Revolution in the air
Financial technology is transforming the financial services industry and the pace of change is accelerating. The new developments can be highly disruptive, but the benefits can be felt by customers, vendors and even established industry operators.
Financial technology (fintech) is booming. Last year alone, the sector received $58.3 billion in financing, while the value of mergers and acquisitions (M&A) was more than $124.1 billion, according to FT Partners, a specialist investment bank focused solely on the sector. Both figures are records for the industry – and they may well be surpassed this year.
Traditionally, financial services firms have operated tried-and-tested business models, both in the way they amass, store and distribute information, and in their relationships with clients and vendors. Today, those models are being redefined by technology – and the repercussions are being felt across insurance, banking, wealth, asset management and capital markets.
In some cases, new developments are highly disruptive to established financial services firms. In others, they can confer tangible benefits, even to old-timers. Frequently, fintech offers a blend of both.
Reaping the benefits
Take retail banking, for example. On one hand, functions that have always been part of the industry, such as payments, can now be undertaken by non-bank players – a situation that threatens to disintermediate incumbent payment providers from their customers. On the other, established players are taking advantage of fintech to introduce state-of-the-art apps, bringing numerous accounts under one roof, making it easier for users to gauge their financial position and improving customer relationships. Equally, cost centres such as regulatory compliance can be shrunk by providers that offer regulatory technology, helping financial services institutions to reduce costs and increase effectiveness.
“The economics of banking and insurance are increasingly challenged, which is why they are all trying to save money,” says Bridgepoint director James Reynolds. “Technology can help with that. It can help to ensure compliance, it can help with training staff in regulatory compliance, and it can help with improving and automating processes to ensure everybody is compliant.”
The largest fintech firm by value, Ant Financial, is estimated to be worth $150 billion
New ways of working
Many fintech firms have developed new approaches to managing processes, thereby increasing the efficiency, speed or volume of processing without increasing the cost. Distributed ledger technologies (DLTs) are a case in point, providing a shared, cryptographically protected record of transactions. The best-known DLT is blockchain, which was developed to support bitcoin transactions, but the technology can be applied far more widely. In essence, it removes the need for firms on either side of a transaction to cross-check that they received what they agreed beforehand.
Today, large transfers of cash or securities are often only completed two days after a trade is agreed. Using DLT can have a dramatic effect on transaction speed and remove a swathe of expensive, post-trade processing. The technology is so radical, however, that regulators and financial institutions will almost certainly need to reinvent the rules and infrastructure that surround DLT transactions. As such, experts believe it will take some time before DLTs become an industry norm.
Banks and asset managers can access tools online, rather than installing systems themselves, meaning they can be employed faster. The systems can be tested as they are built to ensure they are fit for their purpose. And they are far cheaper, too
Other fintech solutions are less dramatic, simply offering technology that works more effectively than legacy systems. As recently as the early 2000s, for example, financial services firms needed to buy or build data centres and create large, fixed, monolithic systems. Today, cloud technology means computer processing and storage can effectively be rented from a data centre, while microservice architectures break down technology into component chunks that can be assembled as needed.
Both are far more flexible than older models, allowing software and resources to be offered as a service, that can be tapped into when needed. Banks and asset managers can access tools online, rather than installing systems themselves, meaning they can be employed faster. The systems can be tested as they are built to ensure they are fit for their purpose. And they are far cheaper, too, giving much smaller companies access to the necessary IT so they can scale up quickly.
But companies need to know how best to use these new technologies – and that can be tough, with legacy systems stretching back decades.
“There are examples where firms end up running the old and new systems together. As a result, they can end up with 1.5x cost rather than a reduced cost, so banks are looking very carefully at how they adopt new technology,” says Jerry Norton, head of strategy for UK financial services business at IT and business consulting group CGI.
Information networks – public and private, social and business – are also connecting customers and service providers in new ways. And information itself is more easily quantified, moved and analysed to enable business decisions.
Historically, financial services firms’ data was effectively locked in vaults by their IT systems. Reviewing and reconciling that data usually took place at the end of the day and it would be processed in batches.
In many cases, each storage system differed slightly from its peers, meaning that data from one system could not be used by another without expensive middleware acting as a translation service between them. Today, standardised application programming interfaces act as gateways that transfer data from one system to another, enabling systems to work together more easily. They can even work alongside older technology, so operators are not forced to undertake expensive replacement work.
The economics of banking and insurance are increasingly challenged, which is why they are all trying to save money. Technology can help with that
Fintech, however, is a broad umbrella term, covering a wide range of ideas, developments and applications. There is huge variation in size, too.
The largest fintech firm by value, Ant Financial, is estimated to be worth around $150 billion. As part of the Chinese online marketplace Alibaba Group, it has leveraged the group’s wider client network to provide retail investors with access to money market funds. Tapping into the relatively underserved market for investment in China, Ant quickly became the largest fund provider in the country, offering access to both proprietary and third-party investments.
Environment makes an enormous difference to a fintech firm’s prospects, however. Square, for example, provides a service designed to make it cheaper and easier for up-and-coming businesses to accept credit card payments.
Led by Twitter founder Jack Dorsey, Square listed on the New York Stock Exchange in 2015 for $2.9 billion and 2018 revenues amounted to $3.3 billion. But the company is tapping into the mature US retail payments sector and it has yet to make an annual profit.
The European approach
In the EU and the UK, regulators have sought to use fintech to drive competition in the market. Under the EU’s payment services directive and the UK’s Open Banking Initiative, operators can develop account aggregation services, providing customers with a single view of their finances across multiple providers. Banks need to seek customers’ permission first, but the technology is there, regulators are in favour and some groups, such as Dutch firm ING, are already offering it to clients.
Intriguingly, however, the pace of change could be particularly marked in emerging markets.
“It’s a bit like the adoption of the mobile phone in many African countries,” says Mike Tae, head of strategy and M&A at global fintech specialist Broadridge. “They didn’t have the landline infrastructure, so adoption of mobiles leapt ahead of countries that did have that infrastructure. Fintech is likely to go the same way. We’ll see the first adoption of new technology where there is an absence at present, rather than where it has to replace something.”
In some cases, new developments are highly disruptive to established financial services firms. In others, they can confer tangible benefits, even to old-timers
Across the industry, fintech is creating totally new avenues for financial services, in terms of cost, access and efficiency.
“We are seeing an increasing number of fintech firms helping financial services clients to manage huge flows of data not only within their own businesses, but also in the markets they operate in more broadly. A whole swathe of fintech businesses has emerged in this area in the past year alone,” says Reynolds.
Distributed ledgers can be used to issue tokens that allow rapid and transparent transactions via a lightweight technology framework. Crowdfunding platforms can help small business to raise seed capital and grow far more rapidly than they could before. Online utilities can provide common services to banks that mutualise the costs.
The pace of change is creating regulatory challenges as authorities struggle to apply existing rules or develop new ones that will protect investors and users. But they are also alive to the need to support innovation. The EU’s Fintech Action Plan, launched in 2018, involves a light-touch regulatory approach, designed to foster growth. Globally, too, fintech firms are moving into mainstream finance, delivering meaningful change into what has historically been a conservative and risk-averse industry n