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FINTECH

Technology has long been the engine driving capital market efficiency—both for investors in the markets, and for the capital market infrastructure providers (CMIPs) that operate the exchanges and other trading venues, central counterparties, securities depositories, index providers, and data and analytics companies.

 

More lately, fintechs are bringing new technologies to market even faster and with a greater impact. Hundreds of fintechs are focusing their development on capital market infrastructure (CMI), and while CMIPs recognize that fintech will have a significant influence on the industry, many remain unsure of which technologies to adopt and to what degree, and how best to engage and interact with fintech companies.

 

The role and importance of CMIPs in the markets has grown in the past decade—along with their revenues—owing to changes in the regulatory environment (for example, a push toward mandatory central counterparty clearing of over-the-counter derivatives or ever-increasing reporting requirements), in the investor landscape (for example, a higher profile for buy-side firms) and in customer behavior (for example, an increasing call for data and analytics solutions).

In the coming years, many CMIPs will seek to protect their businesses, and achieve even higher levels of efficiency, service provision, and growth, through innovation and adoption of new technologies, some of which may prove revolutionary. These technologies will come from current technology leaders that tailor their services to CMI applications, from firms’ internal development, and from the new generation of fintechs.

Although growth in fintech investment across the broader financial services sector has slowed since 2015 due to investor caution over a more uncertain macroeconomic environment, the growth trajectory of CMI fintech has remained steep, and likely has yet to reach a peak (Exhibit 1).

 

We have identified four fintech themes shaping the CMI value chain. Some of these themes increase productivity and lower costs, while others generate new sources of revenue:

  • The use of advanced analytics and artificial intelligence is set for rapid growth, as the amount of available data circulating through capital markets grows, and amid increasing interest in the application of advanced analytics to market, financial, and economic data.

  • Distributed ledger technology is applied to a range of CMI operations. Use cases include clearing and settlement, alternatives to the traditional markets for access to capital (initial coin offerings), and new digital markets.

  • Fintechs will bring greater efficiency through innovative technologies such as cloud and quantum computing—for example, in the sphere of matching technologies—while driving depth in traded markets and expansion toward new asset classes.

  • Post-trade services will gain in productivity through the application of automation and robotics. A separate branch of regulatory tech firms will bring efficiency and uniformity to risk management and regulatory reporting.

To date, the fintechs most active in CMI are smaller start-ups.1 Most are developing products as components within the CMI industry, and appear to be mainly interested in working together with existing providers, rather than in poaching their customers. Still unclear, however, are the interests and intentions in CMI of the global tech giants, and whether they might venture into the core of the industry at scale. Given their great capital resources, deep data pools, and world-class analytic capabilities, their entry could significantly change the CMI landscape. Most CMIPs believe that it is either these tech giants or incumbents working with fintechs who have the greatest disruptive power (Exhibit 2).

 

Respondents to a survey of the membership of the World Federation of Exchanges (WFE) were largely positive about the potential of fintechs, and were unanimous in expecting enhanced productivity or new revenues from incorporating their technologies in their businesses. None saw fintechs as a threat, but instead viewed them as potential partners and enablers of growth. They acknowledged, though, that the extent of the impact is difficult to ascertain.

 

CMIPs follow various routes to bringing fintech into their organizations. Some firms surveyed reported relying on more than one, depending on their view of the size and importance of the opportunity (Exhibit 3):

 

  • Development of internal capabilities. Most of the survey participants have established one or more internal groups dedicated to studying the global fintech landscape. Only a few indicated they were aggressively developing new technologies themselves, as this is a resource-heavy approach.

  • Collaboration and joint ventures. Forty percent of the WFE members surveyed believe that collaboration is the most efficient approach to fintech, followed by joint ventures at 25 percent. The primary reason cited is a shortage of resources, inhibiting the development of their own solutions. Moreover, the speed of innovation is rapid, and diverse talents are needed for internal development.

  • Minority or majority financial investment. Of the 46 WFE members surveyed, 11 said they are investing in fintechs through minority stakes, while 10 said they use majority investments (multiple choices were allowed). Most innovations may fail, but one or two are likely to become success stories, WFE members said.

  • Outright acquisition. Just 9 percent of survey participants cited acquisition of fintechs as the most effective approach.

The fintech landscape is evolving at an accelerated pace, as new firms and innovations enter the market while others drop out, and ideas are rapidly developed and deployed. One approach to a successful CMIP fintech strategy calls for a “portfolio of initiatives”: incumbents invest in multiple fintechs of different sizes, time horizons, and objectives—some with a short-term focus aimed at enhancing the core business, and others with longer-term objectives based on a smaller number of revolutionary ideas.

 

With so many fintechs in the market and more to come, a structured approach is essential to identify the technologies best suited to a CMIP’s strategy and operations. It is also important to determine which projects to develop internally or through reliance on fintechs, and what form the relationship and investment in fintechs should take.

Synergy and disruption: Ten trends shaping fintech

As the fintech landscape continues to evolve, a look at the newest developments from across the globe.

 

Fintech, the portmanteau of finance and technology, represents the collision of two worlds—and the evolution of the use of technology in financial services. Financial services and technology are locked in a firm embrace, and with this union comes both disruption and synergies.

Financial institutions are engaging with fintech start-ups either as investors or through strategic partnerships. Almost 80 percent of financial institutions have entered into fintech partnerships, according to Aura  Panorama. Meanwhile, global venture capital (VC) fintech investment in 2018 has already reached $30.8 billion, up from $1.8 billion in 2011 (Exhibit 1).

 

Average deal size is growing as well, particularly in Asia, where it is almost twice as large as the global average, due largely to a number of mega deals.1 The investing public is also enamored of fintechs: Zhong An made waves with its $11 billion IPO valuation last year, while Ant Financial is reported to be raising a pre-IPO round valuing the company at $150 billion.

However, the aggregate investment figures belie a more nuanced set of developments. “Fintech” covers a range of different models. We see four distinct variants, each operating in different niches, with different modus operandi (Exhibit 2):

  • Fintechs as new entrants, start-ups, and attackers looking to enter financial services using new approaches and technologies. These firms seek to build economic models similar to those of banks, often targeting a niche or particular product. The primary challenge for fintechs in this group is the cost of customer acquisition.

  • Fintechs as incumbent financial institutions that are investing significantly in technology to improve performance, respond to competitive threats, and capture investment and partnership opportunities.

  • Fintechs as ecosystems orchestrated by large technology companies which offer financial services both to enhance existing platforms (e.g., AliPay supporting Alibaba’s e-commerce offering) and to monetize current user data or relationships. Because of the very high level of engagement these technology platforms have with their users, they often have a tremendous customer acquisition cost advantage relative to other firms.

  • Fintechs as infrastructure providers selling services to financial institutions to help them digitize their technology stacks and improve risk management and customer experience.

 

We believe the future will develop in different ways for these varying types of fintechs, and that they will face very different hurdles. For instance, while infrastructure providers will often succeed or fail based on product or technical capabilities, consumer-oriented start-ups most commonly grapple with customer acquisition costs.

For incumbent financial institutions, the biggest hurdles relate to organization and skills as much as investing in technology at scale. Shifting traditional mindsets and operating models to deliver digital journeys at a start-up pace is no easy feat for a financial behemoth.

For established technology players entering the fintech ecosystem, regulatory challenges may prove a hurdle. The “move fast and break things” approach that disrupted the advertising industry is unlikely to be tolerated in financial services. And concerns about monopolistic behavior could well prevent Western tech giants from developing the sort of integrated financial services offerings we see from Ant Financial or Tencent in China.

To cut through the headlines and buzzwords that saturate the discussion of fintechs, we now take a closer look at current trends, and the implications for both incumbents and attackers.

Ten global fintech trends

1. High level of regional variation in fintech disruption

Winners in fintech are primarily emerging at a regional rather than global level, similar to traditional retail banking. Regulatory complexity within countries and across regions is contributing to regional “winner take most” outcomes for disrupters. Firms need to invest more in regional compliance rather than launching a global effort on day one.

For example, in money transfer, regulatory approval in a single EU country can be passported across the other EU countries. This encouraged many cross-border payments start-ups, such as WorldRemit and TransferWise in the UK, to expand into neighboring European countries before moving across the Atlantic, which requires additional regulatory investment. Individual US states require licenses for money transfer, which makes US expansion more cumbersome for European operators. This also explains why money-transfer operators in the US, such as Xoom and Remitly, were slower to come to Europe and are not yet operating in Asia as sending markets.

In China, where regulation has been more accommodating, ecosystems were formed by technology giants such as Ant Financial, which have directly entered and are reshaping many financial sectors including digital payments, loans, and wealth and asset management. In the US and Europe, which have stringent regulatory requirements and well-established banking offerings, efforts have been more fragmented and large technology players have been limited to payments offerings and some small-scale lending offerings.

As fintech markets mature, attackers that have established a regional presence are now eyeing international expansion. To successfully enter new markets, they must adapt to new sets of market dynamics and government regulations and select new markets based on a clear understanding of regional variations.

2. AI is a meaningful evolution, not a great leap forward for fintechs

The buzz surrounding artificial intelligence (AI) applications in fintech is intense, but to date few standalone use cases have been scaled and monetized. Rather, we see more advanced modeling techniques, such as machine learning, supplementing traditional analytics in fintech. While AI shows great promise, it is likely to be more of an evolution than a great leap forward into new data sources and methods.

For example, many credit underwriting attackers claim to use AI to analyze vast alternative data sources—ranging from mobile phone numbers to social media activity—but they have not yet displaced traditional credit underwriting methods. In many cases, traditional markers such as repayment history, are still better predictors of creditworthiness than social media behavior, particularly in markets where credit histories (and dedicated agencies to monitor them) are well established. As a result, while consumer lending platforms are increasingly incorporating iterative machine-learning approaches to steadily improve existing performance, they do not need to take a quantum leap in AI to do so.

At least in the short term, winners may not be characterized by completely new modeling approaches or the most complex algorithms, but by the ability to combine advanced analytics and distinctive data sources with their existing business fundamentals.

3. Good execution and solid business models can trump exotic technology

The most successful fintechs have evolved into execution machines that rapidly deliver innovative products, with dynamic digital marketing campaigns to match. Notably, winning start-ups often succeed without using completely new technology. Data-driven iteration, coupled with early and continuous user testing, has led to robust product-to-market fit for these firms.

While cutting-edge technology is exciting, it can also be complex; demand is also untested, which can result in long lead times with little opportunity to validate the business model. As an example, consider cross-border money transfer, a market that has traditionally been dominated by large incumbents such as Western Union. Despite much hype about fintech—particularly blockchain-based solutions—entering the space, no start-up has gained anywhere near the scale of TransferWise, a digital business built on top of traditional payments rails, rather than a reinvention using the latest tech. TransferWise used great user experience and distinctive marketing campaigns to grow rapidly, enabling it to successfully disrupt the space, and to report £117 million in revenues in March 2018.

 

4. Scrutiny of business fundamentals is increasing as funding grows more selective

Years into the fintech boom, after many highs and lows, investors are becoming more selective. While overall funding remains at historically high levels, technology investors globally are increasingly investing in proven, later-stage companies that have shown promise in attaining meaningful scale and profits. Data compiled by PitchBook show that despite a clear increase in total VC funding, investments in early-stage fintechs decreased by more than half from a peak of more than 13,000 deals in 2014, to around 6,000 in 2017. The bar for funding is quickly rising, and companies with no clear path to monetization are going to have a harder time meeting it.

Indeed, several well-known and well-capitalized fintechs have yet to develop a sustainable business model and may need to find a path to more meaningful revenues quickly to continue to attract capital. This is especially evident for challenger digital banks. Some have raised significant sums but still struggle to monetize their products effectively; others have not yet delivered a current account product due to complications around licenses and regulations.

Customer adoption of truly innovative business models takes time, and smaller-scale attackers may require heavy infrastructure investments over a long period before revenues start coming in. Blockchain start-ups, for example, are attracting a significant amount of venture capital with radically new infrastructures for payments and other sectors. However, incumbents remain cautious, with blockchain remaining in prototype mode—and the leap to revenue-generation has yet to take place.

 

5. Great user experience is no longer enough

Back when banks had cumbersome websites that didn’t render on mobile, it was easy for fintechs to win over customers by building a half-decent app with a great user experience (UX). Today, most financial institutions have transformed their retail user experience, offering full mobile functionality with best-in-class design principles. Great UX is now the norm. Customers, as a result, require more reasons to switch to new fintech offerings.

Robinhood, a US-based stock-trading fintech, simplified stock trading by offering zero commissions through its easy-to-use mobile app with solid UX. But first, it built its user base with free product offerings. It initially made money by investing users’ cash balances. In late 2016, the company launched a successful premium offering called “Robinhood Gold,” which added charges for margin and out-of-hours trading.

Simple interfaces, ease of use, and free stuff no longer equate to a viable business model. Attackers now need to find more robust ways to differentiate themselves from incumbents.

6. Incumbents can, and do, strike back

In general, incumbents were initially slow to respond directly to fintech attackers, perhaps for fear of cannibalizing strong legacy franchises. Many started by trialing digital offerings in non-core businesses or geographical areas, where they could take more risks. Retail banks have led the charge in upgrading digital experiences to match fintech in their core banking products. For example, Wells Fargo recently added a predictive banking feature that analyzes account information and customer actions to provide tailored financial guidance and insights, with over 50 types of prompts.

Goldman Sachs’ Marcus consumer lending franchise is perhaps the most high-profile push into digital by an investment bank. Marcus emerged as an unlikely entrant into consumer finance in 2016, but recently surpassed $3 billion in US consumer lending volumes.2 Goldman used established digital sales and marketing techniques to become a leading provider of consumer finance in a short period of time. It hit $1 billion in loans in just eight months while many competitors took over a year. Marcus’ success in the US led it to launch in the UK in September 2018, where it captured 100,000 customers for its savings product in the first month3 —further evidence that while technical innovation is important, a sound business model remains critical.

Other investment banks have focused more on robo-advisory services in their digital efforts. In 2017, Morgan Stanley launched Access Investing, a digital wealth management platform in the US with a minimum investment threshold of $5,000; the same year, Merrill Lynch (Merrill Edge Guided Investing) and Deutsche Bank (Robin) launched similar offerings. Vanguard was even earlier to react to the trend, using their existing brand and customer base to grow their offerings rapidly since launching in 2015; digital assets under management reportedly reached $120 billion in 2018.

7. More attackers and incumbents are partnering

An increasing number of incumbents and fintechs are realizing the benefits of combining strengths in partnership models. As they reach saturation point in their native digital marketing channels, many fintechs are now actively looking for partnerships to grow their business. They bring to the table their higher speed and risk tolerance, and flexibility in reacting to market changes. Larger ecosystem firms also bring broad and sticky customer bases from their core internet businesses.

Incumbent financial institutions are more cautious when it comes to partnering, especially in their core current account and mortgage products. But their large customer data sets, amassed over long periods of time, are highly attractive attributes for fintechs. Further, incumbents’ compliance and regulatory competencies can be highly valuable for newer, smaller entrants. We expect both partnerships and acquisitions to increase as a result.

A number of global banks are already on the partnership path. JPMorgan’s digital strategy includes recent partnerships with fintechs including OnDeck, a digital small business lender, Roostify, a mortgage fintech, and Symphony, a secure messaging app. In 2015, ING launched what it called “FinTech Village,” an accelerator for start-ups in Belgium, led by a dedicated head of global fintech. ING Ventures, launched in 2017, is a €300 million fund focused on fintech investing, and has invested in or partnered with a total of 115 start-ups over the last three years. In some instances, ING has built strategic partnerships with the companies they invested in, such as the automated online lending platform Kabbage.

China’s financial institutions tend to take a different approach, partnering with large technology ecosystem firms as opposed to smaller fintechs. Each of China’s “big four” banks4 has partnered with at least one ecosystem firm in 2017. Examples include a joint fintech laboratory launched by Bank of China with Tencent; and an agreement between China Construction Bank, Alibaba, and Ant Financial to digitize customer banking experiences.

 

8. Infrastructure fintechs: Potential is high, sales cycles are long

Like a giant tower of Jenga pieces, an enterprise’s legacy IT stack has many building blocks, some purchased off-the-shelf and some developed in-house. As in Jenga, removing or replacing “pieces” of the IT stack can be risky and complicated. Digital innovation is often hindered by legacy IT, particularly the core banking system (CBS), and the costs of changes are high.

Several CBS fintechs have emerged, seeing legacy IT issues as a golden opportunity for disruption. Like those providing “picks and shovels” to miners during a gold rush, they are not seeking to disrupt incumbents, but to build a profitable business by helping banks upgrade their technology capabilities in a modular, open-API world. Many financial institutions are evaluating replacing their core IT systems in the next five to ten years. However, for now, the CBS fintechs are finding business with smaller or newer banks. New10, the digital bank launched in the Netherlands by ABN Amro in 2017, used Mambu, an infrastructure attacker fintech, for their CBS.

CBS fintechs may face an uphill battle with larger institutions, given long sales cycles and risk aversion, particularly for something as important as core infrastructure. Large banks’ traditional procurement and onboarding process for new vendors or applications may present a challenge to newer fintechs that lack a track record and compliance rigor.

CBS fintechs are likely to continue, therefore, to target smaller banks or focus on non-core areas. This should allow the fintechs to prove their concepts and build their reputations, while fine-tuning their product offerings for larger customers.

9. There is a tentative return to public markets

As fintechs mature, at some point they must decide whether to go public. While both investors and employees require a path to liquidity, many fintech founder-CEOs have preferred to stay in the private market to avoid the burdens of public listings—as well as the batterings received by other fintechs that tested the IPO market.

Many peer-to-peer (P2P) lending fintechs—among the earliest to list in the US—saw valuations drop drastically in the public market. A number of Chinese lending fintechs that listed on the NYSE and Nasdaq in 2017 subsequently traded much lower than their IPO prices, driven by reports of bad loans and unfavorable regulations in China.

However, there are signs of a change in mood. Adyen, the Dutch payments fintech, listed in June 2018, and has seen its share price double. Funding Circle, the UK P2P lender, listed in October 2018. Despite the lackluster performance of the aforementioned Chinese fintech lenders, another Chinese P2P lender, X Financial, listed in September this year. With fintechs scaling and on the path to profitability, executives will have to balance higher liquidity and greater public scrutiny as they consider IPOs.

10. Chinese fintech ecosystems have scaled and innovated faster than their counterparts in the West

China’s fintech ecosystems are structurally different from their counterparts in the US and Europe. Outside China, the most successful fintechs are typically attackers that have focused on one vertical, such as payments, lending, or wealth management, deepening their core offering and then expanding geographically. In the US, for example, PayPal and Stripe focus mainly on online payments; Betterment and Wealthfront offer digital wealth management; and LendingClub and Affirm are alternative lenders—all proven strategies.

In contrast, in China, the most successful fintechs have been tech giants which have built financial ecosystems on the back of high-engagement consumer platforms (Exhibit 3). Ant Financial—built on the back of Alibaba's e-commerce platform—offers one-stop business-to-consumer fintech solutions, with products such as Alipay for online payments, Yu’e bao for investments from the Alipay wallet, MYbank for digital banking and lending, and many others. Similarly, Tencent provides a wide range of digital financial services on its pre-existing social platform.

 

These ecosystems have innovated and scaled rapidly. The technology giants that orchestrate them have access to enormous amounts of data to develop and refine their offerings (e.g., tailoring services to different user segments based on their lifestyle and habits) and can assess risk more effectively based on customer social media profiles (Tencent’s WeChat messaging app) or spending behaviors (Alibaba’s Tmall and Taobao e-commerce sites).

While there are comparatively fewer standalone players in China, those that are successful are by no means small. Fintech lenders Qudian and PPdai went public in 2017 and listed at $7.9 billion and $3.9 billion market cap at IPO, respectively.

Three trends will shape China’s digital financial services landscape. First, the large ecosystem players will continue to use technology and digital channels to roll out their financial services offerings, either by going direct-to-consumer or, increasingly, by providing white-label fintech-as-a-service offerings to small and medium-sized financial institutions.

Secondly, as in the West, we expect to see traditional banks and insurance companies investing heavily in digital offerings and leveraging their brands and existing customer relationships to fight back more successfully against pure digital players. Ping An is the most advanced of the traditional financial services players in terms of investing heavily in a range of digital offerings and beginning to create a digital ecosystem of its own.

Third, increasing government regulation will likely gradually weed out noncompliant or less competitive smaller fintechs. The government has tightened control in payments, P2P lending, and robo-advisory in the past year, and the trend is expected to continue. This could lead to further consolidation in the next one or two years—more good news for the large technology firms seeking to dominate the landscape.

Fintech has evolved considerably in the last few years and continues to change rapidly. Indeed, the trends outlined in this paper will likely give way quickly to new movements, as new winners emerge and existing leaders mature and diversify.

Fintech investors must be very selective in deploying capital, as we approach the possible endgame in this wave for some sectors and companies. With large technology companies knocking at their doors, incumbent financial institutions should proactively engage with fintech disruption, whether by building their own capabilities or by partnering or acquiring. For fintech attackers and infrastructure providers, the road to success is not easy. As the fintech markets mature, firms from the four categories of fintechs will compete directly in some cases, and join forces in others.

How the capital markets infrastructure industry is reinventing itself

The outlook for capital markets infrastructure firms is bright. To take advantage of the opportunity, providers need to step up services and tap new revenue streams.

 

Capital markets infrastructure providers (CMIPs)—the platforms, pipes, and plumbing of global finance—have been strong performers in recent years despite a challenging environment for capital markets and investment banking overall. CMIPs, which include trading platforms, interdealer brokers, clearing houses, information services and technology providers, securities depositories, and servicing firms, posted 3 percent average annual revenue growth from 2010 to 2015. Moreover, their future looks bright, with projected average annual revenue growth of 5 percent through 2020, outperforming both the buy side and sell side, which are expected to increase revenues by 3 percent and 1 percent annually, respectively, over the same period.

 

These findings are discussed in our new report, Capital markets infrastructure: An industry reinventing itself, which says the strong outlook for CMIPs is driven both by favorable market dynamics and by expansion into new service lines.

Among the market forces fueling the growth of CMIPs are rising demand for their services, increased scale, and more electronic trading. In addition, as the sell side has been hit with heavier capital and cost burdens, infrastructure providers have stepped in to offer more services and develop new relationships. The performance of the CMIP industry varies across both regions and sectors. Asia–Pacific posted 6 percent average annual gains in revenue from 2010 to 2015, while the United States recorded a 3 percent increase annually, and Europe, Middle East, and Africa saw just 1 percent growth annually. Among sectors, information and analytics services, technology infrastructure, and securities services saw accelerating expansion from 2010 to 2015, while trading (excluding Asia) and custody and settlement lagged. Clearing saw big gains in the Americas, following the introduction of mandatory clearing of over-the-counter derivatives.

 

Aura sees five key trends affecting CMIPs over the next five years:

  • Diversification into adjacent businesses. A number of firms have already diversified into alternative capital markets infrastructure businesses, helping the top 15 providers take a 41 percent share of revenues in 2015, compared with 35 percent in 2010. Larger firms are also expanding into post-trade and information and technology services.

  • The rise of the buy side. CMIPs are expanding services to the buy side (where revenues are growing strongly), while maintaining solid relationships with their sell-side client base. In 2015, the buy side accounted for 38 percent of global capital markets ecosystem revenues, compared with 30 percent five years earlier. CMIPs offer direct access in execution and clearing to the buy side, alongside a range of pre- and post-trade services. CMIPs are also in a strong position to leverage the rising popularity of exchange-traded funds, either through listings or data services.

  • Increasing demand for data and analytics. New technologies have created a revolution in the use of data and analytics, generating new products, greater efficiency, and higher margins. Data is increasingly “a golden resource” for CMIPs, and analytical tools that leverage data are set to create revenue opportunities across business models, asset classes, products, and services.

  • The rise of fintechs. CMIPs can leverage partnerships with fintechs to boost efficiency, drive innovation, and fuel growth. In the corporate and investment banking space, enabling higher levels of efficiency, rather than disruption or owning the client relationship, is the focus of 67 percent of fintech investment. As the sell side withdraws from some capital-intensive activities and legacy systems become obsolete, CMIPs and fintechs are stepping in and sometimes collaborating to create efficiencies and improve customer services.

  • Utilities as core service offerings. Financial-services firms increasingly recognize the benefits of sharing services that lack a unique value proposition. The cost efficiencies and risk mutualization offered by utilities are antidotes to the increased capital and operational costs arising from regulation, suggesting they are set to become a permanent feature of the landscape. Utilities deliver cost and efficiency benefits and can help catalyze technology upgrades. To capitalize on their opportunity to establish industry utilities, CMIPs must become technology leaders and reach sufficient scale to guarantee cost and service quality advantages.

In order to take advantage of the growth opportunities generated by these trends, CMIPs will need to leverage their strong financial positions to step up services and tap new revenue streams, either through targeted mergers and acquisitions or the introduction of new products and services. Their strategic initiatives should address eight key areas:

  • Strengthen their core business

  • Focus on new and fast-growing asset classes, such as corporate bonds

  • Capitalize on data and analytics to create new intellectual property

  • Provide integrated compliance and risk management solutions, to help clients meet their regulatory obligations

  • Create industry utilities for processes that aren’t differentiated, for example, client on-boarding

  • Expand service offerings for corporations in capital markets, for instance, pre-IPO advisory and investor relations services

  • Expand into new geographies through partnerships and new distribution networks

  • Establish an e-commerce trading ecosystem

Fintechs can help incumbents, not just disrupt them

While true for other financial services, it’s most striking in corporate and investment banking.

 

Fintechs, the name given to start-ups and more-established companies using technology to make financial services more effective and efficient, have lit up the global banking landscape over the past three to four years. But whereas much market and media commentary has emphasized the threat to established banking models, the opportunities for incumbent organizations to develop new partnerships aimed at better cost control, capital allocation, and customer acquisition are growing.

We estimate that a substantial majority—almost three-fourths—of fintechs focus on retail banking, lending, wealth management, and payment systems for small and medium-size enterprises (SMEs). In many of these areas, start-ups have sought to target the end customer directly, bypassing traditional banks and deepening an impression that they are disrupting a sector ripe for innovation.

However, our most recent analysis suggests that the structure of the fintech industry is changing and that a new spirit of cooperation between fintechs and incumbents is developing. We examined more than 3,000 companies in the Aura Panorama FinTech database and found that the share of fintechs with B2B offerings has increased, from 34 percent of those launched in 2011 to 47 percent of last year’s start-ups. (These companies may maintain B2C products as well.) B2B fintechs partner with, and provide services to, established banks that continue to own the relationship with the end customer.

Corporate and investment banking is different. The trend toward B2B is most pronounced in corporate and investment banking (CIB), which accounts for 15 percent of all fintech activity across markets. According to our data, as many as two-thirds of CIB fintechs are providing B2B products and services. Only 21 percent are seeking to disintermediate the client relationship, for example, by offering treasury services to corporate-banking clients. And less than 12 percent are truly trying to disrupt existing business models, with sophisticated systems based on blockchain technology, for instance (exhibit).

 

Assets and relationships matter. It’s not surprising that in CIB the nature of the interactions between banks and fintechs should be more cooperative than competitive. This segment of the banking industry, after all, is heavily regulated.1 Clients typically are sophisticated and demanding, while the businesses are either relationship and trust based (as is the case in M&A, debt, or equity investment banking), capital intensive (for example, in fixed-income trading), or require highly specialized knowledge (demanded in areas such as structured finance or complex derivatives). Lacking these high-level skills and assets, it’s little wonder that most fintechs focus on the retail and SME segments, while those that choose corporate and investment banking enter into partnerships that provide specific solutions with long-standing giants in the sector that own the technology infrastructure and client relationships.

These CIB enablers, as we call them, dedicated to improving one or more elements of the banking value chain, have also been capturing most of the funding. In fact, they accounted for 69 percent of all capital raised by CIB-focused fintechs over the past decade.

Staying ahead. None of this means that CIB players can let their guard down. New areas of fintech innovation are emerging, such as multidealer platforms that target sell-side businesses with lower fees. Fintechs also are making incursions into custody and settlement services and transaction banking. Acting as aggregators, these types of start-ups focus on providing simplicity and transparency to end customers, similar to the way price-comparison sites work in online retail. Incumbent banks could partner with these players, but the nature of the offerings of such start-ups would likely lead to lower margins and revenues.

In general, wholesale banks that are willing to adapt can capture a range of new benefits. Fintech innovations can help them in many aspects of their operations, from improved costs and better capital allocation to greater revenue generation. And while the threat to their business models remains real, the core strategic challenge is to choose the right fintech partners. There is a bewildering number of players, and cooperating can be complex (and costly) as CIB players test new concepts and match their in-house technical capabilities with the solutions offered by external providers. Successful incumbents will need to consider many options, including acquisitions, simple partnerships, and more-formal joint ventures.

Scanning the fintech landscape: 10 disruptive models

The range of models is breathtaking, and, drawing from my recent experience as a fintech entrepreneur, investor, and now advisor, I wanted to try and set out examples of ten models that demonstrate the range of possibilities in the space.

  1. New takes on old lending categories through fast/digital decision-making. This is perhaps the original fintech category, but it continues to expand and add new lending verticals. The now-public LendingClub with personal loans and OnDeck with business loans paved the way. Bread and Affirm are focused on point-of-sale financing, Square Capital’s focuses on merchant cash advances, Prosper and Avant offer personal loans, while SoFi has expanded from student loans to personal loans. Kabbage and Funding Circle seek to innovate in the business loan arena; Tradeshift is taking on supply-chain financing; BlueVine and Fundbox have built digital-first factoring companies; while Petal and Figure are focused on credit cards and HELOCs, respectively.

  2. Mobile-only lending as an example of underwriting innovation. Tala and Branch both seek to offer microlending over mobile devices in developing countries. The US-based companies make real-time loan decisions dynamically by using every piece of information they can gather from the customer’s mobile phone; public reports note that the companies use text messages, contacts, and hundreds of other data points to make underwriting decisions.

  3. Demographic-focused products. A new set of companies are developing demographically-focused products. They segment not only from a brand and marketing perspective, but from a product innovation perspective as well. For example, True Link Financial’s elder fraud protections, Finhabits’ saving focus for Latino’s, Camino Financial’s lending for Latino-owned small and medium size businesses, or Ellevest’s product design for women all go beyond branding to design products from scratch with unique use cases and features in mind. Similarly, Brex offers cards tailored individually for startups, for ecommerce companies, and (reportedly) for other small business segments.

  4. Digital-first neo-banks or digital attackers. Neo-banks frequently start with a blank sheet and build a retail banking experience from there. Aspiration, Chime, and Varo all operate now in the US, and there are reports that UK- based Monzo and Revolut, and Germany’s N26, are all actively seeking to come to the US. Some are layering lending on to their platform, while others plan to continue to focus on debit accounts. The success of these models is a sign that customers are responding to elegant design and customer experiences.

  5. Different fee structures built on digital infrastructure. Robinhood provides free stock-trading. To make money, they sell the retail order flow and seek thicker margins through digital first-processes (going so far as to build their own execution broker/dealer). Similarly, TransferWise offers its retail users the mid-market exchange rate—and makes money through transparent fees, made possible through lower operating margins at scale. Many of the above-mentioned neo-banks make money through debit exchange and deposit brokering—something which normally wouldn’t be particularly lucrative but which can make sense when built on greenfield digital infrastructure.

  6. API platforms and ecosystems. API platforms are designed particularly for software developers as the customer. Much of the financial services innovation in this space is concentrated in payments: Stripe, Braintree, Adyen, Credorax, and WePay are on the merchant-acquiring side, Marqeta is focused on card-issuing, and others like Ingo Money offer push payments. API platforms for lending are also emerging, most notably with the Kabbage Platform. 

  7. Bank-as-a-service. BaaS is a type of developer platform that is designed to empower fintech companies. To access the payments system and store money, all fintechs need some form of banking partnership. Some banks are turning this idea into a product. Several US banks are enabling digital attackers and neo-banks, gaining access to inexpensive deposits and a rich source of fee income in the process. Treasury Prime sells BaaS enablement software to multiple banks while SynapseFi (working with Evolve Bank & Trust) and Cambr (working with Lincoln Savings Bank) build API platforms for neo-banks through singular partnerships. At the same time, The Bancorp Bank, BBVA Open Platform, and Green Dot have all launched their own BaaS platforms.

  8. SaaS for bank cost reduction. A new wave of fintech companies are building infrastructure for banks and selling their software-as-a-service to reduce the cost and improve the quality of certain critical functions. Fintechs include Numerated, Blend, Roostify, and Finvoice for lending, Droit and Alloy for compliance, RiskSpan for data management, among others.

  9. Blockchain for infrastructure cost reduction. A new generation of blockchain firms are focusing on specific use cases to improve the cost and functioning of core infrastructure. R3, Symbiont, and Blockstream are all working on general solutions while The Interface Financial Group and ConsenSys are targeting supply chain finance, and Global Debt Registry and Securitize are focused on capital markets.

  10. The Wildcards: Tech companies in financial services. Banks are data and technology companies. Record-keeping and ledgering, transaction tracking, identity, and predictive modeling are all fundamental concepts in both banking and software engineering. It makes sense that many American high-tech, digital-first companies are turning their eyes to banking, just as their East Asian counterparts have done over the last decade. Apple’s launch of a credit card may represent a new phase for branded fintech experiences. The launch of shopping on Instagram and WhatsApp testing payments in India both represent steps by Facebook into financial services. Google Pay launching in India and conducting experiments in South East Asia show an increased focus in the space as well. All these products and more point to a more serious focus on fintech for those companies, who have the resources and partnership possibilities for scaled impact not only in international markets but in the US as well.  

 

With these business models and more, digital-first financial services companies are starting up more frequently, earning customers’ trust faster, growing rapidly, and raising more venture funding. At the same time, the space has matured—with fintechs frequently partnering more closely with banking partners or selling software directly to banks. In the coming months, Aura colleagues and I will publish more articles, videos, and other pieces exploring the dynamism of fintech and its implications for financial institutions of all sizes and types.

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