Fintech innovations such as blockchain, robo-advisory, artificial intelligence (AI) and big data analytics, are challenging the existing industry hegemons and the antiquated operating models supporting financial markets. Calastone hosted a webinar on November 15, 2017 which explored a number of fintech trends and developments.
The facilitation of material improvements to user experiences has to be the guiding principle behind any technological innovation. “When I think about the future of fintech, I think it needs to solve two issues, namely removing the friction from financial services and broadening access for consumers. There is too much friction meaning people do not enjoy financial services. For example, it is not fun to make a payment so fintech needs to make these processes simpler. I remember the first time I took an Uber, and I got a massive kick getting out of the taxi and just walking away instead of sitting there and trying to pay the guy and get a receipt,” said Reinier Musters, founding partner at Orange Growth Capital, a fintech investment firm.
Similar advancements are possible in financial services, provided the technology is adopted holistically and not in siloes. Ken Tregidgo, deputy CEO at Calastone, said he envisaged a future whereby machine learning tools comb through big data sourced from consumer bank accounts, which have now been opened up to third party providers following passage of the Payment Services Directive 2 (PSD2). With this, consumer buying patterns can be identified, mapped and analysed giving way for virtual financial assistants or robo-advisors to provide investment recommendations. “Investors would also benefit from a consolidated view of their portfolio across all asset classes in one place with access controlled by them”, he said.
Blockchain is another enabler of change in financial services, although its impact will primarily be felt in the middle and back office. Katrina Sartorius, managing director at Aegon Institutional, said the shared nature of blockchain now meant all counterparties could have access to the same data sets, something which would streamline back office reconciliations. This is just one example of blockchain’s applicability, with a number of test cases and proof of concepts being trialled across the industry. Calastone, for example, announced that it will transition its entire fund transaction network onto a DLT infrastructure, having undertaken a successful proof of concept in June 2017.
Thoughtful application of fintech solutions like blockchain is imperative. Having a bright idea is not tantamount to success. Fintechs need to understand the requirements of prospective customers if they are to monetise their products. Richard Street, head of EMEA, global client coverage at RBC Investor & Treasury Services, pointed out fintech fundamentally had to solve a purpose, adding that many existing problems at banks could be fixed without implementing a disruptive technology.
Musters agreed. “A lot of companies come into our offices and pitch blockchain, and we say that we do not invest in blockchain. We do, however, invest in companies that solve business problems. Blockchain may not always be the best technology available to solve a problem,” he said. Innovations like blockchain should only be applied if they are the optimal solution to a business challenge. A detailed analysis of the issues that financial businesses face should always be the first step Fintech companies take. They also need to ensure they hire the right balance of people, between those who are entrepreneurial in nature versus individuals with financial services expertise in order to ensure they develop and deliver relevant solutions for clients.
Fintech providers also need to be sensitive to the business challenges in financial services. Banks are systemically important financial institutions (SIFIs) entrusted with safekeeping peoples’ deposits whereas fund managers are fiduciaries responsible for looking after the savings of retail and institutional investors. Risks are not taken lightly by these organisations, meaning any integration of fintech has to be done cautiously and safely. A failure to ensure technology interoperates with legacy systems could cause significant paralysis at these companies potentially endangering consumer capital.
“Fintech integration should ideally be undertaken in a way that is low risk, meaning migrations need to be gradual. It should not require a big bang adoption, but a phased transition which co-exists and interacts with legacy technology. Take Calastone, for example. We have encouraged STP (straight-through-processing) adoption in small steps, and on a conservative time-frame and business case which suits our clients,” said Tregidgo. The same, he said, was true of blockchain. “Blockchain is being applied across the industry in micropayments and equity settlement and clearing, but the migration path has to be realistic, and the technology must interoperate with existing systems,” said Tregidgo.
The industry’s opinions and attitudes towards fintechs is maturing. Having once faced a barrage of hostility from large financial institutions, fintechs are gradually becoming more accepted, mainly because the industry has recognised its own weaknesses. Major banks and fund managers have internal structures and regulatory requirements that create an unfavourable environment for innovation to flourish. Such corporate shackles endemic at financial institutions are not a problem facing agile fintechs, paving the way for synergies to be explored between the two sectors.
However, fintech start-ups do face constraints in resources and capital, which is encouraging them to forge strategic partnerships with open-minded financial institutions. Through collaboration rather than competition, financial institutions and fintechs will be able to work together driving and developing interesting products for clients. While this is a positive development, Musters acknowledged these mutual agreements often took a long time to formalise due to banks’ compliance policies putting serious financial strain on start-ups burning through seed capital. Most start-ups will operate with working capital to cover a 12 to 18-month time horizon, but discussions with established financial institutions occasionally drag on for much longer. This creates a poisonous cycle as delays facilitate instability at start-ups, prompting counterparty risk concerns at the financial institutions they are negotiating with.
The enablement of disruptive technology is also being augmented by regulators, who are taking a progressive approach to innovation. Many regulators have realised that technologies like blockchain and AI could potentially support major improvements in transparency and simplify inefficient reporting processes at financial institutions.
Regulators including the FCA are also motivating innovation through the establishment of sandboxes, which are safe environments for fintech providers to trial and test their products before going to the wider market. “The key for regulators is not trying to overly regulate or control innovation but working with technologists,” said Sartorius.
Innovation needs to be ingested by the fund management community if it is to continue raising assets, particularly from technologically advanced next-gen or millennial investors. This investor demographic wants services delivered quickly, seamlessly and inexpensively, traits which the funds’ world have yet to perfect. Fintech – including the application of blockchain – is going to play a big role in allowing this happen.
