I fell sideways into banking IT, and I haven’t looked back since, to be honest.

[00:03:02.08] Ben: I wanted to ask you: so, your last job in banking was at QNB and you were Chief Innovation Officer. What does a Chief Innovation Officer do? So, for example, is that a role that holds a budget, or is it one where you sort of seek to influence the rest of the organization and guide them towards some sort of digital future?

Leda: It absolutely varies. In some organizations, the Chief Innovation Officer is part of a marketing effort and they’re there to drive organizational learning in and organizational positioning out. In those cases, the job doesn’t have much of a budget, and it tends to be all about teaching the organization what they should know and helping the organization tell a story to the market about how they’re thinking about the future. Then, there’s another type of Chief Innovation Officer that it’s all about the third frontier of technology — so, the stuff that is really out there, that is not going to be useful or usable for the next 10 years but the bank should be thinking about them. They’re doing a lot of experiments, and they tend to have budgets for POCs, but not much beyond that. And then, there is the Chief Innovation Officer that is essentially the new technology IT person. So, I would say that my role at BNY Mellon was a combination of the first and second. So, while I was at BNY, my role was a lot about bringing learning into the organization and helping the organization position itself in a changing market, and running experiments with technologies that, at the time, were very new for us. My role at QNB was very different. It was, what are the things that we should be doing and we should be seen to be doing for the type of corporate citizenship we want to have in our chosen markets, both in Near East Africa but also in the sort of Far East subcontinent and beyond — Southeast Asia, where competition and technical literacy was extremely high. So, the Chief Innovation role for QNB was, “Come in and help us do the things we need to do fast, but also help us move the needle a little bit on the ways of working internally.” And I say ‘move the needle a little bit’ because a lot of Chief Innovation Officers are all about the internal workshops. This was, I would say, more indexed into doing things that were business focused and external-facing without changing the infrastructure of the bank. So, it was things that could either plug into that infrastructure or stay on the glass, and less about changing the ways of working. So, to answer your question, it could be anything, and my two innovation roles have actually been very different — but very useful in the sequence that they were in because a lot of the experiments we had done at BNY Mellon were the learning I needed in order to go straight into implementation at QNB.

[00:05:56.05] Ben: Do you think it’s a more important role than it was in the past?

I don’t think there has been a clear sense of where profitability will lie in the future.

Leda: Perversely, I would say no. Actually, somebody called me recently and said, “Would you take another innovation role?” I was like, “Nope.” I think it was an extremely important role early on because it both signaled internally and externally, that the organization is engaging with some hard topics. And also, it showed an acknowledgment that the way we work, the way we learn, isn’t right for the way that the market is moving, and therefore we need to change. Fast forward almost 15 years later, there are very, very few organizations that have moved the needle meaningfully in terms of either way of working or transformative technology use. Some have, but they’re few and far between. And even those that have, haven’t done it through their innovation departments. So, I would say that the function it represented as a department is more vital than ever — the new ways of working, the different deployment schedules, leveraging technology differently, all of that is more important than ever — but I would say that the structure doesn’t work anymore. What the innovation departments taught us is that we can’t do it through innovation departments. It has to be right at the heart of the business.

[00:07:10.10] Ben: And do you think that’s why those banks have found it so hard to introduce significant change? Because there hasn’t been this sort of CXO buy-in, other broader buy-in of management. And therefore, do you think it’s as much cultural as it is technological change that’s needed?

Leda: Yes and no. So, I think there is a cultural change that is bigger than the technical change — I think you’re right — but I think it’s much more systemic than saying people are resisting. I don’t think people are resisting. I think the structures we have created are not conducive to the type of decision making we need. Everything from the fact that you may be running an agile project in your part of the bank, but the testing schedules for the wider bank are waterfall and therefore you need to book in your testing before you’ve started building. It’s mad, right? It makes no sense. But it is how it is. Similarly, the risk matrices you apply, the way you measure success on a quarterly basis, the way that shareholders measure success, all of those things we bundle under culture change, but it’s actually much bigger than culture. It’s about how we build up the business, how the business reports success to the owners of the business, and how the business makes sure mistakes are not made. So, it is facile to say culture and dismiss all of those things as an attitude problem. It isn’t. I would say that the biggest challenge — when we started this journey, part of the question was, “Well, are these technologies real? Are they useful?” And we spent a lot of time in labs, testing and finding that the technologies are both real and useful. They’re robust, they’re scalable, they reduce the total cost of ownership, they do all the good stuff. But they also fundamentally transform the business model, both in terms of how they enable you to operate in a way that you’re not prepared to operate in — the speed of decision making that these technologies enable you to do, you don’t have the governance for. So there’s a big change piece that is around governance and approvals that is human, yes, but not just cultural; it’s organizational. The second piece is that cheaper infrastructure and faster infrastructure kind of requires a different business model because you can’t go charging the same for a very different service. Your customers are wise to the fact that you do different things and potentially less from a human perspective. So, I would say that the challenge hasn’t been technical for a while. It’s governance and monetization.

Maybe what we’re seeing is a transition to a world where retail banking is a public service utility. And I’m not saying it necessarily needs to be run by the government but it is approached by a utility, and therefore the profit structures become very different. And that’s something that your challenger banks don’t necessarily address

[00:09:46.03] Ben: On that topic of business models, banks, in general, know where they’re headed in that direction — you know, what the business model opportunities are — and if they know where they are, which one would suit them best?

Leda: I don’t think they do. I don’t think they do. And it’s not an easy thing. I don’t think there has been a clear sense of where profitability will lie in the future. I was recording a podcast with John Egan from BNP Paribas, recently, and he led with the statement, “Banks don’t know how to make money in the new situation. Therefore, what are the options?” And it’s very refreshing to hear someone say that from within a bank, although admittedly, he doesn’t sit on the traditional side of the bank. I think there are a couple of pieces there. One is the appetite of the market is shifting. Certain products that we were comfortable seeing being profitable, aren’t profitable anymore. Retail banking isn’t profitable. Mortgages, credit cards, institutional banking, transaction banking, investment banking, that’s all still profitable, but the regulatory pressure to change pricing and the way that money is made is definitely making it less profitable than it once was. It’ll be interesting to see how far the regulator will push certain things. I’m seeing banks change their infrastructure and invest in technology, not because they want to be seen as innovative, but because they want to lower their total cost of ownership. They’ve reached a point where growing their top line is much harder than it used to be, then, actually reducing your operating costs is the only way to increase profitability. So, we’re definitely seeing that shift. But I would say that monetization is a challenge for the challengers — funnily enough — not just the traditional banks, because the challengers, they are extremely well-capitalized, burning through cash, building up something that is very, very beautiful from a UX perspective, that is, challenging banks, the assumptions we had on how hard or easy it should be to do certain things, they have definitely reduced what has now come to be considered predatory pricing and all of that. But at its bare bones, their business model is not too different. I was at a panel a few months ago, and Nick Ogden turned to Anne Boden and said, “What challenger? Your business model is exactly the same as everyone else’s!” And Anne made some very interesting points around pricing and focus on the consumer. And she’s right in all of those points, but actually, at the level that Nick was raising the challenge, he is right. If you look at the challenger banking model, their proposition was, “We can make money the same way, but by being cheaper to run, we can also be cheaper to use. So we will pass that benefit to our customers.” The reality is, retail banking is not profitable, not in the same way it used to be. And the traditional banks are making money because they have universal banking. And the challengers are looking at their business model going, “Oops, that doesn’t make money.” You know, there are the Revolut’s of the world that do make money through crypto trading. There are other ways, but the traditional retail banking, as we knew it, is only profitable for the big banks, after the third or fourth product per customer, which is not a scale that your challengers have. And I went on for an hour here to answer a very straightforward question. I don’t think they know how to make money. And I don’t think it’s an incumbent problem. I think it’s a systemic problem. It’s banking, as we know it.

[00:13:26.04] Ben: If retail banking becomes some sort of a lost leader almost, to around which you have to bolt on more profitable businesses, what does a more radical business model look like? One that accepts the premise that, you know, retail banking is not inherently very profitable.

Leda: I would start with the proposition that maybe it doesn’t need to be. Maybe what we’re seeing is a transition to a world where retail banking is a public service utility. And I’m not saying it necessarily needs to be run by the government but it is approached by a utility, and therefore the profit structures become very different. And that’s something that your challenger banks don’t necessarily address because, in order to have a credit card and an affordable mortgage and an affordable consumer loan, you tend to have a balanced book, underwriting, repacks, and investment vehicles that move that debt around and leverage it in instruments that are highly complicated and have nothing to do with retail banking. And that is how you make mortgages more affordable. That’s how, allegedly and theoretically, you make credit cards more affordable. Now, I think there are two questions inherent in the question you just asked. One is, can you create retail banking that is systemically independent from institutional transaction investment corporate banking? And I would say not with the current pricing models that we’re used to because things slosh about and move around. And the second is, can you create a business model that says, “It won’t be particularly profitable, we will do it at cost and we will perceive it as a utility.” It is possible. The technology we have to do it would allow for the running cost and maintenance cost to be lower. But I would say that the cost of lending will probably go up, or you will have to pay for a current account, which in some societies already happens, and people wouldn’t even blink. But in places like Britain, people were like, “Whoa, what’s that all about?”

even if it makes perfect sense to focus on the thing you’re best at or the thing customer comes to you for and leave other things to others who are better at them, there is an emotional blocker there

[00:15:30.03] Ben: Do you think we’re seeing the first indications that that’s actually happening? In the sense that the manufacturing balance sheet part of the banking is becoming more and more heavily regulated and I guess less and less profitable? And then secondly, because we’re already starting to see big bank mergers, which would suggest that we’re moving into a phase now where institutions are trying to just maximize economies of scale, which is what’s at play here. Would you say we’re already heading in that direction or we’ll take a more direct intervention from governments or regulators to make it happen?

The challenger banks measure their success in terms of accounts or in terms of being primary accounts, but the number of people who close their high-street bank account is minimal. The whole notion of being multi-banked is a given now.

Leda: It’s too early to tell, actually, is what I would think. We’ve definitely seen, as you rightly point out, some mergers and consolidations. But in the world of banking, those mergers and consolidations — or de-mergers — are part of how business is done. We have not seen big banks exit retail banking, which I bet is tempting. But actually, bankers, not to bash them as cynical, but I have never met a bank CEO who didn’t feel a sense of duty towards the community they serve. And even though no bank CEO’s retail arm is where the money is made, they all feel extremely strongly about retaining that. And I can’t stress that enough, there is no bank out there that I can think of — actually no, I lie; there are a couple in very particular circumstances — but for the vast majority of banks, their retail division either breaks even or loses some money. But no one ever considers killing it, because they do feel a sense of duty and responsibility to their communities. And they don’t need the regulator to tell them that. They actually do that themselves. So, to answer your question in the negative, the obvious thing would be to kill your retail banking and focus on the profitable stuff, but people don’t. And I don’t think the regulator would permit it, even if people were inclined to go that way. I think there will be a couple of things: there will be consolidation, as you say, because there’s definitely profitability in scale. I think we will see an acceptance that certain products will become less profitable, and that will become the new normal. And I hope — but I have seen very little indication of that — I hope that people will start making the hard decisions to invest in the infrastructure of the core entity, not the greenfield captives, not the small experiments, but really create an overhaul of the infrastructure of the bank, that will mean that the cost of ownership and the cost of doing business will go down. And therefore, yes, you know, the return on equity will be terrible for a few years. But once they’ve paid off the cost of build, then actually, they will have a much lighter infrastructure. So the fact that certain things are not as profitable won’t matter as much, because they’ll be much cheaper to run.

[00:18:26.28] Ben: I want to come back to that point about how banks should transform technology. And so, I’m going to come back to that, but just in the meantime, I wanted to ask you: so, if retail banking doesn’t necessarily get split off from other types of banking, do you think you’ll have different players doing the manufacturing from those that do the distribution? Because, as you say, the manufacturing part is capital intensive, it’s not very profitable, but the distribution part seems to be where you could achieve network effects and where you could achieve much higher margins and potentially very low cost of customer acquisition and so on.

No one will ever enjoy buying banking services. One of the things that the banks have to accept is that you can make it as snazzy and fun and cute as you like, it’s not going to change the way people feel about it.

Leda: Well, you speak sense, and that should be the direction of travel, right? Whether it will happen or not, will depend on a lot of things. Regulation is one — we don’t have a clear direction of travel from the regulators, but there is an increasing push for separation clarity and demarcation lines between different pieces of the life cycle that the regulator is pushing towards. So, that may be a factor. But what is holding banks back from doing this is emotional, it’s not practical. I mean, over the years — I worked in a transaction bank and custody bank and I kept saying to them, “Plumbing is amazing! Why do you care about the sexy stuff?” Like, plumbing is where you can make money, you’re needed, but it is unsexy and people emotionally want to do the more exciting stuff, the client-facing stuff. So, even if it makes perfect sense to focus on the thing you’re best at or the thing customer comes to you for and leave other things to others who are better at them, there is an emotional blocker there. So, you see, for instance, quite a lot of the traditional high-street banks who don’t actually drive profitability through their retail businesses, should say, “I’ll tell you what: open banking has landed, I’m not very good at this digital journey stuff. But people still want to have their money in a place that feels secure, so why don’t you, Mister Startup, create all your propositions on top of my platform and account, your customers’ money will be in an HSBC account, but they won’t even see HSBC, they will see PensionBee and Revolut. Neither of them is doing that, and there are many reasons for it. For the challengers, it’s both the independence that you get from having your own license, but also the feeling of being a grown-up and sitting at the grown-ups table, and not just being a little app that sits on top of another system. The traditional banks are convinced from the old way of running relationships, that owning the customer is important, right? If you sit inside a traditional bank, there are usually fights between departments about who owns the customer. The notion that you need the customer touchpoints, you need to own the customer, that’s where profitability comes from, is actually complicated, convoluted, and in some cases, entirely misled.

Leda: The point is that you have the challengers spending a lot of time and money creating infrastructure that, to your point, should be created by someone else and it should be sold as a utility to all banks. The traditional banks are spending a lot of time trying to create propositions and user journeys that they’re not very good at. Meanwhile, they don’t make any money from them and they could just sit back, take the deposits, let other people be creative. They were symbiotic relationships that could have been explored and haven’t. And I think we’ve reached the point now, where none of what exists makes sense at scale. All of the various banking players will need to think about scalable and robust infrastructure. And, as part of that same discussion, they will need to think, “What am I for? And do I need to build all the bits that I will use to be that?” And my personal view is one should only build the technology that is tied to their differentiator and partner or buy the rest because it means that you carry less legacy, you carry less need for dependence on know-how, and if technology moves on and your provider doesn’t, then great, you change providers.

[00:22:37.11] Ben: So if we think about, I don’t know, eCommerce, right? You’ve got Amazon as an aggregator, and Shopify as a platform, right? How do you think it plays on banking? Do you think banks can be aggregators? Or do you think they’re destined to be platforms?

the data that you need for timely, intelligent, embedded financial services is there, but nobody is doing it yet

Leda: That’s a very good question, and I think it depends on two things. One is the economics of it. So, the way that financial relationships are monetized right now makes it very hard to go down, actually, either of those paths, because the way you make money is hard to unbundle. It’s not a case of, “Okay, now you will be doing 30% of that process, so you get 30% of the revenue.” It’s sadly not how it works. The second challenge is, which bank has the technology to actually even start thinking about that? The people who are quietly, but interestingly, doing quite a lot of that work is Standard Chartered. They are looking at the types of work they have historically done and creating partnerships to allow them to retain their usefulness. So, it’s less about, are you an aggregator or are you a platform? And more about, in what you currently do, where do you retain brand relevance? And where are you still actually a meaningful part of the puzzle? And who can you partner with upstream and downstream to make that piece where you’re still good, bigger? And the only bank I’ve seen do that to any meaningful scale, actually, so far is Standard Chartered.

[00:24:08.19] Ben: The big advantage that the incumbents have, as you say, is every challenger is spending hundreds of millions of dollars on trying to acquire customers that the incumbents already have.

Leda: That the incumbents already have and don’t lose, right? Because it’s actually a false statistic we see. Because you are absolutely right. The challengers measure their success in terms of accounts or in terms of being primary accounts, but the number of people who close their high-street bank account is minimal. The whole notion of being multi-banked is a given now. I don’t know a single person who has one bank account.

[00:24:43.27] Ben: Yeah. So, you’re almost saying that that’s not a meaningful statistic anymore, right?

Leda: No. So, I’ve done a very informal survey of a few friends of mine who took the leap, so to speak, and started paying their salary into a challenger. And so, rather than having your traditional bank for your salary to be paid into when you’re spending money, playing money in your challengers, they actually started paying their salary into their Starling, their Monzo, their N26. But you ask the next question, if the vast majority of them sweep what they don’t expect to use immediately. So, actually, the deposits, which is where the money is made from a banking perspective, still go to the traditional institutions, either because they offer better interest rates, or because they offer higher protection, better security. The motivations are multifaceted, but if you say that the main thing that a banking player will monetize is deposits, then even the people who pay their salary into the challengers — and I would say that that number is nowhere near as high as the total number of customers, obviously — even these guys don’t leave their deposits in the challenger in any meaningful sense.

we will see much more embedded finance, much more embedded payments, actually much more complicated financial transactions being embedded in the commercial activity, but it won’t be driven by finance. It will be driven by the consumer need and the consumer opportunity.

[00:25:57.29] Ben: And do you think that’s like some sort of proxy for trust? And do you think trust is the key attribute to be able to do aggregation? I.e. I’m going to introduce you to other products and services you might find useful and value-added, because you’ve given me your trust?

Leda: Trust is absolutely vital. However, I think the main thing is that people don’t want to think about any of these things unless they absolutely have to. So, the proactive up-and-cross sell the banks are trying to do is noise. Nobody says, “Do you know what I’m gonna do today? I’m gonna pick a car loan. This is my plan for the afternoon.” People will say, “I have to renew my mortgage and I hate it, and I’ve been putting it off.” No one will ever enjoy buying banking services. One of the things that the banks have to accept is that you can make it as snazzy and fun and cute as you like, it’s not going to change the way people feel about it. The second thing is, people want these things to be available when you need them. So, I keep getting mortgage offers from my bank — my high-street bank — even though my mortgage is paid for out of that bank; but I get first-time buyer offers on a weekly basis. So, the data that you need for timely, intelligent, embedded financial services is there, but nobody is doing it yet. And I mean, from the standard banks. And I would say that the challenges are not doing as much of it as they could.

Leda: There was a proposal I saw recently that N26, was going to be doing this. I don’t know whether it actually went live or it got delayed because of COVID. But essentially, it was, if all your movements take place within your N26 account, N26 says to you, “Hey, leader, you pay this much for rent, you qualify for this kind of mortgage, and you can afford an apartment in the neighborhoods you do most of your spending in. So, in the neighborhoods where you spend your life, you can afford to buy.” Those data points are actually available, either publicly or through your own protected account. Now, that is a useful service, right? That is intelligent, embedded finance. But I don’t think that my mortgage provider saying “Do you want a credit card? You can afford one.” Or, my high-street bank saying, “Would you like to buy a house? We can help you.” is in any way helpful. Trust or no trust — because, of course, I would trust them to execute — but it’s not like the supermarket where you will buy your favorite shampoo because it’s an offer even though you don’t need it. And yet, the way financial products are promoted is exactly like your supermarket offers. People will see it and buy it. No, it doesn’t work that way. So, intelligent embedded finance is technically possible. It’s absolutely possible from a data perspective. When it becomes the way we offer services, then the people who do it best will be the people who read the situations best, not the people who have the best pricing.

digitization is not about allowing the banks to dominate this conversation. It’s about allowing them to stay compliant and relevant with the way people live

[00:29:01.18] Ben: So you’ve mentioned the term ‘embedded finance’, which is something that’s become, I think, really quite fashionable, over the course of 2020. Do you not think that it will be embedded into products and services that aren’t financial at all in nature, i.e. those that have the highest engagement? Because that always seemed, to me, the problem, as you said, which is, I only go into my banking app when I need to do banking, whereas, you know, I’m in WhatsApp all day. So, isn’t it easier to try to engage me with financial products and services through apps and services that I’m regularly using, and in which I have the pool of engagement?

Leda: I would expect so, but I think that the starting point would be interesting. So, for instance, the Uber example is a very interesting one, right? By taking away the process of payment, they’ve given you back, what? Two minutes of your life? And yet, it felt like a revelation the first time it happened. Uber didn’t create embedded payments to help MasterCard make money. They did it to create a proposition that would make them more attractive to the user. So, I think we will start seeing embedded finance for that purpose. And it will put everything on its head. I was speaking to someone who works for Experian, and they were saying, “Creating a good credit footprint has become second nature. We all know you need to brush your teeth and have a good credit score.” But the reality is that assumes you need to enter the credit system. That’s an assumption that we have made without even thinking about it. But is that the right thing? Is that something we should be encouraging new generations to do? So, for me, the interesting thing is, we will see much more embedded finance, much more embedded payment, actually much more complicated financial transactions being embedded in the commercial activity, but it won’t be driven by finance. It will be driven by the consumer need and the consumer opportunity.

[00:30:56.12] Ben: If I were to summarize, you’re saying that it will be more intelligent, more useful, and it will be pull not push, right?

Leda: Yeah.

[00:31:03.25] Ben: Changing the topic slightly, do you think that open banking is the catalyst to move us to this world of pull not push, and intelligent and useful embedded banking services?

the consumer will not choose the bank that has the best user journey; they will choose the bank that gets out of their way the most

Leda: I was asked a similar question not too long ago, and we had been talking about dance earlier and something entirely unrelated. And I used the analogy in a way that was relevant in the moment, but I think it still works. And what I said is, gravity is essential for dancing. But nobody thought, “Gravity is great. How could I use it? Let me invent dancing.” And the thing that has been frustrating for most big organizations that open banking came, and the banks kept looking at it until the eyes bled, and couldn’t figure out how to make it work for them, how to make money through it. And I heard equally a lot of startups looking at it and going, “There’s an opportunity in there but I don’t know how to monetize it.” And I think that if you stop staring at it, and you start going down the path of solving real problems, then open banking will be an enabler, a facilitator, and an accelerant to things that you can do to solve real problems. A little bit like you couldn’t dance without gravity, but the two are not… You know, nobody came up with dancing or slides by thinking I need to use gravity for something.

the boat that said ‘digitization is your key to future profitability’ has sailed. The boat now says ‘digitization is a key to survival and compliance’

[00:32:20.16] Ben: It seems to me that the whole digitization of the industry banking, is the new driving force to embedded finance, all these other downstream applications that will be super useful and value-added. But it doesn’t seem like open banking itself is actually that relative to everything else that important. Or do you disagree? Do you see it as being really quite significant in pushing us towards this?

Leda: I think open banking is going to be significant in enabling solutions that wouldn’t have been possible before. But it’s for the consumer, and for the creativity that the industry will see. It’s not for the incumbents. I think that, as I said earlier, embedded finance, and those truly empowering capabilities won’t come from the banks. They might be powered by the banks, but they won’t come from the banks. So, the revolution and the truly transformative pieces won’t be because the banks finally found a way of doing this. It will be because somebody thought of something that is now possible because of open banking. So, digitization is not about allowing the banks to dominate this conversation. It’s about allowing them to stay compliant and relevant with the way people live. So, for instance, at my high-street bank, you can’t set up an international payment on the app. You can only do it online. Now, if you’re not a banker, you either don’t question that, or you assume it’s for security purposes. If you are a banker, you know that’s because their systems don’t talk to each other and the online bank is on an entirely different infrastructure than the mobile bank. The reality is that a time will come — and that time is not far away from us — that the challengers and some of the incumbents will solve some of these problems. So, the consumer will not choose the bank that has the best user journey; they will choose the bank that gets out of their way the most. And by getting out of their way equally means not bombarding them with products they don’t want, but also enabling them to do things on-the-go. I remember a few years ago, I was here, in Athens, visiting my parents, and I needed — it was a routine KYC check for my mortgage. I couldn’t do it remotely. I had to go in-person into the branch that has changed in the intervening time. So, there are things that are hygiene factors these days, both because the customers expect them and because the regulator expects them, but I think that the boat that said ‘digitization is your key to future profitability’ has sailed. The boat now says ‘digitization is a key to survival and compliance’.

[00:35:06.26] Ben: I suppose asking the question a different way, do you think that… So, open banking kind of creates an obligation to share customer data. Customers, as we observe in other realms, they’re happy to share their data where they perceive there’s a utility for doing so. So, do you not think that this will happen anyway, as the right use cases emerge?

Leda: I don’t think that use cases will come from the banks. Now, I think open banking is not an obligation to share data, it’s an obligation to share infrastructure that enables the sharing of data, should the customer consents to it. And the onus was on that consent mechanism, because banks would allow you to screen scrape in the past, which is extremely insecure, but cheaper to do. I think creating that infrastructure for consent and control has been what? Has been a sort of a point of contention, because it was expensive, and the banks couldn’t figure out how to make money with it. But I firmly believe that the creative solutions that leverage open banking are not going to come by people who look at open banking and think how can I make this — make money? They will come from people who are solving problems and go, “Oh, look! With open banking, it’s much safer and easier to do that.”

[00:36:18.12] Ben: What effect you see COVID-19 having on banks, on B2B FinTech companies, and then on the B2C challengers?

Leda: I think it very much remains to be seen. I’m extremely skeptical of all the triumph of, ‘this has sealed our digital efforts and accelerated and…’ I don’t see that. What I see is, banks that knew they had challenges and problems in their infrastructure faced those problems by throwing more people at the problem, the people working extremely hard to create bridging solutions, and delivering for the clients and the bank being extremely proud of their people — as they should be. And then, the conversation of whether they should actually challenge change, restructure being not even started. So, I would say that the banks have done well in the midst of COVID because of sheer hard work, creativity, and determination on their human sides. But not because their systems were up to scratch. And I’m not seeing anyone saying “Okay, our systems were not exactly up to scratch, and I should do something about that.”

you can’t change systems without changing the supporting economics and surrounding governance. Which means that if you’re doing the slow refurb process, you’re going to have a schizophrenic organization for quite a long time

[00:37:30.03] Ben: What about, do you think, they’re investing more in B2B FinTech solutions to help them to digitize faster or to, at least, service customers digitally faster than they were?

Leda: There is some loan disbursement work that has gone ahead. But honestly, what happened when COVID hit is that people went into panic mode because they needed to deploy quick solutions for particularly loan holidays for both businesses and individuals. The systems were not set up to do that. And the reality was that if you have a COBOL-based system to change an interest rate is two months’ worth of development work. The reality is they threw the people at it, they made the change, but the system is still COBOL-based.

[00:38:13.24] Ben: And then, what about the B2C FinTech companies? Because there was a piece that was written by McKinsey, I think it was called, “Rerouting Profitability” or something, and they made the point that all of these challenges in the unit economics of some of these businesses have been laid there, and now they’re struggling to raise new funding, and the FinTech sector is an existential crisis. How do you react to that kind of comment?

Leda: I’ve heard about the existential crisis before. I saw that report. And they were saying the FinTech sector is an existential crisis, then the FinTechs responded all over Twitter and LinkedIn, “You’re the one, an existential crisis”. And the reality is, no one is an existential crisis. This is a long game. It’s a long game. And in the last 15 years, everything is moving in the direction we said it would, but because it’s not moving as fast or as radically and because the startups that were around at the beginning are mostly not still around, therefore, the winners and the losers are not as black and white, people are feeling a little bit more relaxed than they should. But we said 10–15 years ago, the economics of banking are changing, the significance of technology is changing, the world will be more connected, service orchestration will be the name of the game, unit economics will change. All of that is happening. It’s just happening slowly, as you should expect, and therefore, I don’t understand people who are trying to find comfort in these radical revelatory moments of, “We fixed it” or “This was wrong” or “This is right, and that is wrong”. It doesn’t go that way. There is a direction of travel and we’ve been very much moving in that direction for 15 years. Certain events accelerate certain parts of the journey — regulatory moves, certain mergers, the rise of the Chinese giants, COVID. But it’s not a pivotal moment after which everything is different.

[00:40:10.02] Ben: What about payments? Do you think the impacts on payments from open banking has been more transformational?

Leda: I mean, my answer when it comes to open banking is, it is what it is, right? There’s no change. Payments are in an area that has had a lot of focus and has had a lot of innovation over the last 10 years. It hasn’t been transformative, because the monetization relationships are similar. But we’ve seen incredible speed in payments, particularly cross-border. So, payments, I would say, is a place where we’ve had so much innovation and creativity, that unless the rest of the banking infrastructure starts catching up in terms of the build of the systems that can support, there’s only so much more that we can see in payments, because there’s a little bit of saturation.

[00:41:00.10] Ben: I want to go back to something you said earlier on. If we think about this, there’s typically been a few approaches to technology transformation. One is the Big Bang approach, which I think is becoming increasingly less viable or palatable. And then you’ve got this progressive…

Leda: People lose their jobs when they do that, right?

Ben: Yeah. I mean, I just think it’s just, the time to value is too long, the risk to value is too high. And so, we’ve seen people moving to more progressive renovation type renewal strategies, and then also, as you said — I think you used the term ‘greenfield captives’ — but this idea of building a new digital bank, and then trying to migrate customers and books of business to that new bank. So, first of all, I’m sort of inferring you’re a bit of a skeptic when it comes to this build and migrate strategy. So is progressive renovation the right approach to technology transformation, or do you see another option?

Leda: There are many options, right? One is Big Bang, the other is refurbish as you go, and the third is build and migrate. We have not seen the migrate part happen yet. Some of the greenfield builds have failed to provide the skills. So, First Direct is a good example, right? Everyone who uses First Direct loves it. Why am I still on the old HSBC systems? I don’t know. But they haven’t migrated. Now, I would suggest that it’s too late now because even though First Direct customers are very happy, the technology is almost 20 years old now. But even with a successful challenger, no migration took place. Then, you have situations like RBS’s Bo where, for whatever reason, they pulled the plug on the effort. Now, a lot has been said, and a lot of criticism has been piled on top of RBS for killing Bo. I actually think that I don’t know enough about the ins and outs of it, but I think if you think something isn’t working, having the courage to say, “Pivot, move” is actually brilliant, is what we should be doing as well. That’s what we said our innovation departments were for. And the fact that quite a lot of the technology is being redeployed elsewhere shows that the experiment was not a failure. But the whole idea of build something at arm’s length and migrate didn’t work there.

Leda: There’s currently Mox in Southeast Asia, which looks to be an immense success — they’re onboarding a new customer every minute. Will Standard Chartered migrate customers on to there? No idea — remains to be seen. So, the build and migrate thing is brilliant as an idea and lower risk. It’s just that the migrate thing never seems to happen. The Big Bang approach doesn’t work, and we’ve seen a lot of very good CTOs stop being very good CTOs — in fact stopping CTOs at all. It’s the fastest way to end your career, right? So what are you left with? You’re left with slow refurbishment. And the thing about slow refurbishment is that it has two massive challenges. One is, it’s a long game, and people lose momentum and focus. It’s a long game. Like, if you start doing that, it’s going to take 10–15 years. And in year three people start going, “Are we still doing this?” And the answer is “Yep. And we’ll be doing it for quite a lot longer.” So people start losing focus, it stops feeling like a top priority, it feels like an endless log in a bottomless pit. The second challenge is that you can’t change — and we touched on it earlier — you can’t change systems without changing the supporting economics and surrounding governance. Which means that if you’re doing the slow refurb process, you’re going to have a schizophrenic organization for quite a long time, where part of your organization will have a different governance model and a different pricing model and that creates immense tensions, both in terms of the operating model viability, but also in terms of humans. Imagine a team that sits in the same office opposite to each other, half of them have transitioned to a new system with new governance with real-time approvals from risk and compliance and a different pricing model. And the guy sitting opposite you has to go to the risk committee. And if they miss their slot, they have to wait for three months. But that’s the reality: if you’re doing a slow migration, you have to change the system, the pricing, and the governance for each part of the bank, and then move on to the next one. And it’s not just the cost of running two parallel infrastructures until you can migrate and switch off. It’s the fact that you’re gonna have to be running two different organizations, from a governance and pricing, etc. perspective.

[00:45:26.24] Ben: One idea that I hear more often is, you know, as you said, I don’t believe there is a silver bullet — but this idea that maybe you can put some sort of orchestration platform in between channels and record-keeping, which enables you to deliver better customer experiences, and sort of buys you time to replace those record-keeping systems, which is where the real complexity and the real legacy lies. So, how do you react to that idea of introducing a new orchestration layer?

Leda: Bring it! Great! But you still need to fix the human governance, which seems to fall off everyone to lift.

[00:46:10.21] Ben: And do you think it’s issues of governance that are ultimately the reason why these greenfield captives don’t become the bank at large?

Leda: That’s a very, very good question, and ‘I am not sure’ is the answer. I would suspect the answer will be different in every captive. And it would depend a lot on whether the captive is expected to run on the existing bank infrastructure — in which case, it’s not just the governance, it’s also the infrastructure — or whether you have your own board and you’re essentially not just a separate entity name, but you’re genuinely a separate entity, in which case your decisions can be different. I think it varies. It could be lack of conviction, it could be the fact that nobody has successfully done it yet. It could be a case of, when is it big enough? Or when do you know? So, Mox is very young, so it’s easy to pick them as an example — Mox is succeeding by every metric right now, but it’s extremely early. Assuming that the plan is if Mox succeeds — and I hope they will, and I think they will — if the plan is, well, we expect that some of the traditional bank customers will choose to go to Mox, great! But if the plan is, we will migrate the customers when Mox has achieved size and scale, I bet you that nobody has specified exact numbers for that. It is so far into the future. But then it becomes a question of, okay, what is big enough? How long do you wait?

[00:47:37.16] Ben: And it’s not obvious that all customers will want that kind of service. And it’s not also obvious, to me, at least, that the regulator will allow it, because what happens to rural areas? What happens to non-digital customers?

Leda: The answer to that will be many-fold. I haven’t seen a regulator yet force banks to have branches. So, that could be a very interesting legal case that says, “If you allow Revolut, and Monzo, and Starling to have a banking charter without the responsibility to maintain branches, why are you putting the onus on me?” It’d be extremely difficult to have rules for one and not for the other, right? So, there is currently no obligation to serve the rural areas, there’s currently no obligation to have branches, there’s currently no obligation to serve the elderly. So you could see challengers that emerge that cater to those communities or you could find that actually, the way things go, they become even further underserved and marginalized. But with no obligation to retain a physical presence and the mounting cost of retaining a physical presence, I am not sure that the considerations you raised would carry the day — valid as they are.

[00:48:52.22] Ben: I guess there’s another reason to move fast, otherwise, you’re left with this sort of rump of hearts of expensive-to-serve customers. And I think it also maybe depends on something you said at the start, which is, whether this ultimately becomes some sort of public service utility, in which case, maybe there does become requirements about serving rural customers and things like that. A slightly different topic. So, I think we’ve been through the hype cycle with everything to do with cryptocurrencies, and digital assets, but it feels like we might be back into some sort of slope of enlightenment. What do you see is the role of digital assets in banking?

Leda: There are three different pieces there, right? And when this whole thing started, we couldn’t imagine them separate to each other. One is digital assets, the second is crypto assets, and the third is distributed architectures. I would say that distributed architectures and what we understood as smart contracts were a revelation, it blew our mind. But there are now ways of doing them that are much kinder to the environment than a traditional blockchain. There are ways of having a distributed architecture that isn’t DLT. There are reasons why you might still choose DLT, but you can have a distributed architecture in immutable records without DLT. So you would need some good reasons to have DLT that would go beyond those basic functionalities that, for a time, we couldn’t fathom outside DLT, but now we can.

Leda: The second thing is digital assets. And I think we were going in that direction anyway but the advent of blockchain and other digital assets forced us to create security of holding and transacting in assets that don’t even have any magic, physical representation. Because we have been dealing in digital assets and digital ledgers for a long time, but the assumption was that there was capital adequacy, that if I make a transfer to you, if the bank has that physical cash or that physical gold somewhere in its coffers, that doesn’t exist anymore. So the transition to regulating and understanding digital assets and creating a certain degree of complexity is there and is now also decoupled from crypto cash and crypto-assets. Which means that crypto has become its own segment, where part of what you’re doing is creating the distributed architecture and crypto and digital assets with the added layer of not having that provenance and ownership — essentially becoming a bearer asset, like money would be in the physical world, but in the digital space. And I think it’s not a space I personally have a massive interest in anymore. That’s not that I don’t find it interesting, is that there are only so many hours in the day. But I do find that for the industry, decoupling those three things has been helpful because then you can have the benefits of the architecture and the benefits with digital asset without getting into the moral and regulatory conversations around the crypto side, unless it’s absolutely what you were trying to achieve.

[00:51:59.13] Ben: Yep. Okay, last question. So, we’ve got this far and we haven’t talked about the technology giants — Google or Apple — moving into banking and finance. What’s the role of those mainly American and Chinese technology giants in banking in Europe?

Leda: I would say that the Chinese giants and the American giants represent a very different type of challenge because the Chinese giants have a very well-developed financial proposition. It’s not just payments, it’s investments — if you look at the two big Chinese entities, they started with payment, sure, but that’s not where they stopped. So, I would say that them coming into Europe presents a very interesting challenge because they’ve worked out how to become financial services provision players and they don’t need to build scale in Europe to become profitable, because they can leverage their scale in Asia. They already have scale. What will be interesting is how the regulator will treat their entry point, whether they will expect a lot of infrastructure separation — in which case they would need to rebuild their support, and their infrastructure in Europe in order to have that scale — or whether they would allow them to cross leverage. But I think it’s a very interesting thing with the Chinese giants in particular, that their regulatory framework has very much allowed those entities to grow because of how the regulatory framework is in China. You don’t have anything of that size in Europe, and that’s not an accident. That’s partly because the regulator is pointing growth in a different direction. From a US perspective, the giants that are being looked at as potentially entering our space are only dabbling in payments. So, they’re looking at extending whatever it is they’re currently doing into the next step, as we were talking about — the embedded infrastructure makes it natural for these entities to offer payment services, and facilitate some of those. There is no indication that the deeper credit lending and investment pieces are being addressed. The only pieces we’ve seen have been through partnership — you know, that short-lived partnership between Amazon and Wells Fargo and then more successful, but equally limited for now partnership between Goldman Sachs and Apple. We’re not seeing an appetite for those guys to become regulated financial services providers the way that Alibaba and Tencent have.

[00:54:33.01] Ben: Where do you think the bigger challenge comes from?

Leda: If you’re talking about the biggest challenge to profitability for banks in Europe, actually, I think it comes from the regulator, who’s increasingly demanding unbundling and transparency and simplicity and pushing for technology transformation without allowing the banks to pass that cost on to their customers. The business models that both of those two geographic units of giants represent would have to be tweaked a little as they enter Europe, but from a bank, multiple payment providers that sit on top of their infrastructure doesn’t provide an existential threat. Neither does a Chinese tourist making all payments through WeChat. It’s what happens about pushing them up and down the value chain, and how they monetize the place where they land, which is why I find the model that Standard Chartered is doing very interesting, because they’ve had to deal with those Chinese giants and have taken, to me, the logical path of, there are certain battles that are not worth fighting, because we weren’t winning them before these guys appeared. Therefore, let’s focus on the things that we’re still needed for, that we do well, that we have scale for, and then we can even still partner with those guys and give them depth where they don’t need to build infrastructure. Because one of the things that both the Chinese and American giants have in common is the fact that they are clear as to what it is they’re for. And what it is they’re for may be multifaceted, because they have many different business lines under their umbrella, but they’re clear as to their purpose, and they don’t carry unnecessary infrastructure if it’s not aligned to their purpose. So I think it’s important for European entities to learn that lesson.

[00:56:18.08] Ben: If an incumbent is clear about what they stand for, and they align around that, and potentially also pursue some sort of ecosystem-based model, then there’s no reason why banks can’t surf this wave of digitization and emerge on the other side with happy customers and profits.

Leda: I mean, I am not going to foretell such a happy ending for anyone because they’re potentially too many banks, and what passes as profitability for the average bank is possibly not to be seen again in the market. But I would say that anyone who refuses to do that will definitely not have a seat at the table. Consumers — and I don’t just mean retail consumers, I mean, customers across all value chains — and regulators are much more demanding, and rightly so, in terms of service provision, focus, transparency, and pricing. And therefore, unless you really know what it is you provide, what it is you’re for, you can become overwhelmed by options. Think about it, you can revamp your lending infrastructure in 10 different ways. If you can’t decide whether lending is important to you, how will you know what the best way of revamping is?

Ben: Thank you very much, indeed, for your time. That was great.

Leda: Absolute pleasure. Thank you so much!

Evolving an Entrepreneurial Ecosystem (#31)

Structural Shifts with Ian HATHAWAY, Senior Fellow at The Brookings Institution

We discuss with Ian Hathaway — Senior Executive Director at Techstars, Senior Fellow at The Brookings Institution, and a Co-founder and Board Member of the Center for American Entrepreneurship and book author (latest book co-authored is called ‘The Startup Community Way’ ). In this episode, Ben and Ian discuss entrepreneurial ecosystems, what governments are getting wrong when they try to foster entrepreneurship and how they can create better outcomes; why entrepreneurship can lead to bigger and better outcomes than direct engagement in politics; why entrepreneurs are going to have more opportunities than ever during the pandemic and after it — and more.

Ian recommends:

 

  1. One book: “What You Do is Who You Are” by Ben Horowitz
  2. One influencer: Naval Ravikant
  3. Best recent article: What is a tech company, by Ben Thompson
  4. Favourite brand: Apple
  5. Productivity hack: Say ‘No’

The difference between a small business owner and an entrepreneur is the ambition to grow.

[00:01:22.21] Ben: So, Ian, thanks very much for coming on the Structural Shifts podcast. We’re going to cover in quite a lot of detail your new book. But before we get started, I just wanted to ask you a broader question, which is, in what sorts of health do you think American entrepreneurship is today? Because we sort of get the impression, because there’s been so many world-beating tech companies that have come out of Silicon Valley that everything is rosy. Would you agree with that statement?

Ian: So I view entrepreneurship much more broadly than Silicon Valley, for sure. In my framework, I think the difference between a small business owner and an entrepreneur is the ambition to grow. That’s much broader than most people think about in tech, but to stick to the tech and venture-backed world, the US market has a long tail, right? A substantial portion of startup activity, venture-back startup activity happens, of course, in the Bay Area, but an even larger portion happens outside of it. And in those markets, the capital efficiency maybe is what we’re talking about here, is much better. So Silicon Valley is just a completely different place, even within the context of the United States.

[00:02:43.04] Ben: But I was reading some statistics. Actually, the number of new companies that’s getting started each year, has actually been going down. So I’m just wondering, you know, do we have the impression that maybe entrepreneurship in America is kind of doing better than it actually is?

Ian: Well, so, the Business Formation Statistics, which you’re talking about is covering business owners of all growth, ambitions, all sectors, right? That’s been on a steady decline since the late 1970s. And in fact, that’s a trend that has been carried across all of the OECD. I believe that’s more demographically driven than anything — as population growth declines and as society ages, business formation rates, overall, are reduced. Now, businesses are also getting much bigger. There’s no rule that says, if the business formation rate is subdued, that businesses must get bigger. And overall, the average business is getting much bigger. There’s a huge debate happening on what the implications of that are. I think it varies substantially across sectors. But one of the things that I and some other researchers documented back in 2014, is that the business formation rate, even in the high-tech sectors is declining as well, which will startle a lot of people. But it’s just because that denominator is so resilient, and the companies are getting so big.

[00:04:14.19] Ben: What was the rationale for writing this book?

Ian: Yeah, I guess I should go all the way back to 2012. My co-author, Brad Feld, wrote a book called, ‘Startup Communities’, documenting his experience as an entrepreneur turned venture capitalist and community builder while in Boulder. He moved to Boulder in 1995, didn’t really know anybody, had a successful career in Boston as an entrepreneur, started investing in the Valley, New York, East Coast — and wanted to just get involved in Boulder. There was a lot happening, but it wasn’t really concentrated. And so, he spent, you know, the next couple of decades doing that work. He felt that Boulder was unique in terms of the entrepreneurial output that it has achieved and that that collaborative spirit, that community was a big part of that reason. So he wrote that book.

First of all, the entrepreneurs must lead the community. Secondly, the entrepreneurs must have a long-term commitment.

Ian: We started talking in 2016 about ways we might work together and one of the things we discussed was an evolution on his Startup Communities book and the frameworks that were included in that. Given that my background before working on a full-time basis with startups, as I do today, and big tech companies, as I did, you know, over the last decade, I was a full-time researcher. So, I have a research background and an economics background. And that was one of the appeals, I believe, for Brad was, “Hey, look, we’ve got knowledge and interest in startups and ecosystems, we have different frameworks in our heads. Let’s bring those together and see what comes out of it.” And so, that was kind of the script. And we began work in the spring of 2017. We had a bunch of fits and starts, a couple of hiatuses, nonlinear progressions, which we’ll talk about, I’m sure. And the book was finally published this last summer. So three years in total, from start to finish.

[00:06:13.25] Ben: Maybe let’s talk about what the first book is about, right? Which is principally about the Boulder thesis. So would you mind just introducing us to that, the four principles of the Boulder thesis in creating a community?

Ian: Yeah, so the Boulder thesis is simple, but not easy. First of all, the entrepreneurs must lead the community. Secondly, the entrepreneurs must have a long-term commitment. So originally, in the book that said a 20-year view; that’s evolved to a 20-year view from today, which means it’s always 20 years ahead of you. So, you’d be thinking in generations not in, you know, weeks or years. The third is that it must be inclusive of anyone who wants to participate. And the fourth is that it must engage the entire entrepreneurial stack, which I interpret as a derivation of inclusivity — so people from various domains, roles, experience levels, and so on. And that that engagement is constant.

if you think about a city as a series of systems, the startup community is the beating heart of entrepreneurship in a city

[00:07:12.29] Ben: You know, when you talk about a long-term commitment — so generational commitment — and you, yourself acknowledge that these things are hard, and the outcomes are uncertain. I mean, how difficult does that make it to recruit the key actors for a startup community?

Ian: It’s very difficult because most people don’t work on those time cycles. But there’s nothing that can be done about it because these long feedback cycles are inherent. That’s one of the reasons why we wrote this new book, which we can dig into that a little bit more, and why we wrote it in the way we did, which is explaining these systemic properties of startup communities and entrepreneurial ecosystems. But taking a quick step back, it’s also why Brad emphasized why entrepreneurs should lead the community. That’s not to say that non-entrepreneurs cannot be involved in building startup communities, helping founders, and in fact playing leadership roles, right? In many nascent communities, it’s these non-entrepreneurial community builders, whether as a side hustle or as their full-time job they are catalyzing efforts because entrepreneurs are heads-down, doing what entrepreneurs do, which is building their businesses. So, it’s not to say that, that non-entrepreneurs don’t have a role, but it’s that the entrepreneurs who are committed to being in a place for a long period of time, building their businesses there, knowing that it’s a — you know, even a successful outcome it’s 10 to 20 years before that liquidity event occurs, and those resources can get recycled back into whatever comes next. That’s just the reality of the situation. And so, that’s why the emphasis on entrepreneurs leading. Not only because the entrepreneurs are the ultimate end-users of the startup ecosystem — if they’re not benefiting from it, or participating or engaging, then it’s not valuable to them, which happens in many communities. But it really is an acknowledgment of the long-term commitment that’s required.

The mistake that’s often made is looking at the factors that currently exist in successful ecosystems and equating that with what it takes to get there.

Ian: Now, to build on that quickly, one of the things we talk about is the difference between the community and the ecosystem. Quickly, I’ll just say, if you think about a city as a series of systems, the startup community is the beating heart of entrepreneurship in a city. It’s really the founders, it’s the people who work with them on a consistent daily basis, whether as their full-time job or maybe something that they do outside of their job — maybe they’re mentors, maybe they’re angel investors or something like that. It’s having a firm understanding of what the entrepreneurs do and what they need, but it’s more than that. It’s also this kind of kinship connection, right? It’s a common identity, it’s kind of a love of place and that sort of thing. The ecosystem is a broader construct, which is, of course, all of these resources and actors who bring them that can either accelerate or impede the progress of entrepreneurship in a community. They have different organizational structures that align or are misaligned to varying degrees with entrepreneurship and entrepreneurial communities, they have different incentives — so, people want governments to engage a great deal in the building of ecosystems, which makes sense, because, you know, ecosystems in startup communities are sort of like a public good for the benefit of entrepreneurs. But governments have a much bigger mandate, right? So, their mandate is typically around creating jobs and having economic vitality and safe and enjoyable cities. And so, because of not just the hierarchical, top-down structure of governments not being aligned with the behavior of startups and startup communities, it’s also very different incentives.

Ian: And so, back to this long-term arc, this concept we discussed is community ecosystem fit, and why developing a strong startup community must precede the development of a robust ecosystem. Part of the motivation behind that was something we observed in many cities, which is you pull in these ecosystem actors — whether it’s potential angel investors, corporations, governments, and so on — their response was, “Well, you know, the entrepreneurs aren’t any good. You can tell me all day long I should be more collaborative and helpful and focused on the needs of the entrepreneurs, but all the entrepreneurs here suck. So why would I want to do that?” Now, we can push back on that and say, “Look, well, you know, what are you doing to help that situation? But fair point.” And so, once the startup community is producing a high rate of companies that are interesting, it then becomes a resource attractor that pulls those things in. And so, that’s a very long answer to your question about, you know, how do we get around that — this need for a long-term view — and my answer is that the entrepreneurs will be the ones who will create the interest by producing interesting companies.

[00:12:30.20] Ben: Is it not slightly a Catch-22 situation, where, when you’re trying to create a new startup community, we don’t have successful entrepreneurs? Because, you know, in a way, the community depends on being led by successful entrepreneurs and if they don’t exist, then it makes it harder to create that community, right? How do you overcome that challenge?

Ian: The mistake that’s often made is looking at the factors that currently exist in successful ecosystems and equating that with what it takes to get there. The resources, the actors, they co-evolve along with success. We’re going through the early days of a boom cycle, right? If you believe there has been this outward shift in technological opportunities, there has been a shift in certainly the supply of venture capital into these ecosystems. But these are emergent systems. And so, we can’t just force success. We can’t say, “Okay, these seem to be the ingredients of success. Let’s just place them here and then innovation will happen.” The reality is what’s valuable will emerge. There will be certain principles that apply across geographies, but it truly will be unique to each time and place. That’s an inherently uncertain process and when that gets choked off, progress is stifled. So, that’s the frustrating thing. The Catch-22 is really about that we want to manufacture success, but it’s the attempted manufacturing of success which is actually what can impede success from emerging from the bottom up, principally led by the entrepreneurs.

you can improve the odds that your company will succeed by being more collaborative and engaging in a community, regardless of where you live

[00:14:22.14] Ben: I want to talk a bit about what’s different, or what changed versus the 2012 book. So, you talked a bit about, you know, how you wanted to talk more about what you’d learned from Boulder. But I think also, this whole notion of an adaptive ecosystem is new in the second book. And then also, I think you took a much broader lens, right? So you wanted to look at the startup community and ecosystem through a broader lens, which included some of the geopolitical events that we’ve lived through in the interim. So, can you just talk about that — what evolved versus the original Startup Community book?

Ian: Yeah! So, our process is actually pleasantly recursive of a complex adaptive system. The process itself evolved. Our mission emerged from our process of discovery. So, the 2012 book was really about Boulder and Brad’s perspective of here’s what the situation was, here’s what we did, here’s what worked, here’s what didn’t, here was the outcome — of course, with it being about one place. You know, I thought that book was very principles-oriented. It was very actionable too. There were tangible ideas that people can go and try this thing or that thing. But because it’s about one place, it’s inherently limited. It was so early. I mean, Brad is really a pioneer in this thinking. And so, people in lots of places adopted the principles and the practices from that book. They found varying degrees of success with that because their city was so different from Boulder, and that’s the main criticism, that this is an idealized state of the world. If you’ve been to Boulder, it’s teeming with talent, large institutions, it has a huge entrepreneurial spirit, the community is so collaborative. I actually think the collaborative nature of the Boulder startup community is reflective of the entire Boulder community, rather than the other way around. And it’s just this fantastic place. So that was kind of the main criticism is like, “Look, try going to Paris where people undermine each other.” Nicolas Colin, our mutual friend, he wrote a book review of the Startup Community Way, saying, “There’s kind of this Kumbaya spirit emanating from Brad and then also Brad and Ian, which didn’t really apply in Paris.” And so, that’s fair.

Ian: But I still think, even if you view Boulder, which is not perfect as the idealized state of collaboration, there’s still a lot that can be learned from that. Why the evolution was, as startup communities, entrepreneurial ecosystems garnered more attention over the last decade, the scope and scale of ecosystem actors increased, right? Governments, corporations, universities, other actors, and so on, have been putting more resources, getting more involved in more places. And one of the things they were looking for were tangible frameworks, right? It’s very difficult to convince those actors without sufficient evidence, and theory and frameworks to guide, that this bottom-up approach of experimentation — learning — adaptation, which is so familiar to entrepreneurs and entrepreneurial community builders, that that’s actually the way to do this work, because it feels a little hand-wavy, right? It feels kind of like it’s bullshit.

Ian: And so, our mission was to say — and I think that’s part of the appeal of working with me, someone with an economics and research background to say — look, let’s dress this up with some data, let’s dress this up with some more theoretical frameworks. And that kind of was the initial mission, to do that. But through, I guess, maybe we were four or five months in, we have 30,000 words written and just think of it as, you know, Startup Communities 2012 book with more evidence, theory, frameworks, from economics, sociology, economic geography, that sort of thing. But it was still a linear progression from the first book. As I talked to more people, I realized that it was just this complete disconnect, almost of mental models about bottom-up versus top-down, you know, planning and execution versus experimentation and adaptation. And so, we realized that we were on a different mission. I don’t have a background in systems science. My background is in political economy and economics, but I discovered complex systems along the way. And as soon as I — you know, having talked to lots of people, reviewed lots of work — as soon as that framework came into my mind, I realized immediately that this is what needed to be the centerpiece of our book, to explain the inherent uncertainty, the nonlinear behavior, the uniqueness of each place, and why that presents these challenges. So, we threw the first 30,000 words or so that we wrote away and we began a new — and so, that sent us down this path of explaining the behavior of startup communities and entrepreneurial ecosystems through the lens of complex adaptive systems.

[00:19:48.24] Ben: So, I’m trying to draw a parallel: in nature, you can’t control ecosystems. You can merely sort of seek to guide them, to influence them. And this is very much the same philosophy you take with startup communities and the attendant ecosystems. But what are some of the equivalents? How do you give an ecosystem the energy, the nutrients, the oxygen to grow? What can be done that’s replicable across different places?

Ian: This is not to say that the inputs don’t matter, right? It’s an empirical reality that entrepreneurship, especially in the knowledge economy, and especially if we want to talk about tech and venture-backed entrepreneurship, is concentrated in certain types of places, right? The distribution is very spiky. That’s an empirical reality. It is beneficial to have a density of highly-educated, ambitious people, right? It’s advantageous to be around other high-tech institutions, whether they’re businesses or universities, and so on. Those things matter, but they’re not enough. What our point is, it’s about the integration of those elements, right? If I view the process of starting and scaling a high-potential company, as a search — not entirely, but to a large degree, it’s a search for the resources you need to succeed. Many of them exist outside the boundaries of the company, right? So, whether it’s a key senior hire, it’s early-stage mentoring — we talk about investment capital a lot, right? It’s a relationship with the customer. All these things are dependent on the exchange of intangibles, fundamentally underpinned by relationships, which require trust.

Ian: And so, what we’re really talking about when we talk about integration, is building better relationships. And so, one of the points that we make throughout is — and this is the part that’s empowering, especially for people in places that don’t have all these resources, where people do have ambitions, and they do want to be better, and they want to stay where they are — is by building a community of like-minded people who are committed to a cause — entrepreneurship, technology, they’re committed to that place — if they could be committed to each other, create a critical mass of knowledge sharing, support learning, sharing contacts, expanding networks, we believe that the odds of success for any one company will be greater. It doesn’t guarantee success, it also doesn’t guarantee success to be in Silicon Valley. It just improves the odds of success. I mean, maybe we could debate that today, if that’s turned negative. But that’s the fundamental point we’re making is, you can improve the odds that your company will succeed by being more collaborative and engaging in a community, regardless of where you live.

[00:23:10.09] Ben: And how do you get some of those stakeholders to be collaborative, and to not want to take control? Because, as you said, they’re not the principal actors; the principal actors or the leaders have to be the startups. But you still need the participation of governments, universities, organizations that are typically very top-down driven, very hierarchical. How do you get them to behave in the appropriate, collaborative manner to really help the ecosystem?

Ian: Well, it helps to have individual champions from those places. And this is a subtle nuance that’s missed. Sometimes it’s a key individual or individuals who drive the whole thing in a community. Fred Terman’s role, from Stanford and Silicon Valley, has been talked about a lot. Brad Feld, honestly, in Boulder is sort of a local hero. There are a number of stories throughout. There’s even one from the Viking Range Company — I don’t know if you’re familiar with that — but high-end ranges in the United States, a small town in Mississippi, there’s a famous story about how the founder of that company created an entire local services economy to support high-end families who would come to purchase these ranges. This role of a local champion can be really important, whether that’s in an official capacity or non-official capacity. Too often, though, however, these institutions are disconnected from the entrepreneurial community. University towns are a great one in particular. Even in Boulder, which is a city of 100,000 people, it’s fairly densely populated for having a small city vibe. The university is just adjacent to downtown, but in my experience, it’s very disconnected from the startup community. So in an ecosystem ranking or a research report, it might say, “Well, this is an example of a research institution that’s feeding entrepreneurship.” In my opinion, it doesn’t. So, it’s more about the talent that it’s producing, it’s drawing interesting people to the community, it’s driving economic growth. But I wouldn’t say that, that university and countless other places, are driving the entrepreneurial community. And in worst instances — I’ve seen in a bunch of especially smaller, less-developed ecosystems — there are what I’ll broadly call entrepreneurial supports; these are innovation centers, incubators, co-working spaces, and so on. They’re almost always funded by the government, and the people leading it have no entrepreneurial experience. What they have experience doing is extracting, or I should say, getting these initiatives funded by the government and maintaining those relationships. They at best, are irrelevant, and at worst, harmful. They suck the oxygen out of the community, and they can be actually predatory to entrepreneurs in too many places.

what each city is going to find is that about 10% of the companies will create 90% of the value

Ian: Going back to one of the first things we talked about, which is, if you live in an environment like that, the best thing you can do is to build a critical mass of people who don’t behave that way, to help each other. One of the things that I’ve found, even more transactional — I mean, I know it’s very easy, the American way is to say, “Hey, be informal, be collaborative, be helpful.” That can be seen as a naive view towards many cultures. But what I have seen is that when people do embody those values — being helpful to others, without expectation of something in return, being less transactional, at all times — that shifts the dynamic, and people start to think in positive-sum terms, right? Like, “Oh, well, if that person does well, that’s good for me, too. This is going to grow our ecosystem overall and that’s a good outcome for me as well.” And so, you know, my message would be entrepreneurs creating a critical mass, in spite of those obstacles. It’d be great to unlock the power or the resources that some of those larger institutions have, but you don’t need it. And one of the ways to get around that is by creating a critical mass, creating successes, and then those larger actors have to adapt or die because they’re no longer the most important force in that ecosystem.

[00:27:41.23] Ben: Do you think is as present now as it was historic? I mean, is it more difficult to find people that will act in that way, and with that level of generosity?

Ian: I believe the startup communities in which I operate — so this could be a biased view, just because of my network — but I find that the entrepreneurs are fairly collaborative. The Startup Community community is fairly collaborative, more so than obviously, many other sectors of the economy. I do think that mentorship is one of the ways that this has manifested, I think mentorship around entrepreneurship has been adopted pretty much worldwide at this point.

[00:28:27.09] Ben: You know, you’re giving advice to governments around ecosystem development. And what should they be doing? Because you’ve already said they should not be necessarily investing in or funding incubators, and accelerators. So what should a government do to foster a startup community and then an ecosystem?

Ian: Well, it’s not that they shouldn’t do those things. It’s the way in which they do those things. So, the first order of business is figuring out what is needed. I can’t tell you how many times, whether it’s from a mayor in the US to a minister of innovation in country XYZ, that says, “Oh, we’re doing this, this and this.” And the question I always ask is, “Well, you know, where did that idea come from? What do the entrepreneurs think of that?” And they never know. They’ve never taken the time to say, “Well, what actually is needed here? And what can we do to see that?” So that’s the first principle, which, again, it’s super simple, but it’s not easy because governments aren’t used to acting in that way. The second thing, it’s not that they shouldn’t fund accelerators, incubators, and so on. Actually, there’s a super important role for government to catalyze those things, especially early on, but don’t do it in perpetuity. Let the private sector fill in eventually. And make sure that entrepreneurs are involved. I’ve done some survey work on a bunch of different dimensions. And the number one thing — at least in the way that I’ve structured these surveys, where I’m kind of generalizing between positive and negative — on the negative side, the number one thing is not involving entrepreneurs with any of the decision-making process and how money is spent. That doesn’t mean you want to have an entrepreneur, necessarily, who’s the CEO of an innovation center, a co-working space, something like that. But you should have entrepreneurs involved with the design, and from the governance perspective, on the board. That way, we ensure that it’s relevant. Over time, the entrepreneurs, the successful entrepreneurs who are in that community should begin to fund those initiatives. Otherwise, again, they’re not valuable.

the most powerful political actors in the United States, where I’m from, are the people who’ve had the major entrepreneurial successes

Ian: So that, I think is more kind of the role of government, right? Be smart, be agile, fund many things, not just one thing — that tends to happen as well. You know, they’ll pick winners, and everything goes to this, they try to consolidate. But actually, I think a better thing to do is fund maybe a handful of things over a two or three-year period, and then let them be self-sustaining at that point, see what works, see what doesn’t. Also, think about stage. So, it feels to me like there’s been almost an oversaturation of very early-stage entrepreneurial support, in most places in the world. We saw the S curve adoption for accelerators. Now, there’s pre-accelerators, pre-pre-accelerators. And I think that’s fantastic! I think we have more experiments that are going on. But what each city is going to find is that about 10% of the companies will create 90% of the value. So it’s the ones who have achieved that product market fit who have the traction, and maybe are unclear about navigating international markets, or what it means to be a CEO in a company that goes from 10 to 50 people overnight, that sort of thing. There’s a huge under provision of that and I think that’s where the industry of entrepreneurship support needs to really fill in that gap. Because we haven’t seen that yet.

[00:32:17.03] Ben: In the book, you say, these are things that measure the things that are least important, right? But you’ve got a government that’s clearly very keen to demonstrate progress, very keen to demonstrate they’re getting return on investment. So, how do you get them to think about the right metrics for success, and to apply a long-term vantage point to this, when again, you know, they’re hungry for short-term success?

Ian: Well, the first thing that I do is explain to them that any metrics must be oriented around whatever the program’s goal is. So, if their ultimate goal is about job creation, wealth creation, okay, I understand that. But too many people will sell them a solution saying, “Oh, yeah, this thing we’re going to do, this program that is supporting entrepreneurship, will create x jobs.” Oftentimes, governments will fund initiatives and the key metric is how many jobs did this create at this point in time? Which is the wrong metric. What I might be more interested in is what kind of lift do they give to the marginal company who participated, right? How did, let’s say, a top of funnel community catalyst program, what kind of relationships spun out of that, if that’s kind of the goal? Or, what kind of people did it pull into entrepreneurship? So making sure that it’s structured around what the programs actually do, having a clear value chain that explains, okay, if job creation is actually what you want, how we get there is having companies with better outcomes. Let me tell you how you help companies have better outcomes, and we can create that value chain. But making sure what you’re measuring is actually built around the program.

Ian: The other thing, too, is that I believe that system structure explains so much of the performance of an ecosystem. So we’ve been doing a bunch of network mapping exercises in a few markets where we’re looking at who’s influential. There’s some academic research, and also some policy research that supports this, that when the influential actors in the ecosystem are entrepreneurial, have had entrepreneurial success, or they support organizations that are heavily influenced and/or funded by entrepreneurs, those tend to be more productive ecosystems than those with less. So, there’s empirical support behind these theories that we’re talking about. And so, that’s one of the things that we do, we map out the ecosystem. Who are the businesses that have reached to scale, have had some success, and how are they integrated in? What are they connecting up with? Often what we find is that the most successful entrepreneurs are isolated. They’re not linking up with any of these support programs. So, the metrics, in this case, are outputs. How many companies participated in this program? How many people attended this event? What I want to know is, have the most impactful companies touched any of these things we’re paying for? Or who is this angel investor over here who seems to be connected to every high-impact company that has come out of this community in the last 10 years? How can we engage her more in our efforts? What do they think we could be doing better? And just by mapping that out, and not only who the influential actors are, but how they’re all connected through meaningful relationships — whether they’re investment, mentorship, program participation — that explains a lot. And then you have a well-informed strategy about, again, taking the system’s view of how can we better integrate these things and make sure that the most productive programs have the resources they need, and maybe the ones that aren’t, that are just sort of creating a lot of noise, but not producing tangible outcomes, high-impact outcomes — maybe you start winding those down. And that’s okay. That’s normal and healthy.

[00:36:16.27] Ben: We talked about the introduction of the whole complex adaptive systems framework. We’ve talked about developing what was learned in the interim period. But the other thing that strikes as different with the second book, is this idea of it having a broader context. Now you’re looking at startup communities through a broader lens, including a geopolitical one. And you talk about your experience of living in London at the time of Brexit. I suppose the question I wanted to ask is, like, you know, you mentioned Nicolas Colin, but Nicolas has this view that, you know, almost through entrepreneurship, you can make a bigger change than you can through engaging directly in politics, for example. So would you say that, that was a big motivation for writing the book? And do you subscribe to that view that entrepreneurship can lead to bigger and better outcomes than a direct engagement in politics?

I’m incredibly optimistic about the future of entrepreneurship in America, in Europe, globally. I think entrepreneurs are going to have more opportunities than ever, coming out of this crisis, during this crisis. And we’re going to need that

Ian: Well, I’ll answer the second one first, which is, absolutely, yes. In fact, you might say that the most powerful political actors in the United States where I’m from are the people who’ve had the major entrepreneurial successes. So, kind of reverse engineering math. You know, I’ve always been fascinated by geography. I’m committed to entrepreneurship, working with entrepreneurs, writing about entrepreneurship, explaining the importance of it to economic vitality, and, you know, to vibrant cities. I’ve just always been interested in these things. But it’s also personal to me. Although I’ve spent most of my adult life in California — well, I went to school in Chicago, spent time there — California, Washington DC, London, I spent a little time in Geneva, we talked about that a few weeks back. I grew up in a small, agricultural and industrial town, in the Midwest, in Ohio. It was part of the Detroit supply chain. And we didn’t have a lot of opportunities. I was born in 1980. That’s when manufacturing employment peaked in that region. We had a self-sustaining community. But I was born in the beginning of the decline. My father is a brilliant innovator. He has no college, no university degree, but he has, I don’t know, something like 50 or 60 patents in transportation logistics. And it’s always been this weird thing. It’s kind of like, my dad had these jobs, but he had these crazy hobbies in redesigning transportation logistics infrastructure. But he was not successful economically in these endeavors. He was not a successful entrepreneur. And what I had thought about was, well, what if instead of being from where we were, where we lived, if we were instead from Palo Alto, California, if you just changed that one piece, would my dad have had a very different outcome? Therefore, would I have had a very different life trajectory and so on? And I think the answer is not 100%, but I would imagine the odds of success would have been much higher. And I would like to see that equalized more.

Ian: I think we’re living through an era where there has been a massive proliferation of entrepreneurial high-tech activity around the world. People forget — you know, I know that Silicon Valley gets a lot of the attention, but people forget how fast activity has diffused. I did a report in 2018 with an urban economist named Richard Florida, where we mapped just over a decade and a half period, about the spread of venture capital, which we used as a proxy for high-tech entrepreneurship. Not a perfect one by any means, but it is a reliable data source for what it measures. And, you know, I guess, in 1992, the US got something like 97% of all venture capital. It’s now less than half. It’s 40%. And I think half of that decline happened in the last seven years. So, people forget how quickly this is diffusing in geographies, not only outside of Silicon Valley, but outside of the United States. And so, I feel like my soul’s mission in this work is so that entrepreneurs, regardless of where they want to live, can improve the odds of succeeding. That doesn’t guarantee they will, but if we can move the needle, and so that people don’t feel like they have to ride the train an hour and a half into London every morning, just to have a job in the industry they want to work in or, you know, face exorbitant housing or wildfires in San Francisco, and congestion. Like, I hope we can move the needle on that. And so, that’s what’s motivating me.

[00:41:18.07] Ben: The neoliberal kind of supply-side economics view was that people have to move to where the jobs are, right? We need to get mobility of labor. But, one of the downsides is that it’s very detrimental to happiness, because people have to give up their community links and so on. And so, what you’re saying, your philosophy in life is to take the opportunities to the people rather than vice versa?

Ian: Yeah. And also, the reality is that high-profile, high-tech successes happen in way more places than people realize. A successful company can be formed anywhere. The question is, how repeatable is that process? What happens after that success? I’ll use the example of my adopted hometown where my family moved to, on the central coast of California, called San Luis Obispo. It’s a 45,000-person town, small university, huge agricultural element, beautiful place where retirees and people on long-weekend holidays like to go from San Francisco and Los Angeles. In 2015, there was a company called Mind Body, which it’s been a unicorn exit. They were the first company to really get venture funding. Like, nothing happened and then it went from basically zero to a unicorn exit. Now the question is, what happens next? So, I just spoke to an entrepreneur down in Orange County, California — for people who don’t know, that’s between LA and San Diego — and he was saying, “We’ve had loads of exits. But then, people don’t reengage. There’s no community.” And so, what we’re after is we’re not going to predict where the next unicorn or 100 million or 500 million exit occurs. It’s, can you increase the odds that they will occur in your place? And when they do occur, how do we build a community of support around that so that the people will want to reinvest and stay engaged, rather than leaving or, you know, going off to the proverbial beach and disengaging? And that varies across geographies, significantly. And that’s really what this is all about.

[00:43:29.03] Ben: And that diffusion of startup success that you talked about, do you think that’s going to accelerate now, post-pandemic? I mean, do you think being physically close to the other actors in the startup community and an ecosystem is still as important as it was?

Ian: I feel like distributed work, there’s been a permanent shift on that, at least in the United States. Our cities are unsustainable, to a degree. You know, cities in Europe are unsustainable, but they’re just completely configured in a different way. I mean, the San Francisco Bay Area, Los Angeles, they’re almost unlivable, they don’t have the right infrastructure. So, I feel like there’s at least a permanent shift in some of that activity. But we have to remember that even the people who are moving to smaller cities — second, third-tier cities — they still spent years building relationships in those larger cities, they’re going to have a meaningful relationship with those places. I mean, I don’t want to be remote 100% of the time, I don’t want to work out of my house. So, I actually like the model of, you know, whether my colleagues sit next to me on a daily basis is irrelevant to me so long as we have the foundation and we come together when it’s needed. I do believe that the human element is important. Having said that, if you’re an early-stage company on rapid product iteration cycles, that’s hard to be distributed. I mean, I think it’s okay to have a distributed company, as long as it’s by teams, especially having engineering teams where people are completely isolated, that’s really hard to do rapid iteration. So I don’t think that will be permanent.

Ian: Another thing is, you know, there’s been all these announcements from big tech companies in San Francisco, like Twitter and Facebook saying, “Okay, permanent remote work.” The key indicator for me will be what happens to the executives. If the executives don’t leave, then it won’t be lasting, because it’s a strong signal that if you want to be promoted in the company, you still need to be at headquarters. And that’s been going on for a long time anyway, right? All these satellite companies. I know people in Europe feel that strongly that a lot of these American tech companies like, you know, you’re always second-class citizen if you’re in one of the satellite offices. So, we’ll see if that evolves. So yeah, I think, more importantly, though, that we’ve just gone through a massive shift in society and the structure of our economy. Entrepreneurs are best positioned to respond to that. Some people are being forced into entrepreneurship, maybe for the first time. So, I actually see a huge explosion in entrepreneurship happening overall and I’m incredibly optimistic about that.

[00:46:30.09] Ben: You wrote quite a lot about having a creative class, a spirit of rebellion. And there’s that great case study of Jerusalem in the book — great work with it — where the guys visited by a public official, saying, “Oh, we’re going to seed 200 startups.” He said, “You’d be better off seeding 200 rock bands”. Do you need to create the draw to bring people in, that will then create the foundations for community?

Ian: I think it’s extremely important. You know, in general, people go to places for three reasons: they go to a place for work or opportunity. Second, they go to a place for family or personal connections. The third is they go to a place desirable. So, if you’re a place that’s lacking on opportunities — family is sort of, there’s nothing you can do about that, right? Family and personal connections. But the third thing, making it a desirable place. Absolutely! Especially now, if you’re trying to attract people from the entrepreneurial class, knowledge workers that we’ve proven can more or less be based anywhere, if you have an airport or rail links that can get you into those major markets in a reasonable way, and the communities are desirable, they have social, natural, cultural amenities — I think that’s what people want. So I think it’s hugely important. And also, you know, additionally, this is something that people in the traditional institutional actors, the governments, the other civically-minded corporations and universities and so on, can do something about. It’s a little more in their lane.

Ian: One of the things that I tell governments often is, you know, they so desperately want to do the exciting things, you know, “Let’s create a huge startup campus!” I think they like going to ribbon-cutting ceremonies — that is like a tangible thing that’s exciting and fun. But then it’s like, just stay in your lane. Like, is this a great city to live in? Paris, fix your traffic congestion problem! You know, like, why don’t you start there? Taxation, regulation, all that. But a big part of it is, you know, making your community a place where people with options want to be. A big part of that, for me, is a healthy and vibrant small business sector, right? Quality restaurants and bars and that sort of thing. And so, yeah, I think it’s hugely important. I can say it in eight different ways, but absolutely, yes.

[00:49:05.19] Ben: Yeah. And I think the proxy sometimes, for success, is to build infrastructure, right? But infrastructure won’t bring companies by itself.

Ian: No. Well, today’s infrastructure is what? High-speed internet and interesting places to work.

[00:49:22.20] Ben: Yeah, exactly. Because I think, yeah, the definition of infrastructure is often defined in the industrial age terms, which is, we need new roads, we need new railways. I think you’re right. I mean, the actual kind of conception of what infrastructure should be, probably hasn’t been updated in many politicians’ minds.

Ian: Yeah, absolutely.

[00:49:42.13] Ben: What happens for those cities and those countries that can’t create a vibrant startup community?

Ian: They’re probably falling behind if they haven’t already. Entrepreneurship, in general, is important for a more vibrant economy and community, creates jobs, provides better services, increases productivity. In normal times, you know, creative destruction, even in the small business sector is super important. Kind of old, tired businesses move out while young, exciting ones move in. Everything’s updated and reflects the current demands of consumers and businesses, right? So, we want a healthy amount of that in general. So, if we focus on just the innovation-driven businesses, they’re the ones… Innovation-driven startups are shepherding in new industries, new sources of growth. Oftentimes, economic development initiatives are focused on the industries of the past and present — cluster analyses, you probably heard that terminology. Those are the strengths yesterday and today, but what entrepreneurs do is they look for sources of new opportunity. So, again, can’t guarantee success, but a healthy amount of that going on is really good for the long-term prospects, not only for those companies that achieve success but for the entire community.

Ian: One of the best books on economics I’ve read in the last decade, is called ‘The New Geography of Jobs’ written by Enrico Moretti, who’s an Italian economist at UC Berkeley. And his overall thing is, look, let’s divide the world into two types. Let’s divide the economy into two types of businesses. There’s the non-tradable sector, which produces local goods and services; this can be high value, low value, you know, everything from taxis and barbers, all the way up to lawyers and doctors. The tradable sector produces goods and services that can be bought and sold all around the world. Everything from agriculture — food — to the high-tech, innovative sectors. Within the tradable sector is the innovative sector. And his whole thing is, you know, you don’t have to work at a high-tech company, or a knowledge-intensive company that’s tapping into huge global markets, in order to benefit from that. What you need to do, if you’re destined to be a barista or a school teacher, you want to live in a community that has some amount of that going on, because those are well-paying jobs, those businesses are bringing revenue, and so income and wealth into that region is then spent to support the local services economy. So you want a healthy amount of that in your community to propel long-term economic vitality and opportunities for people.

[00:52:55.17] Ben: What’s your view on Europe? Do you think Europe has enough vibrant startup communities? Do you think Europe is building enough digital-age businesses to be successful or to have the same level of success in the future that has had over the last few decades?

Ian: Yes, absolutely. You know, I’ve mostly spent time in London. London, to me, feels top of the stack in terms of not only entrepreneurial activity, but collaborative spirit. I feel like people are generally helpful, interesting, people are weird. There’s that spirit of rebellion going on. I can’t say too much about many of the other places. But what I will say is, you know, the US is at an inflection point, and we’re definitely, because of our political dysfunction, our inability to address major challenges, putting aside outright hostility to foreigners — including high-skilled foreigners — we’re losing our edge. We have a major election coming up and I think the outcome of that could have a huge impact on the future of innovation here, as a talent magnet. Another great book to read on that — Harvard Business School Professor Bill Kerr wrote a book called ‘The Gift of Global Talent’, and it’s documenting how the US has been by leaps and bounds, a major beneficiary of foreign talent. Foreign talent has driven our innovation economy to a very large degree. So, you know, if you’re a European founder, entrepreneur, investor in the US, you know, depending on your embeddedness in this country, and you’ve had enough of our response to COVID, maybe you spent the last four months back at home and you realized, “Hey, life is better here!” Because it is. I think the European lifestyle is much better overall. And so, you know, I think that’s one dynamic at play — the US losing its relative position.

Ian: And, as I said before, Europe is a great place to live — I feel like that makes it a talent magnet — and a lot of progress has been made in a short amount of time. I think that that’s one of the things people forget. There’s a book that I read, called ‘100 Years of History in Silicon Valley’ — something like that; I forget the exact title — and it talks about how it was 100 years unfolding. You know, this didn’t happen overnight. People really do forget that. I think the first proper venture firm was founded in 1959 and the evolution of Silicon Valley’s technological prowess goes back much further. I recently realized that that book was written in 1996. And now, we’re 125 years in the making. As I mentioned before, we more or less can’t document the presence of venture capital in Europe before the mid-’90s, really. Early ’90s. Now, there were some, but it was very disparate. So, you know, that’s kind of a lot of progress in a short amount of time. So, I just want to frame it in that so people are mindful of how much has moved forward at a very, very rapid pace.

[00:56:22.06] Ben: Just to revisit the US election for a second. I mean, you paint this as a really pivotal moment, which I think most people would agree with, right? Do you think that entrepreneurs in the US — particularly those that have been very, very successful, and have major influence — do you think they’ve been sufficiently political or vocal?

Ian: I don’t want to paint with too broad of a brush, because people are so different. But I think the general bent for American entrepreneurs is to be more conservative, politically. The definition of that has shifted dramatically. Hardcore libertarian streak. Of course, the irony of that emanating from Silicon Valley is, you know, how propped up Silicon Valley was, and has been? Well, certainly, in the beginning, stages, how propped up it had been by government spending? And some of these entrepreneurs — you know, Elon Musk, in particular, has been a huge direct beneficiary of that. So, you know, the question, ‘have they been outspoken enough?’ I don’t know. It’s kind of all over the map. You know, I do see the private sector actually advancing cultural and moral causes more so than our government right now. It’s something I’ve actually been sort of thinking about, lately, that it’s remarkable how outspoken companies like Nike have had to be around the racial inequity crisis happening. Well, I say ‘happening in America today’ — it’s actually been happening for the last 450 years. I was watching a major league baseball game this past weekend. And I know most people in Europe might not be familiar with baseball, but on the pitching mound, there was a logo, it was #BLM — Black Lives Matter. And the fact that sports, major businesses, so many segments of our society are coming forward in support of that, and yet, our own government is actually hostile to that — you know, a portion of our government is hostile to that. I think that’s pretty remarkable. Really. A lot of businesses feel the need to fill that void.

Ian: So yeah, I don’t know, that’s kind of a meandering answer, but it’s a little bit all over the map. But I think in general, you know, people are stepping up. So, I’m incredibly optimistic about the future of entrepreneurship in America, in Europe, globally. I think entrepreneurs are going to have more opportunities than ever, coming out of this crisis, during this crisis. And we’re going to need that. I would encourage the entrepreneurs themselves, people working directly with them, whether you’re in consulting, podcasting, writing, mentoring, investing, wherever you are in that entrepreneurial stack, to be more collaborative and helpful. I think we’ve learned the importance of community by having it taken away from us. In some ways, my community is stronger, I will feel so much more gratitude to be in the physical presence of others in the future. But it’s really this positive-sum mindset. You know, we talk about ‘give first’, help people without the expectation of receiving something in return immediately. It’s not naive altruism. You expect to get something, but you don’t know when or from whom and in what form. You know, I believe if the global startup community is stronger, and I believe if entrepreneurs are doing better, that I will benefit from that too, because I’m a part of this system. This is like a time to just be grateful for each other, have humility, and build community, and you’ll be much better off if you do that.

[01:00:25.05] Ben: Amen to that! Ian, thank you very much for your time! That was a great discussion!

Ian: Thanks, Ben! It was a pleasure to be here!

Transitioning to a Multi-polar World (#30)

with Michael O’SULLIVAN, author of The Levelling: What’s Next After Globalization

Your host, Ben Robinson, is joined by Michael O’Sullivan, author of ‘The Levelling: What’s Next After Globalization’ and former CIO of the International Wealth Management Division at Credit Suisse. Michael currently serves on the World Economic Forum’s Global Future Council on the New Economy. In this episode, Ben and Michael discuss what is the role central banks will play in the transition period to a post-globalization, multi-polar world; what international organizations should be completely reshaped to meet the needs of this new world, what new institutions should be created, and more.

Michael Recommends

 

  1. One book: “Putin’s People: How the KGB Took Back Russia and Then Took On the West” by Catherine Belton
  2. One influencer: Chris Watling of Longview Economics
  3. Best recent article: Work done by Lisa Sanders for the The New York Times
  4. Favourite brand: “La Femme sans Tête”, bières artisanales de Paris
  5. Productivity hack: be ready to say ‘no’, politely.

Globalization is ephemeral, it’s in the ether, in the sky, in the way that people tend to look at it. There’s no ministry for globalization. So, it’s quite hard to get a grasp on it.

[00:01:23.24] Ben: Michael, thank you so much for coming on the Structural Shifts podcast. I’ve been really looking forward to this because it has been delayed a couple of times, but we finally got to do the podcast.

Michael: Yes, thanks! It’s a great pleasure. I’m delighted to do it.

[00:01:36.27] Ben: I wanted to kick off by just testing a little bit the premise of your book, ‘The Levelling’. Is globalization really over? Or are we just in a period where it’s sort of temporarily in retreat?

Michael: No, I think it’s dead. I think it’s over. I think there are many people, I suppose, for good reason, whose fortunes are tied to globalization, who don’t want it to be over, who deny its passing. Maybe it’s been dwindling as a force — in the last two years, we have been storing up many of the side effects or the perceived side effects of globalization. And that, I think, it’s been dealt a fatal blow by COVID. And I should say, I’m in favor of globalization. I mean, it’s done so much good. Billions of people have risen out of poverty, it’s transformed cities like London, Dubai, etc, it has given us so many technologies. So, I’m in favor of globalization but my reading, as it were, of the situation is that it’s dead and going. We’re moving on to something else now.

[00:02:50.15] Ben: And how objectively can we show that it’s over? Because, again, might it not just be changing form because, if we look at financial flows or trade flows, sure, we can show that it’s in retreat, but what about things like the flow of data? Is it not just becoming more digital?

Michael: I think there’s maybe three things just to bear in mind. One is that globalization is ephemeral, it’s in the ether, in the sky, in the way that people tend to look at it. There’s no ministry for globalization. So, it’s quite hard to get a grasp on it. We do have the benefit of history that we’ve had a wave of globalization from 1870 to about 1912, which looks very like what we’ve seen in the last 30 years or so. And that wave of globalization came to a juddering halt with economic crises, nationalism, etc. So, all of the warning signs are there. And then, thirdly, if I debate globalization with people, what I try and do is bring that debate down to indicators — the movement of people, the flow of ideas, trade — and all of those have been coming to an end, they have been cut off in different ways. So one example I give is that globalization began with the fall of communism, the opening up of Eastern Europe — not just economically, but democratically as well — and now we have events like the shutting of democracy in Hong Kong, which is the bookend to what happened with the fall of communism. You mentioned digital globalization. I think that’s quite interesting because tech and digitization have played a really strong role in globalization but the channels of digitization are being funneled in different ways. So one example I give you is Google in the early 2000s had about, I think, a third of the search market in China. Now it has close to zero. So, what we’re actually seeing is we have more digital activity, but it is becoming more regional. You look at TikTok as another example — potentially global company now being shuttered in terms of how it can be used not just in the US, but also in China and other parts of the world.

One of the problems we have, there really is no Minister or Prime Minister for globalization. It is an interconnected, interdependent activity, and many of those interdependencies are breaking down. In our world, the role of the nation state is still very, very important —Michael O’SULLIVAN

[00:05:18.01] Ben: Why do you think is over? Because as you yourself said, it’s had massive, massive positive effects. It’s a positive that raises economic activity and wealth for everybody. So why do you think it’s overall coming to an end?

Michael: I think that the prime concern I would have is that the economic engine of globalization has slowed. So, in many emerging countries, the rate of growth is slowing. In the developed world, productivity has been slowing — notably so in countries like the UK, where it’s at multi-decade lows. The financial side effects of globalization, the negative ones have been rising, so the world is becoming more and more indebted, which will slow future growth. And then, there’s a range of economic problems that people associate with globalization, such as inequality. To my view, it has really, nothing to do with globalization, but rather the way individual countries have harnessed it. So if you look at the most globalized economies in the world — Ireland, Netherlands, etc. — the income inequality in those countries is actually reasonably well managed, because they use tax to distribute the benefits of globalization. If you look at the US, where inequality is really egregious, they have not used their tax system to spread the benefits of globalization, and that creates discontent with globalization,

[00:06:52.07] Ben: Had globalization been better managed, then it wouldn’t be coming to an end?

Michael: I think that’s largely true. And I think one of the problems we have, there really is no Minister or Prime Minister for globalization. It is an interconnected, interdependent activity, and many of those interdependencies are breaking down. In our world, the role of the nation state is still very, very important. I think COVID is a great example of this: different countries have managed and digested globalization in very different ways with different consequences.

The post-globalized world order will be a multipolar one. What I mean by that is you’d have at least three big regions: China, Europe, the US — for the reason of their size will be dominant but also who will do things increasingly differently — Michael O’SULLIVAN

[00:07:35.16] Ben: You talk quite a lot about Brexit in the book. I suppose we should see Brexit as being part of something bigger, i.e. the end of globalization. But can we really draw that conclusion? I mean, could Brexit not just have been a political mistake, a referendum that should never have happened, a unique set of circumstances? You know, the refugee crisis, etc. Can we not just see Brexit in those terms? I mean, does it have to be read as part of this end of globalization?

Michael: That’s a very good question. To give context, we’ve had two big waves of globalization. The first of the early 20th century, which was led by Britain from London. The second was an American wave of globalization. So, both waves have been led by Anglo-Saxon countries. And the two main Anglo-Saxon countries — the US and the UK — are now in political crises. That much is clear. And those political crises are also crises of globalization. In the case of the UK, I think there is an argument that the calling of the referendum, or the way it was constructed, was accident-prone and could have been done better. I think, however, the way I tend to look at globalization, it’s like a big block of ice that’s begun to fragment and the first really big crack in the world order was Brexit — something that many people thought would be inconceivable happened — and that respected was the first shock, and I think the first really big event that’s taken us into the post-globalization age. And why I’m convinced that it’s linked with globalization is that many of the underlying problems in the end of globalization argument — low productivity, inequality, a country dominated by one city, one elite — you find all of those in the UK. And I think what I’m also drawn to is this whole idea of the rise and fall of nations and the fact that nations go through cycles and globalization is doing the same. The UK is now in a cycle where it’s in, I think and I hope, it’s sort of a bottoming out phase. And in the next few years, we’ll begin to see things improve and be reconstructed. So there is that logic to it, I think.

We would probably feel the end of globalization more severely if it weren’t for central banks, but the cure is arguably storing up worse down the line — Michael O’SULLIVAN

[00:10:09.09] Ben: How does a country like the UK fare in a world that’s deglobalizing? Because, you know, it’s detached itself from a very large trading bloc and so, now it’s seeking, I guess, new alliances, new trading partners in a world that has become less interested in trading. So, how does that play out, do you think?

Michael: Yeah, it has a lot of risks. And one of the risks, I think, is that the discourse in Westminster and in London is not really focused on what’s happening to the world order. It’s really very inward-focused — and this is a risk that things shift outside the UK, and it doesn’t adapt. So I think that there are several things. The most important, I think, is that the post-globalized world order will be a multipolar one. What I mean by that is you’d have at least three big regions: China, Europe, the US — for the reason of their size will be dominant but also who will do things increasingly differently. So, if you look at the way the EU is imposing itself on the tech world in terms of regulation, that’s a good example. So the UK needs to ask, “Okay, first of all, do we want to be outside this very powerful block?” — and that decision is already made. So, then it becomes a relative decision: “How do we position ourselves between these big blocks?” And in particular, two of them, the US and Europe are very, very close political and trade partners. And my hope would have been that they pay acts to arbitrage these regions. It’s a sort of third independent, but not neutral party, whose upholding of the rule of law makes it more where people feel very secure to do business. So, in that plate, the declaration in Parliament that the UK would break the rule of law is extremely worrying. And I think the international consequences of this have not been thought out at all.

Coming out of the global financial crisis, central banks were like doctors who gave financial morphine to the economic patient — Michael O’SULLIVAN

[00:12:17.07] Ben: What role do you think central banks are playing? I mean, do you think their role is helpful or not? In the sense that are they smoothing the transition period by cushioning economies from some of the worst economic effects of the transition? Or do you think they’re prolonging the transition and exacerbating some of the ills of the current age, such as wealth inequality?

Michael: Yes, this is a very good question — quite a complex area. We would probably feel the end of globalization more severely if it weren’t for central banks, but the cure is arguably storing up worse down the line. So the way I tend to phrase that is that coming out of the global financial crisis, central banks were like doctors who gave financial morphine to the economic patient. You know, a doctor, if you’re injured, he or she may give you morphine for a couple of days to take the pain away, but they won’t do it every day for 10 years. And that’s what we’ve had. And to that end, markets, investors, many other players have become dulled and stultified to the reality of economics and what’s happening. So, we’ve had no inflation, except in asset prices, valuation for government bonds for many equities, the technology equities are at all-time highs. What we have is we have bubbles in financial markets, which potentially rob future generations of the returns they will need for their pensions. And I think, at the same time, what the cover of central banks has done is to make it much less urgent for politicians to address underlying economic problems. So, if you look at Europe, there’s actually been relatively little reform on things like capital markets union, banking reform — all these things that were super urgent nine years ago, where we had promises from finance ministers that they would be addressed — pretty much nothing has been done.

[00:14:27.09] Ben: Yes, slowing down reform. And also, I guess, it’s also removing some of the market censoring that happens to politicians and to political actions, right? So, you know, you might argue — I’m sorry, I don’t want to get into counterfactuals, but you might argue that in the run-up to Brexit, there would have been harsher market movements, because the central bank was intervening.

Michael: That’s absolutely true. And I think it raises many legal questions, too, as to what end should central banks go in terms of trying to intervene in markets and economies? And you now have a situation where central banks are trying to mandate themselves or justify themselves on a whole range of criteria. The European Central Bank is now adopting the mantle of the green economy; in the US, the Congress has proposed that the Fed do everything it can to reduce racial inequality, which is a just cause, but it’s much, much better left to politicians and lawmakers than central banks. I don’t know how they would go about doing that. What we want in democracy is we want parliaments and governments to address these problems, not central banks to, if you like, swamp the whole political economy in terms of what they’re trying to do.

[00:15:57.16] Ben: If we break those things down, then, so first of all, how do we sort of de-politicize central banks? Because as you say, it’s absurd to think that the body in charge of monetary policy could affect racial inequality. So, how do we de-politicize central banks?

Michael: So, the world went through — from the ’70s onwards, many central banks were politicized in that their governors or presidents had, in some way, ties to the governments who appointed them. And then we went through a phase where central banks were trying to crush inflation, which was politically very unpopular — the best example was Paul Volcker in the US. And we’ve gone through an era of independent central banks who are run by technocrats, civil servants, independent from politics. And that is beginning to change, I think. There is a sense that, maybe in the States, that the heads in the central banks are somehow siding with the mandates of individual governments. It’s been the case certainly in Japan. And I think that there’s several things we can do. I think the appointment process for central bankers is important, and also the people who populate the committees of the central banks; stressing their mandates, and narrowing their mandates is also very important. And maybe, I think, in future what we need — we probably need another crisis to get over this — is a curbing of extraordinary powers, like quantitative easing. That, when it was introduced, was something that was considered off the charts and now it’s normal. So, there needs to be a debate about the extraordinary powers that central banks have.

I would prefer a total reboot. I think some institutions have remained relevant, like the OECD, because they’ve had a good sense to attach themselves to a bigger framework in the shape of the G20. Others, I think should be completely reshaped — Michael O’SULLIVAN

[00:17:52.21] Ben: Yes, that was gonna be my second question, which is, how do we roll back the balance sheets? How do we de-leverage the central banks? Because I think in the book — you know, the book is already out for a year, so they’re even higher, particularly COVID — but you said they’re as high as they’ve ever been since the Napoleonic Wars. So how do we de-leverage central banks and get back to some sort of sensible level of leverage?

Michael: So the background picture to this is that world debt to GDP levels have been rising, they’re passing out the previous high of the Second World War, on course, as you said, to hit the highs of the period around the Napoleonic Wars. And that’s quite extraordinary if you think of the events associated with that. One of the reasons debt is rising is because interest rates are so low, governments, companies find it very, very easy to borrow and, in particular, government debt has been hoovered up by the central banks. Now, there’s a number of ways of walking back from this. One is the enlightened approach where policymakers decide, “Look, there’s just too much leverage in the world system. We need to pare it back.” And that’s done in a collaborative way across central banks. I don’t think that’s going to happen — that would be too ideal.

[00:19:20.20] Ben: This is what you refer to as the ‘New West Failure’, right?

Michael: It is. We need a reordering of finance in the world, along the lines of the Westphalia Treaty of 1648. That’s a very grand example. But, you know, the size of central banks, the size of debt in the world, is the biggest in centuries. So, we do need a grand setting for this. I certainly think that we are storing up the ammunition for the next financial crisis which will be a crisis of debt and ‘debtness’ and it will probably come about by, you know, additional QE from central banks not working or not functioning, a loss of confidence, and then, for the first time in some time, people begin to look to get the money they’ve lent back, either from governments or countries, projects, companies — and it’s just not there. You get a deep recession. Maybe central banks will try more QE and that won’t work because often, in a credit crunch, monetary power can — in a deep credit crunch, monetary policy can lose its power. So that’s sort of a negative, nasty scenario, which I don’t like to paint, but in the absence of enlightened policy, that’s a potential route for the future.

[00:20:51.26] Ben: And I can’t resist asking you this — I know we’re gonna go slightly off-topic here — because you used to be a CIO, so it’s too tempting not to ask this. But how does one position a portfolio for a world where there’s a massive governmental debt crisis on the horizon?

Michael: Yeah. So, I think you do a number of things. The first thing, I suppose is to figure out what really is a safe asset. So what government debt will you feel really safe holding? I mean, that’s why German bonds, for example, continue to trade-off at a negative yield, because it’s one of the true safe assets — maybe Dutch debt as well. So, if I had a portfolio and there were private equity in it, for example, I would switch that into things like distressed debt funds, long/short credit funds. I think what you can begin to do, as well, is to look at tail-risk strategies — that’s quite a technical term, and what it means is that these are strategies that would form a small part of the portfolio, but if an extreme, negative event happened, they would pay off quite handsomely, they would tend to be kind of derivative-based or derivative-type strategies. And then also, I think, you know, in other parts of a portfolio, you want to aim to hold companies that have got a lot of cash and less debt. Ironically, some of the big tech companies fall in that category, even though they have somewhat stretched valuations.

[00:22:33.13] Ben: So, just coming back to the book and the end of globalization, how do we get back to sustained organic growth? Because some of the things that you talk about in the book have become, I guess, slightly passé or old fashioned, which is you advocate for things like education and rescaling and things that don’t seem to be at top of the political agenda right now. So, is that what we need? Do you think we need to get back to education and re-boosting productivity? Because that’s the only route back to sustained organic growth.

We can continue with globalization as it is, which I think is unlikely. We can have a lapse into chaos and disorder, like the 1910s and ’20s. Or I think what’s much more likely is we’ll have a multipolar world, which I think the way to look at it is that it’s not so much a world dominated by big regions, as to the fact that these big regions do things increasingly distinctly or differently — Michael O’SULLIVAN

Michael: I think someone said — maybe it was Paul Krugman — for developed countries, in the long run, productivity is everything. And I agree with that because it’s the main — unless you’ve got rapidly changing demographics — it’s the main and perhaps the only way to boost economic growth. And I think the first step is that there needs to be a debate and a movement amongst governments to focus on productivity and focus on what I would call ‘trend growth’. So, what’s your sort of trend level of growth? And the best way to improve that is through productivity. As you said, many of the things that drive productivity — you know, rescaling education, careful investment in technology in country strategy — they have been forgotten. If you look at what’s happened to education and educational attainment rates in the US, that’s quite alarming. And many of the other factors around that, things like human development, are regressing. So you’re right. I mean, they’re worse than passé. They’re just being degraded. And there’s really no other way for developed countries to grow in the long term. You can do trade wars, you can try and convince countries to reshore investment, but that’s all one-off kind of short-term stuff. The real driver of growth is through productivity. I think the problem many politicians have with this is that we are in short, political cycles. So, by the time you’ve invested in the factors that drive productivity, you only see the benefits of that maybe 5–10 years down the line.

[00:24:58.03] Ben: I wanted to ask you about the US elections in November because you make the point in the book, you sort of draw the parallel with the 1980s and you say, you know, people were fixated with the end of communism, and they felt as bought what was coming next, which is this period of rapid globalization and internationalization of trade and everything. And to some extent, you say the same thing here. Now, we’re obsessed with a little bit the political circus, and we’re missing this bigger shift. But to what extent is Donald Trump and this US election, a circus versus being really important in determining how we transition to this new world, whether it’s a smooth transition, an elongated transition, etc.?

If there’s any doubt that globalization is over, four more years of Trump will entirely smash that — Michael O’Sullivan

Michael: He is very important. And I think what is important is that, you know, Donald Trump as an individual has a lot to be responsible for. But he has come at a time when that’s maybe apt in that it’s the end of an era and he is the human wrecking ball breaking down the old order. He is not going to be the person to build up the new order. And he has also been enabled by many people principally on the Republican side for whom it’s convenient to have him as President. I think it’s quite clear that, you know, four years of Donald Trump have broken many things. He’s broken America’s diplomacy with Europe, with parts of the Middle East, but not all; obviously, broken diplomatically with China, and sown general confusion. He’s also, I think, devalued many of the institutions in the US — the State Department, some of the financial institutions as well. And then, in that background, four more years of Donald Trump would make permanent all of these ruptures and it would cause the rest of the world to maybe ignore America. Europe in particular will tend to go its own way. I think countries like China will be more and more convinced that the US is in turmoil, and it is weakened, and Russia will probably have the same view. And they will act accordingly. And I think that will well and truly break globalization. If there’s any doubt that globalization is over, four more years of Trump will entirely smash that. Joe Biden, for his part, I think will not be a transformative president, but a restorative president in that he will restore the status quo, he will repair the State Department. His team, I think, is very strong on foreign policy, maybe less so on the economy. And he will, I think in particular, restore relations with Europe and try and rebuild the partnership with Europe, to the detriment, I think, of Russia, and maybe China as well.

[00:28:10.06] Ben: But I guess the point that many people would make is, as you said, he’s a wrecking ball. He’s gutting institutions domestically, globally. But, in a way, is that necessary? Do we need to break these institutions in order to remake them? You know, would a Biden presidency as you said, restore the institutions or, you know, other institutions still fit for purpose? So, I suppose the question is, do we need four more years of Donald Trump to hasten this transition to the new world? Or would it be a disaster and lead to a much, much more uncontrolled transition to the new world?

The level of denial amongst governments and companies that things can go on, as they were, I think, is still very, very high, and that denial needs to be broken — Michael O’SULLIVAN

Michael: I hesitate to recommend four more years of Donald Trump, but a lot of what you’re saying, which I accept, which is that we’re in the midst of a paradigm shift, which is a very overused phrase — and you only get paradigm shifts for a number of decades, maybe centuries, and you only get the rebuilding when a lot of the old order is broken down, there is chaos, and then people come forward with new ideas and new initiatives. And the reason I think we need more breaking is the level of denial amongst governments and companies that things can go on, as they were, I think, is still very, very high, and that denial needs to be broken. So, if you take as an example the debate over the World Trade Organization, which is potentially a defunct and irrelevant organization in the context of a multipolar world, the debate now is to whether we just have a new leader and someone who’s not from Europe, or the States and everything would be fine. And you have similar debates about the World Health Organization, the World Bank, and not about, you know, should these institutions be radically changed or displaced? And what institutions of the future do we need to have?

[00:30:19.06] Ben: And do you have a view on some of that or not? So, you know, I don’t want to run through the list of all the international organizations like the IMF, and so on. But, are some of them still capable of doing the job we need them to do or do you think it’s a total reboot?

Michael: I would prefer a total reboot. I think some have remained relevant, like the OECD, because they’ve had a good sense to attach themselves to a bigger framework in the shape of the G20. They’re sort of the think tank of the G20 now. Others, I think should be completely reshaped. The World Bank, I think should be relocated physically to Africa, which is the one part of the world that really needs the help of the World Bank. And then, I think there needs to be a debate on what the institutions of the 21st century need to be. Do we need, for example, an institution on climate change that has got the power to fine governments and companies in a forceful way for climate damage? Do we need an institution to govern cyberspace and cyber warfare and cybercrime? We don’t have that. We don’t have an international police force for the internet. So, there’s all these things that are beginning to crop up as future problems, and have not yet been framed either in philosophy and law or by institutions.

[00:31:48.20] Ben: Moving to what comes after globalization. So you’ve used the term ‘paradigm shift’, and you’ve also used the term ‘multipolar world’. Is that what globalization gives way to? Does globalization become a multipolar world?

Michael: I think so. I mean, there are many scenarios. We can continue with globalization as it is, which I think is unlikely. We can have a lapse into chaos and disorder, like the 1910s and ’20s. Or I think what’s much more likely is you’ll have a multipolar world, which I think the way to look at it is that it’s not so much a world dominated by big regions, as to the fact that these big regions do things increasingly distinctly or differently. So, again, coming back to the internet — I mean, the US has got the big internet giants, and they are stockmarket monsters. China has cut off its internet, but it has a thriving e-commerce sector. And then Europe doesn’t have any of these big internet companies, but it is becoming the regulator of the internet, looking to protect people from the ills of the Internet.

We’re in a world where lots of issues are emerging and lots of well-placed frustrations are being vented. So, it is definitely a period of turmoil, where democracy and rights and liberties are being contested — Michael O’SULLIVAN

[00:33:12.23] Ben: For how long can it seek to regulate the internet without those platforms? Because, to use an analogy from a previous podcast, it’s sort of trying to control the seas without a Navy or an infrastructure, right?

Michael: Yeah. It can because of its size and the power of its economy, and the fact that Europe in particular is very, very sophisticated in terms of policy, and regulation. So, if Britain were to try and come up with its own set of rules for the internet or how British people consume the global Internet, it may well not be able to do so. But Europe is obviously much bigger. I think the way we’re going now is we’re going towards a values-based, multipolar world. So what I mean by that is that when it comes to economics and politics and climate change, each of the big regions has got very different values and approaches- and those values will inform how they build out their economy. So, Europe wants to protect its citizens and their data. It’s also very strong on the environment, and many of the new policy plans we hear about from Europe, are focused on the green economy. Much less so in the States where there’s just a very different balance between society and the economy. And then China has its own very distinct set of values, which I think we don’t spend enough time trying to understand, in the West. And I think it has its own risks and its own complexities which are maybe not readily apparent in newspaper headlines. And if you look at the Chinese Communist Party, which is a very big machine, inside it you have lots of different groups and rivalries that effectively mirror what you have in western politics just that they’re all under the same big disciplined umbrella. But I think in China, the secret is not just the vision, but also the implementation. They can implement policy for such a big country in a very, very speedy kind of way.

[00:35:38.00] Ben: The gravitational poles are US, China, Europe. Will countries that aren’t in those countries or in those regions have to choose between them? So, you know, will Africa have to align itself with the USA? Or will India — and it looks increasingly like India is already aligning itself with the US — is that what it will be? It’ll be a question of choosing between one of these poles for everybody else?

Michael: Yeah. So, I think there’s maybe a few things here. So, I think countries who fall between the poles — so, Japan in Asia, Australia, they are between America and China; the UK, Russia, in Europe — they’re on different sides of Europe, obviously — they will potentially find life more difficult because they’re not as big as the three poles and they’re sort of mid-sized powers and they have to come to terms with that and reshape their own identity. I mean, Russia has its own crisis in that it’s a military power, but not an economic or financial power. I think other parts of the world are in the stream. India, if you add it on to the area of the Emirates, is potentially in time, another pole, but it has a lot to travel in terms of its development in order to get there. And then I think for countries like, you know, Nigeria, Bangladesh, who are populous and growing, I mean, they have lots of choices. They can sort of say, “Well, let’s co-opt ourselves to China and the Chinese model, or do we still follow what the Americans have done? Or what the Swiss or the Irish have done?” Or they can kind of say, “Well, look, we just do it our own way.“ So, I actually think that these countries — there’s maybe 10 of them — you know, big, populous countries in Asia and Africa, who have not yet really globalized or developed, where they go in the future and how they do it, and what templates they use.

[00:37:35.14] Ben: And you see them as potentially in a strong, almost bargaining position or arbitrage position, do you think, between those poles?

Michael: Not yet. I think what they need to do — and this is where some of the new institutions of the world order would come in — is that these countries perhaps need to collaborate better in terms of building up their own cooperative institutions so that they collectively have more power vis-a-vis the US or China, as it were.

[00:38:05.16] Ben: You’re a big fan of small countries, right? Because you just used the example of Switzerland and Ireland — so, small countries that are very globalized in the sense that they’re magnets for certain kinds of information, trade flows. Are you still as bullish about those small countries in this sort of de-globalizing world?

Michael: I am, obviously, as an Irishman who’s lived in Switzerland, quite biased. And how I got involved in the whole globalization debate is I wrote a book years ago on Ireland and globalization — at the time, Ireland was the most globalized country in the world. I’m still bullish about them because I think this has been shown by the Coronavirus crisis, is these countries in general, they have a resilience, and they have a robustness. So, by virtue of being small and being open to world trade, they’re also very much aware of what’s going on in the world and what they need to do to correct against some of the imbalances that they will suffer. And the countries I have in mind are the likes of Sweden, Switzerland, Norway, Ireland, Singapore, etc. They’re all very different in terms of their culture and politics, but they have similar problems, but also similar ways of dealing with them. They tend to be the best countries who have this mix of strong rule of law, very good institutions, trust in experts, investment in education, etc. So, that model for me is still one that’s really relevant today.

[00:39:52.01] Ben: And how do you align that or reconcile that with also being a fan of supranational bodies like the… I mean, would it not be a good thing for power then to be devolved down increasingly to sort of nation states or even cities within nation states. Because if small is better, small is more agile, if small is more resilient, then is now an argument for fragmentation?

Michael: I mean, you can call it ‘fragmentation’, you can call it ‘devolution’ as well. I think what you may see is you may see countries like France become a bit more devolved to its regions in terms of taking some of the power that’s concentrated in Paris and devolving that to some of the regions. That doesn’t mean that France is going to break apart or that Europe is going to break apart — quite the opposite, because all of these countries are still happy to have the umbrella of the EU and to enjoy its laws on data protection, etc. I think, also, that globally, we do need to look at governance. So, climate change is my favorite example here, where many countries signed up to the Paris Accord, but it doesn’t really have teeth and it’s not, in my view, really contributed anything in terms of lessening climate damage. What you find is many of the big cities in the world, however, are much more progressive, and much more green than their individual governments. So, my suggestion would be that you have a sort of Paris Accord between big cities that it has teeth. They can, for example, tax their hinterlands, they’re better in control of pollution in their economic hinterland, they tend to be more advanced in terms of infrastructure and green policy, than individual countries. So that’s maybe one way to look at governance, I think.

we are beginning to see a fracturing of political systems where dominant parties are being pushed aside — Michael O’Sullivan

[00:41:56.07] Ben: Well, practically for other issues, because you still need a sort of supranational accord, that the cities sign up to. Would you need the same thing when it came to cybersecurity, or what else is coming down the road — you know, genomics, or digital currencies? How would you simultaneously have global accords in a de-globalized world with city states taking more responsibility?

Michael: Yeah, so I think cities are probably apt for climate change. I think something like cyber, you know, you need a cyber accord probably between at least five countries — and most of those will be on the UN Security Council. They are the cyber powers of the world plus a bunch of others because they are the ones who are either initiating or defending many of the cyber attacks and cyberwars. You know, this is an area of activity where there are no rules. So there’s no template or rule that says, “If Russia hacks me, I’m allowed to fire back a missile, because hacking me or hacking my hospitals is a declaration of war. It’s an aggressive act.” So, I think you need increasingly to match the institutions to the locus of the problem, the locus of the issue.

[00:43:24.06] Ben: Who are The Levellers? And why do they matter? And one of the related terms is ‘The Agreements of the People’ — what are the agreements of the people?

Michael: Okay, so the Leveller is a somewhat obscure story, but probably one of the most important in British history. And I’m guessing many people haven’t heard of them.

Ben: I used to live in Putney, and I’d never heard of them.

Michael: So my starting point is that we’re in a world where lots of issues are emerging and lots of well-placed frustrations are being vented — you know, from gender inequality, you’ve got black lives matter, and you’ve got then democracy-based struggles in Belarus — and you can go on for quite a long time. So, it is definitely a period of turmoil, where democracy and rights and liberties are being contested. In some respects, I’m not a fan of a lot of this political debate on Twitter, and I wish a lot of it were more constructive and that they were more constructive channels. I look at a lot of these protests movements, and you ask yourself, you know, can we go beyond protesting? And how would you take a movement forward and make it concrete and begin to embed it in changes and in laws?

Michael: I recall reading a couple of books some time ago on the Putney Debates, which happened in the middle of the 17th century in Britain. So the king was captured by Cromwell’s New Model Army and with the king being captured people had an inkling of what a parliamentary democracy might look like and they began to debate this down in Putney — it was called ‘the Putney Debate’. And it was primarily a debate within the army, the soldiers, and the officers. And one very important cohort was a group called ‘The Levellers’, who effectively were kind of the social democrats of the day. And they and their leaders came up with a template called ‘The Agreement of the People’. Quite a short template, but it’s really, in tangible form, what the people wanted from government and from parliament. And I think that’s missing today. And that needs to be reconceived.

Michael: For lots of somewhat bizarre and interesting reasons, these agreements of the people were written down, but then not fully transcribed or rediscovered for another 200 years. So, it’s an example for a while lost to history, but it was the first popular expression of what a constitutional democracy would look like, at a time in Europe when Europe was just beginning to throw out some huge innovations in politics and nation states. So, a very important time. And I actually think that if people today could look at these agreements of the people and use them as a rough template for what they want — because they were very practical. You know, they talked about people being treated equally by the debt courts, they advocated limited political terms to reduce corruption — so, foreshadowing many of the things we have today. And I think the use of a template would be taking many dissatisfactions with politics and many movements and making them concrete and also constructive, which I think is largely missing.

[00:46:59.27] Ben: I really like your idea of getting off Twitter, because, first of all, you know, Twitter tends not to lead to anything that’s particularly concrete. But also Twitter tends to lead to massive bifurcation which is, it’s very difficult to hold the center ground on Twitter, because it’s the extremes that gain traction on a platform like Twitter. But I suppose the question is, how is this so different from electing representatives with well-defined mandates in the first place? Are you just saying that we, as constituents, would put forward our ideas, and then almost the political parties would be formed to then put those into statute and into place? Would that be the difference then? So, rather than the political class coming up with the manifestos that we then vote on, it becomes much more bottom-up?

Michael: I guess it should ideally be more bottom-up. I think there’s a sense also that many political parties are somewhat jaded in terms of what they represent. And maybe one question, which I think we haven’t seen yet, is whether we get new political parties, new political entrepreneurs coming through. And I think there is dissatisfaction — you know, what we are seeing as well, we are beginning to see a fracturing of political systems where dominant parties are being pushed aside. You’ve seen that in France, the two dominant parties pushed aside. It’s interesting, we haven’t seen it in the UK or the US yet; the two-party systems remain dominant. But I think there needs to be channels constructed for taking, you know, what I think are well-founded grievances, and getting those into law. For example, there’s a lot of work now being done in social media, such as petitions for parliament in the UK — a lot of work being done there, in social media to get people’s petitions into parliament. So there are changes beginning to come through, but certainly not as fast as I thought would happen.

[00:49:10.03] Ben: I like that idea, too, because I think there’s sort of contrast between Twitter — again, to use that analogy — and the way we do politics it has now become enormous. And the politics hasn’t kind of responded yet. Because, you know, I think what Twitter is doing is giving us the sense that we know as much as the political class. I think we really saw that during COVID, which is everybody thought they knew as much about how to cope with this crisis, as the political class did, because it gives that impression of the narrowing of, or this sort of information asymmetry disappearing, which is an illusion. But I think what would be good would be to sort of reboot politics to be more like social media, in the sense that, as you say, we could treat it like a platform, which is, you know, we could contribute all of our ideas, and then you could build new political parties on top of a platform, which would then be much more networked and responsive to changing ideas. Is that what you had in mind, then, that it will become more networked and responsive?

Michael: In a way it is. And again, one lesson I remark on in the book with The Levellers is that they were idealistic. And parties are a result of that. I mean, they were very good at things like pamphleteering. So they were the social media geniuses of their time, but they were totally outmaneuvered by the incumbents. So I think there is a cynicism required as to how the political system works, which needs to be matched with idealism and a desire to change things. You know, I use the example of Emmanuel Macron, who is seen as being a revolutionary political figure. But I think what he figured out was that the best way to do a so-called ‘revolution’ is to take the system from the inside, not the outside. Now, he had the help of many parts of the system and the institutions in doing so. But it seems to me that that’s sort of a speedier way to changing politics than trying to do it from the outside.

[00:51:18.15] Ben: I can’t resist asking the question, which is, how satisfied are you with Emmanuel Macron? Somebody living in France? How much do you think he’s really changed politics? Because he seems to be a bit like Obama or a bit like Donald Trump. He used digital means to campaign in a completely different way. But the governing has been almost very traditional. Do you accept that?

Michael: It has been traditional in that he — I mean, he has replaced one elite with another younger one, for sure. And pretty much all the people around him reflect the fact that France is still very much elitist in terms of politics, in that they all have the same formation, the men and women have the same views, education. I mean, it’s more stark than, say, the UK is. So he and the people around him are still very much a product of the French system, the French elite. They’ve just, I think, made a lot more fresh. I mean, I think there are areas where he stands out. I don’t think in any way he’s corrupt. I think he’s absolutely sincere in what he wants to do and he’s very, very driven, in that sense, in terms of implementing his vision. I think what he has changed, in my view, compared to the two previous presidents — Sarkozy, and Hollande — I think, with both of those, there was a sense that they were kind of filling a gap and that they might not be around for the next four or five years after. Whereas Macron, I think people have a sense that perhaps he will be here for another term, and that we will have a Macron era that he has the time to implement changes. And he, I think, before [00:53:08.12] he had already implemented quite impressive labor market changes. France needs more of those. I think also, one area that’s clearly open to him is Europe and European politics. And certainly, the energy for European politics and political initiatives in Europe is very much in Paris. It’s not in Germany. We will soon have the post-Merkel era, politics will be a lot more fractured, which will leave France as the dominant country driving policy in Europe.

[00:53:46.04] Ben: If Brexit was the first sign of the end of globalization, is TikTok, the first sign of the post-globalized world?

Michael: Actually, it’s an important sign because it shows how a service that should, I suppose in many respects, be harmless and that should be global, and that people in many countries can use it, but has been used for political ends, can become carved up in the manner of this multipolar world. So, you know, in the US and China, there are clear barriers around the use and the ownership of different parts of TikTok, which begin to, at the same time, sketch out the map of this multipolar world that’s coming.

[00:54:47.12] Ben: Last question. COVID: do you think that this is, again, laying bare the fact that we have reached the end of globalization? Or do you think it’s a reason to be optimistic because it’s a crisis that all countries face and really should galvanize us to work together?

Michael: It’s certainly been a test — a dramatic test. And I think what individual healthcare companies, universities have worked together. The absence of collaboration between countries and regions, for me, has been the litmus test — a litmus test that shows that we are at the end of globalization and heading into a more singular, maybe more selfish, multipolar world. In previous crises, you’ve seen countries and governments collaborate — global financial crisis being an example. And we just had an absence of that this time. They’ve squabbled over vaccines and masks, etc. So that’s the lesson that needs to be borne in mind.

[00:55:57.08] Ben: You would just argue, then, that COVID — again, exemplifying what the new world would look like — at the same time is probably bringing it forward faster?

Michael: I think so. I think it accelerated this whole thesis, for sure.

Ben: Michael, thank you very much indeed for coming on the podcast.

Michael: It was good!

When Software has Eaten the World (#29)

Structural Shifts with Belén Romana, Spain’s former head of Treasury

There is a lot of anguish over what’s happening online these days from the rise of hate groups to media manipulation, the propaganda to interference with elections — are the positives of our digital world even worth it? Well, today, your host, Ben Robinson, digs into this question with Belén Romana García — Spain’s former head of Treasury, and an economist who has worked in both the public and private sectors. Belén is also a board member for several public companies and foundations. She says that people are primarily driven by three things: power, money, and knowledge — and she is especially driven by knowledge and curiosity and a desire to understand the world and its possible future. Today, she and Ben discuss, should our elected officials have to learn how to code to better understand the world that we’re living in? Should we scrap GDP as a metric since it’s not accurately reflecting our service economy? Does democracy mean equal voting? And how does the information and infrastructure of our online world affect our freedom or a sense of freedom in real life? And more. 

Belén recommends:

 

  1. One book: A world without work, Patrick Susskind
  2. One influencer: Azeem Azhar
  3. Best recent article: The geopolitics of information, by Eric Rosenbach and Katherine Mansted (Belfer Center for Science and International Affairs)
  4. Favourite brand: Spotify
  5. Productivity hack: Never waste a chance to learn something new. Listen to podcasts while driving, flying, cooking or having a walk.

Information in itself is a huge good that we have in abundance. Of course, when you have any scientific advances or new ways of creating value or knowledge, that does not come without its flaws, and without its problems. It takes time for societies to understand the real implications — good and bad, by the way — of any advance. It’s sort of trial and error. We are understanding the implications, the advantages, the disadvantages, and it will take some time until we do understand the whole thing.

[00:01:32.14] Ben: Thank you very much for joining us! So, the key thing that we wanted to pick up on today is one that you talk about a lot, which is the notion that software is everywhere, and it’s this idea that, as software’s become more powerful, it’s proliferated, and it’s become much more pervasive in our lives, our communication, our politics, our industry — and I thought maybe a good jumping-off place might be the quote from Peter Thiel, the one where he said, “We wanted flying cars. Instead, we got 140 characters.” So, has this world of pervasive software delivered on its potential? i.e. Do you think that the world is now better for having so much software in it?

Belén: Definitely! I think that we are better off. We can communicate better, we can find more data, store that data, analyze that data, deploy that data. So, I think that information in itself is a huge good that we have in abundance. So that’s a much better world. Of course, when you have any scientific advances or new ways of creating value or knowledge, that does not come without its flaws, and without its problems. It takes time for societies to understand the real implications — good and bad, by the way — of any advance. So, I think that we are better off. It’s sort of a trial and error thing. We are understanding the implications, the advantages, the disadvantages, and it will take some time until we do understand the whole thing. And so, it will take some time until we get the world right. And we will try again and again and again. And finally, at some point, we will have a reasonably good set of rules. So, I think that we are better off but we should be quite modest in terms of we have to understand that this is a journey that started, as societies, and it will take us some time to really get it right.

As human beings, we usually get to understand, control, and react. So, the fact that some advances have dangers, that’s always the case; […] And reality leads us to think that once we get to understand, then things are much better after that advancement than before. The problem, of course, it’s always the transition period.

[00:03:44.01] Ben: If we think about some of the negative applications of digitalization, we might think about, you know, its scope for manipulation, for example, or we might think about, you know, some of the scary things that people say about where AI is headed, right? You know, that we’ll be controlled by software, rather than it kind of being used as a tool by us to improve, almost. But you believe that, on balance, overall, it’s been a force for the good?

Belén: I think so. Of course, it has many dangers. But that happens with anything that you can think of. When the car started, there were so many dangers around that and there were no roads. So, it took some time — decades — to set the rules and understand what is good, what is bad, what should be done, what shouldn’t be, who should be controlling that? How should the authority control that? How can we drive around the world? So there were a number of things that happened over decades. But finally, the car gives us many things — of course, good and bad — and if you understand the real implications in groups, for example, climate change, then you get to have a much better deployment of that advance. You know, as human beings, we usually get to understand, control, and react. So, the fact that some advances have dangers, that’s always the case; that happens with medicine, that happens with pharmaceuticals, that happens with anything you could think of, basically. And reality leads us to think that once we get to understand, then things are much better after that advancement than before. The problem, of course, it’s always the transition period. So, since this is a trial and error, and it will take time for us to get it right, there will be many things that will happen that won’t be good, and people that will be harmed. That’s absolutely the case. And that’s a very difficult point because, as I said, when it’s something new, we don’t fully understand the final implications. So, this trial and error… And you see that everywhere. So, we didn’t know that Facebook could be potentially dangerous for political institutions, the suffering, that outcome to understand, “Yeah, this may happen.” And now we are starting to think, should we do something? What can we do? What are the limits? So, does it mean that social networks should be banned? I don’t think so. They should be here for good. It’s like with cars. I mean, the fact that a car is a dangerous tool doesn’t mean that you shouldn’t control it, you shouldn’t regulate it.

We are on a very, very early stage and it’s very difficult for rulers to set the rules. One of the things that I worry about around this — setting the rules — is the fact that Parliaments understand laws, but they don’t understand codes. It turns out that codes are also ruling our lives. So, if we don’t get them to understand code, to understand that language, it will be very difficult for them to set the right rules. And I think that we’re far from that.

[00:06:38.21] Ben: And if we just continue for a second with that analogy of the car, where do you think we are in this transition? You know, it took a long time before cars had seatbelts, it took a long time before cars had emission standards. How far into this digital transition do you think we are? And how good a job do you think the rule setters are doing?

Belén: We are on a very, very early stage and it’s very difficult for rulers to set the rules. One of the things that I worry about around this — setting the rules — is the fact that Parliaments understand laws, but they don’t understand codes. It turns out that codes are also ruling our lives. So, if we don’t get them to understand code, to understand that language, it will be very difficult for them to set the right rules. And I think that we’re far from that. If you had a council of wise men, old men that couldn’t read, and they had to set the rules for the printing press, they would just say, “Okay, whatever is printed that I cannot read should be fair, balanced, whatever.” But they cannot enforce it, because they cannot read the book. I think we are in a similar situation where individuals setting the rules do not speak the language, cannot read the code and hence, all they’re doing so far is giving this open recommendation of should be fair and avoid bias and these things. But then, they are driven by the outcome, and they cannot prevent it from happening, because they don’t understand. So I think that we are at a pretty early stage. We need rulers that understand code.

because of the cyber GDP that we are not measuring, we are not taxing, we are not tracking. So, we don’t know whether we are getting richer or not, we don’t know whether we have a fair tax system or not. Basically, there’s a part of the GDP that is not there.

[00:08:30.29] Ben: I think the EU Cookie Policy is a very good example of a policy that’s set by people that don’t understand the nature of the digital world. What about economists? So, you’re an economist. How good a job do you think economists are doing at understanding the new world and changing their measurement tools? To make it more concrete, we basically live in a world where we don’t think we have any inflation, we think productivity growth sucks. But is that really the case? Because you know, there might not be inflation in the price of streaming music, but there feels like there’s a lot of inflation in other areas — healthcare and such. So, do you think we’re using the right measurement tools for the digital world?

Belén: We, economists are really struggling because we are all educated in an industrial world. So, if you take GDP — GDP nominal versus real is inflation, GDP is a very industrial concept in many ways. I mean, it started as one physical thing times the price, and that is GDP. And the evolution of both the number of physical things and the prices did see it to the GDP real and nominal. We started struggling with services. So, for decades, for example, financial services were not part of the GDP because no one thought it could be measured in terms of any value added. So, with services, which is something in the middle between digital and industrial, we struggle to understand productivity to measure; you don’t have a physical thing — you know, whatever the assets times the price. It’s services. And you know what that means, in a very industrial world. So, we tried to build this bridge with services — did a very good job, but reasonably good, I think. But, if you jump to digital, you don’t have this vertical approach to sector, which has been industrial. And there’s this huge debate now in the economists’ world, around inflation and productivity as you were rightly saying. There are now two camps: some people say we’re heading into a world of no inflation forever, and some people are thinking that we’re heading into a high inflation world because finally, monetary phenomena. But, as I said, I struggle with that, and it’s difficult to get the cyber economy into this, the cyber factor into the GDP.

Belén: Now, I’ll give you one example that I always think of: the value for Google of having Germany, where is it? Is it part of the German GDP? It doesn’t look like that because that value is not the revenue coming from the German part. But more than that it’s network — so, it’s part of the network that increases the value of the whole network. That’s not part of the German GDP. Where is it? My point is that probably it’s part of the Google market cap and that’s why, because of this cyber GDP, we are not measuring, we are not taxing, we are not tracking. So, we don’t know whether we are getting richer or not, we don’t know whether we have a fair tax system or not. Basically, there’s a part of the GDP that is not there. And you see that again, and again, and again. You gave the music industry as an example. That’s a perfect example of something like that. So, we used to have a music industry that could be measured in an industrial way — the number of LPs or the number of stores, or the number of concerts, and then you have tickets times price. Then all of a sudden comes streaming. Basically, in terms of GDP, the music industry has disappeared, because you don’t have much employment, you don’t have tickets, you don’t have LPs. So, you don’t have physical things that you can measure. However, we have never been able to access so much music in our lives. Not necessarily for free. You pay for that — Spotify, you pay for it. But you access a huge store of music that you can choose to confine whatever. That’s not part of the GDP.

The competition policy is basically based on the knowledge that if the prices are low, competition works because the prices are the final signal of a monopoly or oligopoly. It turns out that’s not the case because we’re not paying with money.

[00:13:06.14] Ben: Yeah, it seems to me that the problem that you talk about translates into consumer surplus, right? Which is, you know, by definition, not captured because it’s surplus. And I often wonder if we were able to better understand consumer surplus, and somehow feed that back into GDP, that might be a way of capturing some of the benefits. But I just wonder, in general, if GDP is just, you know, we should scrap it, if it’s just obsolete. And we should start again. Because you know what I mean? It’s like you’re saying, you know, it’s a bit like inflation — you have RPI minus x, RPI minus y. And it’s like, how many things can you augment a broken metric for, in the end, before you have to just start again.

Belén: But the fact that we are using not a perfect measurement does not mean that we should use none. So, for me, the key thing is understanding. Again, understanding that we’re missing part of the economic evolution, wealth — whatever you want to call that — and that we need to develop other means. We will still have a physical world, we will still have services. But we are missing digital. So I think that one of the key things for, first, universities and probably also statistical authorities, is developing that understanding of how to measure. This is a new thing. It does exist, it does create value. So, this is again, a very old debate: value versus price. And that impacts everything. So I’ll give you another example. It’s the competition policy. The competition policy is basically based on the knowledge that if the prices are low, competition works because the prices are the final signal of a monopoly or oligopoly. It turns out that’s not the case because we’re not paying with money. We’re paying with data, and data has no value, no price. So, they’re for free. So, all of a sudden, you have a competition policy based on a very industrial concept that needs to adapt to something different, which is we’re paying with our souls, so to speak — our data. So, I think that the key thing is for, firstly, universities to start thinking about this — and I think that some have already started — thinking of this concept of cyber GDP. And value versus price happens when you have value, but no price or a price that does not fit much with the value as in the case with data. So, I wouldn’t say, okay, we don’t use GDP anymore. But I think that we should, at once, develop other complementary ways of measuring and understanding the digital world.

when you have a huge concentration of power, you have a problem. And as a state, the concentration of power is always dangerous. So, one of the things that I really wonder is why people — that happens especially with younger generations — do not care about giving away their information to companies but they care about giving information to the state.

[00:16:03.20] Ben: I just wanted to return to that idea of regulating the digital economy, because, as you say, you know, in the past, the litmus test was, you know, our prices going up to the end consumer, therefore, there’s sign that the company has market power, and can manipulate pricing. How do we regulate networked businesses? And how worried are you about the increasing size and influence of some of the largest platforms?

Belén: Over the years, when you have a huge concentration of power, you have a problem. And as a state, the concentration of power is always dangerous. So, one of the things that I really wonder is why people — that happens especially with younger generations — do not care about giving away their information to companies but they care about giving information to the state. And if you live in a democratic state, you do have rules, you have a transparent system where you know your rights, and you have tools to defend your rights. That’s not the case with the large platforms. And there are millions of that; you have Facebook measuring video views and charging for it. So, it’s the same as the judge and the defendant is the same. Or you have no ability to prove that whatever video you’ve posted has been more or less than another one. So, you know, I’m starting to read articles on the corporation as a courthouse, because within the Amazon world, it is much more efficient to solve conflicts within Amazon, than using the courts. That’s, I think, hugely problematic, because, as a citizen, even though you know the rules, those are not the standard procedures. I mean, if you live in a democracy, and you don’t like the Prime Minister, you can vote against him or her, and at some point, the guy leaves. You cannot vote against platforms. So, you don’t have any access to understanding how it works, what your rights are, and how you can defend your rights, what kind of tools you have. Whereas democratic societies have all those things very clear. So for me, as a citizen, I would rather give my information to a democratic state than to someone I cannot access. I don’t know where I am.

The problem with data is that the value comes from the aggregation. So, on your own, you cannot get value from your data because your data or my data have no value on themselves. They have to aggregate and aggregation means something that goes farther than the individual.

Belén: So, these platforms have huge power in economic, financial, political, social, and they have no rules. So, I think that we do need to regulate those platforms. And they basically act as monopolists in different fields. So you have a set of monopolists. And that’s, by the way, nothing new. We had that in the late 19th century, where, in the US there were, again, a number of huge monopolists. And the state, at some point, reacted and they said, “Okay, hold on. We need to do something about the mobile or we need to do something about many different industries — the oil industry and then telecoms” — because the power was too much. I think we are exactly where we were at that point. And, in order to avoid that, the competition policy was born. Now, I think we need to think of another competition policy. But I don’t know whether that’s enough. All the states have a regulation for networked industries, but networked industries are something much more national. This is international, isn’t it? And we don’t have common rules. We have common rules on how do we rule the seas. And that’s similar. So, you know, there’s an international law around these. We don’t have an international law around digital and that means sometimes we don’t even have a national law about digital. So I think that we need to develop that.

[00:20:28.23] Ben: Yeah, I suppose the only good precedent there, you know, whether we think is a good piece of legislation or not, something like GDPR, even though it’s a law that’s imposed within one sovereign area, which is the EU, it does tend to have ramifications outside of that sovereign area. Because if you want to do business in the EU, you have to treat customer data in a certain way. And what tends to happen is those policies then tend to become globally applied. But I just wonder, in general, I think you said earlier on that we have politicians that understand the law, but they don’t understand code — I think is what you said — and that was never more evident than in the times that the big platforms are brought to Congress, for their annual grilling, right? And I’m just wondering, you know, if it’s difficult to impose regulation cross border, and if it’s difficult for our current generation of politicians to impose the right kind of regulation at all, is the answer maybe to devolve more responsibility down to us as individuals, and in some way try to give us more transparency so that we make better-informed decisions about the platforms we use and what we share with them and so on? So, i.e. you know, put more responsibility in our hands.

we are clearly moving into a world of fragmented internet

Belén: For a number of reasons. One is they are monopolists. So that’s the first point. The second point is the nature of data. The problem with data is that the value comes from the aggregation. So, on your own, you cannot get value from your data because your data or my data have no value on themselves. They have to aggregate and aggregation means something that goes farther than the individual. So, the combination of the two things makes it very difficult for individuals to really be responsible. So, you would be asking them for something they cannot do because they don’t have the means. I’ll give you one example. For me, GDPR is the first step. But I’d really like the right to be forgotten because that’s something that, you gave away your information, or someone gave away your information, in a situation when we didn’t really know the consequences of that. And then, you suffer those consequences. You know, the right to be forgotten was a concept that was born in Spain — it was a Spanish case that led to this thinking of ‘this is unfair’ because someone did something three decades ago, and the guy is suffering from it again, and again, and again. And the problem is, I’ll give you one example. If you have a public appointment in Spain, your number gets published. And, at the same time, it looks like that should be private. And, you know, years ago, I had an attack, and the police told me, “Everyone knows where you live, and your number.” And I said, “Yeah, but that came from the fact that I was a public official.” So, all of a sudden, you have something that was ruled thinking of a different world, and now all of a sudden becomes a threat. And you cannot do anything because that is not part of the right to be forgotten. That’s nothing wrong, but it’s part of my privacy. And even then, it’s there. So, as an individual, I cannot do much. I need infrastructure or authorities, courts, that help me protect my rights — understand and protect my rights. So I don’t think that individuals are the way out.

[00:24:18.08] Ben: So regulations are still a thorny issue. And the other issue I wanted to talk about was your idea of policing the seas, right? Because what are the seas? I think we’re getting lost slightly in the analogy, but like, you know, what’s the landmass? What’s the sea? And if Europe is a landmass and we don’t have any really large platforms, where do we stand? I mean, for example, for how long can Europe impose regulations like GDPR when it doesn’t have platform companies of its own? Because it’s a bit like, you know, we’re imposing legislation on companies that aren’t even in our jurisdiction.

This dream of an open Internet for every country I think it’s over

Belén: But that’s why I like the analogy of the seas because, in the international law, you do regulate companies that are not part of your jurisdiction. And I think that the internet has been almost a global ocean. I think it’s not anymore. The exception being, of course, China. Right from the beginning, the Chinese thought, “Oh, if this is an ocean, I want to control my ocean, I want to set the rules.” And I think that we are clearly moving into a world of fragmented internet, where we, again, have not an ocean, but different oceans or seas if you want. And you said that the Russians announced that at some point, they wanted to close their internet and have a sort of a narrow channel into their internet so that they can control both — their internet and the channeling. The Chinese, of course, control that. I think that the US is thinking also, we need to think of how we control and have a walled garden — that we know what’s going on, who’s doing what, and we can react to that. So this dream of an open Internet for every country, whatever, I think it’s over. And, of course, that worries me in terms of Europe. So Europe has advantages and disadvantages. The disadvantage is that, of course, we lack any sort of platform. That’s a huge disadvantage. The advantage is that we still are the largest market in the world. We are interesting. The problem is when you’re not interesting at all — then you’re done. But when you can add value, then you have some tools to regulate that value that you are creating. So I think that Europe has that right and that ability. And also, the tradition. I think that we do have the tradition. We may over-regulate sometimes, but we know how to regulate and we think of the individual as someone that has to be protected. That comes from a long, long tradition of European thinking, philosophy, political science, sociology, anything you can think of. So, from that point of view, Europe has a chance.

in the 21st century, those countries or regions or companies, for that matter, that will rule the world will be the ones that will be able to do the three things: produce, store, and analyze data, move around those data — the platforms — and then set the right rules.

Belén: The thing is, for me, that if we use another analogy, and we think of the late 19th century, and how the industrial power was built — and that means power or states or companies — there were three things: the ability to produce things, the ability to move those things — so you needed a physical infrastructure — and then the rules of the game. And if you look at the industrial world, the industrial powers what they did is, Okay, I produce, I build infrastructure — the train being the first one; if you look at how the trains were designed in the 19th century, you knew who was powerful in terms of countries, and who was losing the battle. And only looking at that map is clear. And then, the rules of the game, which is free trade. That, coincidentally only applied to industrial goods, not to agricultural goods. Okay, 100 years have gone, so then digital power — who can produce, store, and analyze data? Very few countries or companies. The infrastructure is the platforms — we lack the infrastructure. And then the rules. So far, we haven’t got any rules. No rules at all, not even this free trade rule. We didn’t have a rule because we didn’t think we needed it. So, in the 21st century, those countries or regions or companies, for that matter, that will rule the world will be the ones that will be able to do the three things: produce, store, and analyze data, move around those data — the platforms — and then set the right rules.

[00:29:14.16] Ben: So how worried are you about Europe? Because at the moment we’re trying to set the rules to some extent — you know, GDPR, for example, PSD2 — but we don’t produce or move the goods, right? Or we don’t have the infrastructure, so we won’t be able to set the rules very long in that case. So, where does that leave us? And do you think the game is over in terms of creating the infrastructure?

The European Union, as a project, is built on conflict, it has always evolved out of problems. It’s not when everything works, and it’s peaceful. Whenever there’s a problem and a crisis, right from the beginning, the inception, the European Union evolves and tries to build on that.

Belén: I think we’re really far behind but it doesn’t mean that we have to say, “Okay, we give up.” I think we should fight. And fighting means a number of things. One is if we could understand how to rule this right — how to read the code — we would have a huge advantage. And that’s something that we could develop. Another thing that for me is hopeful is the fact that we’re starting to listen to the European Commission talking about digitization, which is quite a new thing, in a much more thoughtful way. And I’ll give you one example. So the European authorities came to the conclusion I think — that’s my understanding, I have to say — they came to the conclusion that “Okay, we have lost the war on personal individual data, but there’s a huge wave of data coming, which is data coming from systems, physical things. We are an industrial power, why don’t we build on that?” I think that is great because, by the way, physical things you get to personal data. So even though we lack the platform for personal data, which is the case, we could build platforms around non-human data, if you want. It has stemmed from good systems. I thought this is good, because instead of wasting resources fighting something that’s going to be very difficult, because you’re on late, let’s try to build something that is not built anywhere else, and then we won’t be late.

Belén: So, for me, that’s a very useful way of understanding that. And I think that with COVID-19, that the European Union is using it in a positive way, so to speak. The European Union, as a project, is built on conflict, it has always evolved out of problems. It’s not when everything works, and it’s peaceful. Whenever there’s a problem and a crisis, right from the beginning, the inception, the European Union evolves and tries to build on that. I think that now is starting to happen that. I mean, Europe has a soft power, and Europe has someone that understands that there are two huge giants rising, which is the US and China and thinking that they don’t like each other as much as they did in the past — and Europe is in the middle; that could be a potential advantage if we are smart enough. So, for me, the worst part of it would be if we thought of it as when you have a castle on your right, another castle in your left, and you are on the plain, then whoever comes, you’re done. That is not the way to understand that, I think, because then we’re done. If we build on our chances, I think — and we do have chances — I think that’s quite clear. You know, with the cloud, we’re late, but still, Germany and France are thinking or are starting to create a cloud. Will it be like that? Will it be as competitive? We’ll see. But I think that’s the right move. We should have done that move long ago. But at least we’re starting. So, in relative terms, we are behind the US and China, but we are ahead of the rest of the world. So, I’m hopeful. And I think that Europe is built on this notion of the individual has his rights, which is differential, I think.

[00:33:34.17] Ben: It’s quite interesting what’s happening with Tik Tok because I think, you know, is probably a good way of thinking about this, which is you’ve got this Chinese castle, the US castle. Do you think what we’re now seeing is, you know, those two citadels are trying to now establish and define their spheres of influence? And so, you know, Tik Tok was a case of… That’s almost like an invading army and we’re not going to allow that into our Citadel. And then everything that’s happening with Tik Tok in India seems to be a bit like, you know, India’s kind of aligning around the US castle. And then, I think your current comparison of Europe as kind of no man’s land is quite accurate because Europe hasn’t yet, I don’t think, really decided which castle is going to align itself with. And, as you said, maybe, for a short period of time, that gives us a position of influence because we can arbitrage between those two castles. Is that the way you think about the world, which is that that’s where we are now? The idea of this, you know, Pax Americana kind of world that was global is over, and increasingly nations are gonna have to choose between which of these two castles they align themselves to — or do you think they’ll be more castles like the Russian castle, the African castle?

when we all have access to information, that does not give us knowledge

Belén: A long list of things, as you mentioned. One is India. I don’t think that India is aligning with the US. I think that India is thinking, “I’m large enough and I’m advanced enough, and I have the knowledge and human capital needed to build my own castle. So, what I think that they are doing is, “Okay, let’s create our own apps.” So then it’s much more the understanding of, this is exactly a backdoor that you can use to look around and I want you to have that. It’s not only the influence, but it’s also the information that you get. One of the things with digital, it looks like the network effects come with a huge amount of data and that huge amount of data, if we’re talking about personal data comes from large populations. India, which is a very large country has the means to create its own network effects. They don’t need to have anyone else. As it happens with China. They are large of their own, they don’t need to have anyone else to create network effects. So, I think that they have understood that and they want to build on that. And from that point of view, neither the US nor Europe, on our own, I don’t think we are large enough in terms of that sort of pool of population. Probably, we need to think of something that combines both, otherwise is very difficult. If you think of if the US thought, “Okay, I’m closing my castle, it’s only us”, that’s not enough. That’s clearly not enough. They need to think of other pools of population. And probably we will see, at least, I think that large countries will try to build their own castle. Brazil is another example of a country that thinks that they are large enough, that they have the means, they have the knowledge to do something on their own. And so, we will have that as it happens with it. If you think of the industrial world, of course, the first superpower was the UK, but then Germany reacted pretty soon and then the US. So, you end up having a short number of industrial powers, but a number of industrial powers. So I think that Google sees something similar. I think we will have a number of powers. And I hope that Europe will use that as a chance.

[00:37:36.17] Ben: I think what’s interesting about India is with Geo. They’ve almost sort of separated infrastructure from production, which is to say, “You know, since we own the infrastructure, we’ll allow foreign companies or American platforms to operate on the infrastructure, but we own the infrastructure.” So, they have a certain level of sovereignty, that Europe, for example, doesn’t have, because we need to have the platforms or the infrastructure, right? So, I wonder if that might be the model. You referenced Brazil. I wonder if that might be the model that is followed by others. At least, then, you have a stake in the digital world, whereas if you own neither the infrastructure nor the platform you have, nothing.

Belén: I agree. I think that at least you need to control the highway. And then, you get to decide which car can go through that highway and whether you have to charge or not and the whole thing. If you lack everything — if you lack the highway and the car, you’re done. So, as it was the case in the industrial world, you needed to have infrastructure for the trains that you built, controlled. Otherwise, if we didn’t have the money to build our own infrastructure in the 19th century, the British companies that built it, they did it for their own, not for the Spanish people. It was more to extract value out of mines, basically. So, we had exactly the wrong infrastructure that we did not own, not control, not design. You’re done. You cannot succeed in the industrial world, with those weaknesses.

[00:39:16.15] Ben: I want to speak of something that you talk about, which is that democracy does not equal voting. What do you mean when you say democracy does not equal voting and how is that sort of relevant to this digital shift?

Belén: People tend to think that if I vote, that’s fine, then I can defend my rights. But that’s not true. For example, you have certain rules to control propaganda or financing in a democracy or what kind of information you can give or how long — are you always in campaign or can you be bombarding people again and again and again, do you give them one day they have to think? Whatever. So a number of things that complement the voting. But I think that we have completely forgotten that that infrastructure of rules is key — and if you don’t have that, then voting doesn’t… Any dictator can organize voting. And, quite coincidentally, is always to his advantage, it’s always 95%. It’s not the voting. It is the whole thing that comes before the voting, that grants that that voting will be a legitimate exercise in terms of democratic access. So, that, for me is key. You can opt-out Facebook — that’s voting; you vote with your feet, which does not change much, perhaps, because you’re out, but that’s not much.

when information is for free, we tend to vote out of emotion

[00:41:02.27] Ben: So you’re arguing almost we’re succumbing to this illusion that because we get to vote more often and there are more referenda that we’re somehow more empowered and we have more control over our affairs, whereas you’re saying the opposite is true? Because if I understand what you’re saying, rightly, you’re saying a lot of the underpinnings of democracy as we think about it are being washed away or eroded by digitization. So, can we just delve slightly into that? So if we think about some of the things that are critical to a democracy, such as having accurate information, is that principally on information that you think that democracy is being eroded? Or do you see other areas where the waves of digitization are washing?

COVID-19 was the rise of nation states. They were reborn, and all of a sudden, people turned to them to be protected, in many ways — limiting the movement of citizens, offering healthcare, buying vaccines. So, the nation state has, again, become a key player in the economic and social world, which means that people, when in danger or in a difficult time, and in various situations, they turn to those that are closer to them and have the size to protect them

Belén: I’ll give you one example. I can access a lot of information. Does it mean that I can self-diagnose my illness? That’s completely wrong. I have information but not knowledge. So, the difference between information and knowledge now is quite clear. It has never been the case over centuries in human history. So, we need to understand this difference. And, you know, there was this very interesting exercise. IBM has this Project Debater and they created a machine that can debate with a person and they had this public exercise that you can watch on YouTube, of a guy debating with a machine.

Belén: And that exercise was arranged by Intelligence Squared US. And they have this mechanic whereby the public first says that they are against or for whatever proposition and then after the debate, they vote again. The party that has moved more wheels, if you want, or more opinions, wins. They did exactly the same. And their proposition was, “Should states finance, pre-schooling education?” And the machine was told to say ‘yes’, and why and the individual, ‘no’ and why. And the exercise was, for me, quite telling, because, of course, the machine came with hundreds of examples, of data, if you want. And the individual less, but some. But he, even though he voted he was against that proposition and most of the public was for the proposition at the beginning, he could move more opinions, because he could understand emotion. All of a sudden, when we all have access to information, that does not give us knowledge. That means that we can look at things that we would like. And, of course, you can always find data that justifies your prejudice. That’s always the case. You can look at part of the information, and that leads you to say, “Yes, I’m right!” Or the other part, which is, “I’m wrong.”

Belén: Finally, when information is for free, we tend to vote out of emotion. And when I saw that exercise that I found so interesting, I thought, “Now I understand Brexit.” So finally, is it, “Do I trust you or not? Do I think that you have an intention or not?” So, one of the things that I find quite interesting is that there’s this crisis in democracy, at least democratic states, that people are losing trust in institutions, being those private or public. And then comes COVID-19. And for me, it was quite a surprise because COVID-19 was the rise of nation states. They were reborn, and all of a sudden, people turned to them to be protected, in many ways — limiting the movement of citizens, offering healthcare, buying vaccines. So, the nation state has, again, become a key player in the economic and social world, which means that people, when in danger or in a difficult time, and in various situations, they turn to those that are closer to them and have the size to protect them. If it’s tiny, if it’s only a city, they don’t have the size to give me what I need. I need something larger. I think that’s good for democracy, of course. Any economic crisis raises the danger of populism and all these things. So, I’m not naive from that point of view. But the way I see it, I think that democracies with this huge crisis, have a chance to rebuild themselves. And, for example, the fact that the European Commission is now trying to get to buy enough vaccines, I think that increases their legitimacy. The problem was, in the beginning, the European Commission did not react at all. So it’s not only they lacked legitimacy, they lacked action. The fact that you need someone that can protect you, I think that gives a chance to democracies to react and rebuild themselves. But of course, they need to develop an understanding of the code, to control the rules. So, all these things that we have been mentioning, and of course, build your own infrastructures, as well.

[00:46:55.29] Ben: You often talk about how the conception of democracy is bound up with industrial age concepts, that I suppose the other question is, you know, if democracy depends on nation states, and nation states are with a long term view in trouble, and if democracy depends on the institutions of the industrial age, then is democracy in trouble from two sides?

Belén: The key distribution of wealth comes through wages to work, which is quite an evolution in terms of the history of the humankind. So if you work more, you get the chance to be wealthier. And that means that we are basically all the same because we can become the same over time. And so, why can you vote and not me? And you being first a landowner, then a man or a white man. So, if I am a woman, and black, and I am poor, I can become what you are. So, why can’t I vote? Now, with the digital world, it’s, again, if we find the way to assign prices to value, that can bring us again, to a situation where I can earn my living in a reasonable way, and hence, this whole structure can survive. If that’s not the case, if we cannot understand how value is created and distributed, and therefore, how fair our economies are — we don’t know how fair they are, because we don’t have the right measurement, again, so we will measure part of the fairness or unfairness; but the rest does not exist. So, if democracy is a key to grant fairness, then we need to have those tools. Some people will be helped by training. Some people won’t. So you need to think of how can you protect and help people that won’t be able to be retrained. You know, with COVID-19, I found quite interesting the fact that live sports have suffered so much, and then eSports are thriving. So, all of a sudden, you have a whole sector of eSports that is growing, and that entails employment, in many ways.

[00:49:25.12] Ben: Is that a positive? Because I absolutely 100% share your view. I’m an optimist, I believe that the world that awaits us will be more positive than the world that we leave behind. But I’m worried, like you are, about the transition, because this transition is now happening so much faster on the back of COVID-19. Does that somehow reduce the scope for wars or civil unrest or whatever nastiness that could normally come to because it’s happening now just, you know, at an accelerated rate?

Belén: In terms of the COVID-19 I’m worried about the short term economic effects it brings. That’s absolutely true. And it’s also true that is somehow accelerating these trends. But the positive side of it is that they’re becoming visible. If a problem exists, and it’s visible, you can tackle it. The problem that we have is that these trends have been there for 10 years, 20 years, and they weren’t visible at all. So, there was no public debate, public worry, nothing at all. Remote working has been there for a number of years and some companies were very good at using remote work, and some specific groups of people wanted to only work remotely. But it was sort of a lateral and receivable, but it was clear that it was a trend that at some point would affect many others. Why don’t we have an industrial organization with a service economy? That’s exactly the case. Now, all of a sudden, we have found that, indeed, we didn’t have an industrial organization. Well, now it’s visible. Now everyone is thinking of, “How can we do this? Should it be five days a week? How can we really apply this technology that we already had, but we didn’t use?” So, from that point of view, COVID is making many of these trends visible. I think that is, a tree that falls in the forest — is it falling? No one hears or sees it. It’s exactly the same with problems. And we only look at problems when they are big enough, as societies. Now they have become big enough. So, I think that that will also accelerate the transition in terms of their reaction.

[00:51:47.14] Ben: I almost feel like the furlough scheme, or you know, whatever it’s called in the country. Is, in some way, almost like an experiment in the universal income in a way, which is, how do we compensate people whose jobs are not going to exist in a digital world?

Belén: Yeah, yeah, absolutely. And instead of having the finish with this experiment, now we are all making it. And there will be things that won’t work, but we will find which ones do. So I think that’s another example of things that I think are accelerated. You will get to see that. If you use that analogy of the COVID and digital, some populations are suffering more than others. And so, they get isolated, so you need to protect them more, because they are isolated, because they need to be isolated.

we have the chance to understand better the world that we are already living in. I think that societies have stopped and are thinking — which is really, really helpful because it’s not just the elite thinking

[00:52:38.13] Ben: A lot of people use the war analogy for what we’re going through, which is, the enemy is the disease, it’s not another country. And that’s interesting in a couple of ways, right? One, because the government’s taking an unprecedented or warlike intervention into the economy to boost aggregate demand, and so on, which is interesting. But then, what a lot of people say is that won’t be the rebuilding exercises necessary after a war, which then sustains aggregate demand. But in a way, don’t you think that might also force governments to figure out how to redefine the tax base?

Belén: Not only the tax base but also the economic structure. If you look at the European Union Fund, it talks about two things. One is green, and the other one is digital, which is we need to rebuild the societies thinking of those two things, which is quite a novelty, I have to say. So, we have an enormous amount of money to rebuild the economic structure. And that, I think, is a unique opportunity. So, we don’t have physical infrastructures that have been damaged, as is the case in a war, but we have indices that have been damaged by the digital world, and they have not been able to react. And so, I think that’s a huge chance. It’s sort of a Marshall Plan effort in a different way. So, it’s not bridges and buildings, but it is platforms and data. I think that there’s no clear answer to that. It will depend on the society and how they feel that they need it and whether they have someone that will finance that.

[00:54:35.16] Ben: But that Marshall Plan, if I’m not wrong, that Marshall Plan is something that Europe is thinking about, but it’s not something… You know, whether we consider the UK in Europe or not anymore, I think in four months we’ll find out but the UK doesn’t have an equivalent of the green new deal or the digital Marshall Plan, and the US may or may not, depending on elections in November. So, do you think many countries will take this once-in-a-generation opportunity to rebuild?

Belén: Again, I think about that, and it depends on the country. But in terms of the nation states, we are seeing, again, states are not only regulating but owning and managing a large part of the economy. So, that’s more sort of the ’70-like situation where you had the state doing two things: doing things and regulating those things. And I think that model that looked completely over is back, and it has advantages and disadvantages. So, back to the network effect, much of the technological revolution in the US came from the collaboration between private and public institutions. We never had that in Europe. Now, I think we’re going to have that. And it’s a precondition. But you need to have both sides of the world collaborating. I think that’s key. When you lack both, you lack size or the ability to combine private and public forces, that country will struggle, I think. It’s not only the quality of the politicians, which is key, but also the tools that they have. Probably they won’t have the same tools.

[00:56:29.29] Ben: I want to finish on, if we can, on a really positive note. I think you started by saying that digitization has been a force for the good, right? We may not see it in our GDP statistics or our productivity statistics but we feel it. We feel it in particular as consumers. But then we got on some slightly more negative topics. So we talked about how democracy is struggling in the face of digitization, we talked about how digitization is kind of dissolving the global world into nation states, we talked a bit about how the transition is going to be tough. Maybe we started to get into more optimistic ground with how the pandemic may find a route to faster transition. But I just wanted, if you would, to finish by giving us your most optimistic projection of the future.

Belén: It’s difficult for me because, by nature, I’m not an optimistic person. I think that the problems that you don’t identify, you don’t solve. So, I tend to focus more on the problems than on thinking that there won’t be problems. So that depends on how you define an optimist. But, in my view, I think that we have the chance to understand better the world that we are already living in. I think that societies have stopped and are thinking, which is really, really helpful because it’s not elite thinking. I think the whole society is thinking. It happens — this crisis — at a time when we have already suffered some of the negative impacts of the digital world. So, we have either Facebook political things and things like that. So I think that awareness is higher and I think that’s very good at all levels of society. So, for me, an optimistic or a positive — much more than optimistic, a positive outlook into the future, would be democracies get stronger, because they understand the rules of the game. We get to measure track, and if needed, to control the value and impact of digital and hence, we really create abundance and give it away to us. I think that Europe has the size, the human capital, and now the understanding. So, we have the tools, so let’s use them.

[00:59:19.08] Ben: Belén, thank you very much for your time!

Belén: Thank you! Thank you so much!

What we learned from doing the Structural Shifts Podcast

What the world looks like when seen through “a great series of conversations with people who are building the future”

 
 

In the break between seasons — season 2 starts again on September 24th — we thought we’d take stock and reflect on some of the things we’ve learnt from making our podcast.

When we started Structural Shifts (initially without a name, that came from episode 14), it was just an excuse to reach out to and chat with people whose life and work we found interesting. What surprised us was two-fold: firstly, that people liked it and recommended / introduced other people we should interview, making the whole endeavour sustainable; and, secondly, that many of the evergreen topics we set out to explore bubbled up to the top of the people’s agenda and consciousness.

The fundamental transformations that used to quietly shape our world — over years or decades — suddenly became topics for mainstream conversations. The acceleration everyone’s talking about — we felt it too and it has influenced how we make and develop the podcast.

It’s safe to say that doing the podcast has taught us valuable lessons.

“I found this podcast borderline post-modern, and refreshingly frank. A profound look into what’s next. Love every bit! The guests, the music, the format.” — Simone Cicero, Co-Creator of Platform Design Toolkit

A crisis can be clarifying

The worldwide lockdown had wide-ranging effects, some of them even on the positive side. For example, it enabled us to interview thinkers we greatly admire, but who are geographically remote — like Rita McGrath and John Hagel — as well as to grow our audience.

In a world already hungry for meaning, the pandemic triggered a pressing need for strategic thinking. First, it made people pause and reflect on what truly matters — for their lives, work, for the planet.

Then, because institutional and private reactions to the pandemic left many disillusioned, they became determined to gain a stronger understanding of big topics — fintechinternet business models, geopoliticsthe climatethe future of work.

We had profound, unhurried conversations with people who are thinking and doing things differently. Their thoughtful observations, distilled from decades of practice and reflection, challenged our received wisdom on a range of topics — from innovation to marketing — as well as encouraged us to entertain contrarian viewpoints.

Instead of a just-do-it mentality, the pandemic reinforced the timeless value of reflection and flexibility, reflexes that all our podcast guests share. If you keep an eye out for it, you’ll notice that in every episode we publish.

Good questions are catalysts for change

Good podcasts depend on two key ingredients: interesting guests and good questions.

Our listeners increasingly took care of introducing us to great thinkers, some of whom — like Brett Bivens or Julian Lehr — we caught on the rise to becoming big stars. And we concentrated on trying to get the best out of the conversations.

In the past six months, we’ve spent a lot more time on research. As our audience grew, so did our sense of responsibility to get the best out of every conversation. Many weekends and late nights were spent reading the books our guests had written, which made us well-prepared — and hopefully improved our the return on our listeners’ time.

Some of the book authors we had invited at Structural Shifts podcast

Our goal was also, for ourselves and our listeners, to delve into diverse topics such as the ethics of technological change or building a safety net for the self-employed. A risk because many podcasts listeners like to keep digging into a given topic like investing, we hoped to create the context for the cross-pollination of ideas, frameworks, and viewpoints that can serve both professional and personal pursuits.

As the inner workings and implications of the networked age leapt into view for the entire planet, we developed an even keener focus on asking questions that help us have better, more stimulating conversations. Questions are essential to decode, deconstruct, and rebuild our vision of the world as it is — and as it might become.

The case for techno-optimism is one of our favorite examples of such a conversation, providing signposts to use when engaging in mainstream conversations around key topics in tech and their society-wide impact.

“A great series of conversations with people who are building the future. Each one is like having a dinner conversation with a smart friend who has come back from a voyage. I listen when driving or jogging — the miles just melt away and I arrive with a refreshed mind.”

It’s easier to connect when you share purpose and focus

Another thing we noticed while doing the podcast, especially in the past 6 months, is that people who share the same principles tend to resonate (or “click”) more easily when having conversations remotely.

It was surprisingly easy to delve into complex topics with them because everyone was eager to dive in. Maybe you’ve also noticed how small talk takes less and less time in online meetings as we have more of them.

This desire to have important conversations, to support clarity and good decision-making translated into our guests sharing personal perspectives more openly.

What’s more, it was easier to connect with new guests who dedicated even more time than before to share their expertise and experiences. We’re grateful for every minute they spent with us!

Capturing attention in a roaring world is a big challenge

As Herbert Simon predicted, a wealth of information gives way to a poverty of attention.

Our response to this has never been to compete on giving information, but to focus on carefully curated insights. A great fan of craftsmanship, we meant for the conversation — except for maybe the couple we did on previewing the post-pandemic world — to be timeless; as relevant now or in two years’ time as they were the day they were recorded

We also found that the lockdown period — or more specifically the extra time that many people gained through not travelling and commuting — opened up more demand for the long-form product we offer.

“Always insightful and informative. It is a relaxed conversation with people who have had interesting experiences and something to say. Ben Robinson, brings out the best in each guest.”

The Structural Shifts podcast remains one of our favorite projects, in which our enthusiasm for the topic and our guests’ generosity combine to help you see farther — and more clearly.

Helping ourselves and our network to move from scalable efficiency to scalable learning and, in do doing, to prosper in our networked age is why we do the podcast.

We hope it helps you achieve the same.

“I really love this podcast series. There’s not much content like this coming out from Europe. Should serve as an example to others” — Bozidhar Hristov


Our thanks to all of our guests and listeners and to Sarah Mikutel, our podcast editor. In series 2, we’ll be back with more mind-expanding conversations, covering the token economy, the future of finance, the end of globalization, the startup community way, the new precariat and much more…