The International Monetary Fund’s (IMF) latest Global Financial Stability Report highlights myriad risks for the global financial system.
3 min
The International Monetary Fund’s (IMF) latest Global Financial Stability Report highlights myriad risks for the global financial system. They include the war in Ukraine, high debt, and soaring inflation.
But the report also warned about the impact of decentralized finance, or DeFi, an emerging set of financial services applications that are based on blockchain and other crypto technologies and don’t involve banks other traditional financial intermediaries
Citing possible systemic risk, the IMF wants governments to impose regulations because, the report says, DeFi results in the “buildup of leverage, and is particularly vulnerable to market, liquidity, and cyber risks.”
DeFi may not be a mainstream vehicle yet, but that doesn’t mean financial advisors don’t need to know about it.
What is DeFi?
It’s a kind of financial application that uses “smart contracts,” to operate on a blockchain platform, usually Ethereum. These software programs allow for fully automated, peer-to-peer financial transactions without intermediaries like banks or brokers, which generally means faster settlements of trades.
“With DeFi, users are able to perform most functions that a bank can,” says Jeremy Almond, founder and CEO of Paystand, a B2B payments platform. “This includes earning interest, borrowing, lending, buying insurance, trading derivatives, and trading assets.”
Supporters of DeFi say it offers the potential to democratize financial services for the unbanked. This is a key reason the Federal Reserve is looking at creating a digital currency.
The world currently has around 1.7 billion people who are unbanked, according to Yubo Ruan, founder and CEO of DeFi provider Parallel Finance. “Some of the reasons include a lack of government-issued IDs, problems with credit history, restrictive bank requirements, or a lack of banking infrastructure within a country.”
How easy is it to use?
It can actually be cumbersome. You need several applications to accomplish what may seem like routine transactions if done at a bank, and the jargon and concepts can get complicated.
“A combination of highly technical requirements, high fees, and confusing user interfaces are putting off potential users,” says Jackie Bona, CEO of Valora, a mobile crypto wallet. “This is making it difficult for people to get started in DeFi, scaring away those who need these apps the most.”
What are the risks?
According to Archie Ravishankar, CEO and founder of mobile banking app Cogni: “Regular consumers in this space lack the regulatory protections they’re accustomed to in traditional finance.” So if you lose money, you have no consumer protection, such as the Federal Deposit Insurance Corp. True, you could bring a lawsuit, but the target DeFi organization may be an offshore entity.
Another issue is volatility. Just look at so-called stablecoins such as Luna. Within a week, its value plunged from $80 to virtually zero, tantamount to a run on the bank.
So should financial advisors suggest clients avoid these applications?
Generally, the answer is yes. DeFi is an emerging category of finance and it can be difficult to perform due diligence on new and decentralized technologies. Even those applications that are backed by venture capitalists have seen breaches.
When it comes to clients, DeFi is for those that have a high tolerance for risk. And if they are interested in investing, they should allocate a small part of their portfolio to it.
Can DeFi disrupt traditional financial services?
Even if it takes only a relatively small portion of the global market, the impact would be substantial.
“DeFi certainly has the potential to disrupt traditional finance across the board, and in some ways it already has—on a small scale so far,” says Liam Kelly, Europe news editor for Decrypt, a cryptocurrency news site. But he adds, “a lot of this hinges on breakthroughs in scalability and cutting reasonable lines between things like centralization and decentralization or opaqueness and transparency. Another possibility is that these technologies simply get absorbed by financial institutions to a point where to the consumer, nothing has changed at your brokerage account, except now on the back end it’s running on Ethereum or another blockchain network.”
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Multinationals like Starbucks and Marriott are taking a hard look at their Chinese operations—and tempering their outlooks.
4 min
For years, global companies showcased their Chinese operations as a source of robust growth. A burgeoning middle class, a stream of people moving to cities, and the creation of new services to cater to them—along with the promise of the further opening of the world’s second-largest economy—drew companies eager to tap into the action.
Then Covid hit, isolating China from much of the world. Chinese leader Xi Jinping tightened control of the economy, and U.S.-China relations hit a nadir. After decades of rapid growth, China’s economy is stuck in a rut, with increasing concerns about what will drive the next phase of its growth.
Though Chinese officials have acknowledged the sputtering economy, they have been reluctant to take more than incremental steps to reverse the trend. Making matters worse, government crackdowns on internet companies and measures to burst the country’s property bubble left households and businesses scarred.
Now, multinational companies are taking a hard look at their Chinese operations and tempering their outlooks. Marriott International narrowed its global revenue per available room growth rate to 3% to 4%, citing continued weakness in China and expectations that demand could weaken further in the third quarter. Paris-based Kering , home to brands Gucci and Saint Laurent, posted a 22% decline in sales in the Asia-Pacific region, excluding Japan, in the first half amid weaker demand in Greater China, which includes Hong Kong and Macau.
Pricing pressure and deflation were common themes in quarterly results. Starbucks , which helped build a coffee culture in China over the past 25 years, described it as one of its most notable international challenges as it posted a 14% decline in sales from that business. As Chinese consumers reconsidered whether to spend money on Starbucks lattes, competitors such as Luckin Coffee increased pressure on the Seattle company. Starbucks executives said in their quarterly earnings call that “unprecedented store expansion” by rivals and a price war hurt profits and caused “significant disruptions” to the operating environment.
Executive anxiety extends beyond consumer companies. Elevator maker Otis Worldwide saw new-equipment orders in China fall by double digits in the second quarter, forcing it to cut its outlook for growth out of Asia. CEO Judy Marks told analysts on a quarterly earnings call that prices in China were down roughly 10% year over year, and she doesn’t see the pricing pressure abating. The company is turning to productivity improvements and cost cutting to blunt the hit.
Add in the uncertainty created by deteriorating U.S.-China relations, and many investors are steering clear. The iShares MSCI China exchange-traded fund has lost half its value since March 2021. Recovery attempts have been short-lived. undefined undefined And now some of those concerns are creeping into the U.S. market. “A decade ago China exposure [for a global company] was a way to add revenue growth to our portfolio,” says Margaret Vitrano, co-manager of large-cap growth strategies at ClearBridge Investments in New York. Today, she notes, “we now want to manage the risk of the China exposure.”
Vitrano expects improvement in 2025, but cautions it will be slow. Uncertainty over who will win the U.S. presidential election and the prospect of higher tariffs pose additional risks for global companies.
For now, China is inching along at roughly 5% economic growth—down from a peak of 14% in 2007 and an average of about 8% in the 10 years before the pandemic. Chinese consumers hit by job losses and continued declines in property values are rethinking spending habits. Businesses worried about policy uncertainty are reluctant to invest and hire.
The trouble goes beyond frugal consumers. Xi is changing the economy’s growth model, relying less on the infrastructure and real estate market that fueled earlier growth. That means investing aggressively in manufacturing and exports as China looks to become more self-reliant and guard against geopolitical tensions.
The shift is hurting western multinationals, with deflationary forces amid burgeoning production capacity. “We have seen the investment community mark down expectations for these companies because they will have to change tack with lower-cost products and services,” says Joseph Quinlan, head of market strategy for the chief investment office at Merrill and Bank of America Private Bank.
Another challenge for multinationals outside of China is stiffened competition as Chinese companies innovate and expand—often with the backing of the government. Local rivals are upping the ante across sectors by building on their knowledge of local consumer preferences and the ability to produce higher-quality products.
Some global multinationals are having a hard time keeping up with homegrown innovation. Auto makers including General Motors have seen sales tumble and struggled to turn profitable as Chinese car shoppers increasingly opt for electric vehicles from BYD or NIO that are similar in price to internal-combustion-engine cars from foreign auto makers.
“China’s electric-vehicle makers have by leaps and bounds surpassed the capabilities of foreign brands who have a tie to the profit pool of internal combustible engines that they don’t want to disrupt,” says Christine Phillpotts, a fund manager for Ariel Investments’ emerging markets strategies.
Chinese companies are often faster than global rivals to market with new products or tweaks. “The cycle can be half of what it is for a global multinational with subsidiaries that need to check with headquarters, do an analysis, and then refresh,” Phillpotts says.
For many companies and investors, next year remains a question mark. Ashland CEO Guillermo Novo said in an August call with analysts that the chemical company was seeing a “big change” in China, with activity slowing and competition on pricing becoming more aggressive. The company, he said, was still trying to grasp the repercussions as it has created uncertainty in its 2025 outlook.
Few companies are giving up. Executives at big global consumer and retail companies show no signs of reducing investment, with most still describing China as a long-term growth market, says Dana Telsey, CEO of Telsey Advisory Group.
Starbucks executives described the long-term opportunity as “significant,” with higher growth and margin opportunities in the future as China’s population continues to move from rural to suburban areas. But they also noted that their approach is evolving and they are in the early stages of exploring strategic partnerships.
Walmart sold its stake in August in Chinese e-commerce giant JD.com for $3.6 billion after an eight-year noncompete agreement expired. Analysts expect it to pump the money into its own Sam’s Club and Walmart China operation, which have benefited from the trend toward trading down in China.
“The story isn’t over for the global companies,” Phillpotts says. “It just means the effort and investment will be greater to compete.”
Corrections & Amplifications
Joseph Quinlan is head of market strategy for the chief investment office at Merrill and Bank of America Private Bank. An earlier version of this article incorrectly used his old title.
