Are you curious about “fintech”? It stands for “financial technology” and it is the topic of many conversations at the moment. Fintech is more and more widespread and we are all using it to some extent nowadays.
Have you ever bought something online? The payment mechanism that you used falls under fintech. Have you heard about crowdfunding? That’s fintech. Have you used your phone to pay for anything? Fintech again!
So what has set the scene for fintech being all around us at the moment?
What economic changes are driving growth in fintech?
- The financial crisis pushed people and businesses to be much more price sensitive. As a result, traditional banking relationships weren’t taken for granted anymore. Just because a bank has earned your custom in the past, doesn’t mean that it will keep it forever. Customers are susceptible to new offerings: if they can get the same outcome for a lower cost, they’re switching.
- Many established players had internal problems: lack of lending stock to offer, exceptionally low risk-taking capacity, new regulatory parameters, overstaffing and reputational damage. All that was holding back their ability to operate functionally and to give the service that customers needed.
- Due to quantitative easing, there has been a huge amount of money looking for a new home. In order to kick-start the economy, central banks like the ECB have engaged in bond-buying programmes. Investors who held bonds had a choice to keep them, or to sell them to the ECB. They might then have chosen to reinvest the money in riskier assets and potentially in stocks. This money looking for investments boosted the stock market, but also resulted in lower borrowing rates – negligible even. As a result, large companies were able to borrow for practically nothing. This has had two outcomes: companies were able to buy back their own stock , thereby increasing the value of each share. Since borrowing was comparatively easy, and since there was little incentive in putting significant amounts of cash on deposit due to interest rates being at an all-time low, many companies have been looking for businesses to invest in. The fintech sector thus benefited from an influx of venture capital.
What social changes are driving growth in fintech?
- It used to be the case that you would open an account in the same bank that your father and grandfather used to bank with. That’s definitely not the case anymore. Today’s millennials don’t automatically think that their parents’ bank is going to be theirs too. Banks aren’t inheriting customers; they must work for them.
- Millenials have now “come of age” and a recent survey highlighted that a majority would prefer to go to the dentist than listen to what banks are saying. In fact, 1 in 3 Millenials is open to switching banks in the next 90 days, and 33% think they won’t need a bank at all.
- There has been a huge growth in the number of small businesses, particularly in the form of the freelancer who is part of the liquid workforce. This requires individuals and smaller businesses to make and accept payments and obtain financing – but the usual, heavy infrastructure of company financial services doesn’t fit their needs. They need something a lot lighter, and a lot easier to set up.
What technological changes are driving the growth in fintech?
- Fintech lenders have up to a 400-basis point cost advantage over banks. In other words, fintech lenders have up to 4% extra margin in their loans because they don’t have buildings, staff, distribution costs, etc.
- Fintech goes hand in hand with “Big Data”. Big data is shorthand for the trail of information that we leave when we do anything online. Computers today are incredibly powerful. They can “crunch numbers” in astronomical quantities. When you are able to compare trillions of data points about billions of people doing things online, you can see patterns emerge. The predictions based on these patterns are more and more reliable because the data points are numerous enough. In turn, predictive analytics yielded from big data offer immense potential to predict what a customer is likely to do next. This allows companies to suggest or offer services “just in time”, just when a customer needs them.
- People want to get queries answered today via Twitter, they are more likely to come across an ad on FaceBook than in the newspaper, they prefer to chat with a customer representative online rather than make a call to a data centre. Fintechs are much further ahead in this sector than banks and are “on the same page” as customers and their needs.
- Technology companies have adopted a “mobile first” mindset, as people are more likely to engage with any and every type of service on a mobile today than on a desktop.
- Project management has changed from waterfall to agile leading to “creative destruction“: there is increased innovation and a sort of “arms race” in the fintech and banking industries. Nimble startups can move much more quickly than large companies, because there are fewer people involved and virtually no bureaucracy. In a large company, any new project needs to be subject to a business case, to senior management buy-in and layers of decision making. So it seems that startups would have the advantage, as they can move faster and there is no need to make a case for innovating and moving fast to a group of people who, in a bigger company, might be very happy with the status quo. However, as startups eat into the business of bigger companies – and banks, in the fintech sector -, these big companies are forced to innovate in order to stay in the race and not become obsolete. Here, the fact that they are big plays in their favour: deep pockets, already established distribution channels, an existing customer base, specialist human resources, economies of scale, etc. So if big companies are willing to listen and avoid being complacent, they might benefit from the startups’ initial disruption, as well as the startups’ outcomes and mistakes. Much of the market is still untapped at this point, so it is difficult to predict who will come out the winner, but it’s certainly fascinating to watch developments in this area.
All of that said, much of fintech is seeking to achieve incremental innovation as opposed to disrupting existing business models. Indeed, there are companies that are trying to eat their competitor’s lunch, but the food on the plate is still the same. Take the example of peer-to-peer lending: the person who has excess money can lend it to another party through a trustworthy platform. In the past, this would have been fraught with difficulties, and banks were the go-to entity to borrow money. Now with fintech and, in that specific instance, peer-to-peer lending, anybody can be a de facto “bank” and lend money, and earn interest on it. This is the same value model as retail banking, but a peer-to-peer business is facilitating it in a different way.
What purpose does fintech serve?
Fintech has a very functional purpose: these facilities make life faster, easier and cheaper. A mobile payments app linked to my debit or credit cards removes the need to carry them around. A peer-to-peer foreign exchange facility reduces the cost of doing business abroad.
Blockchain dramatically increases the security of transactions and hence improves quality, reduces risk and delivers peace of mind (To find out more about blockchain, read this article or that article or watch this 2-minute video).
Big data informs suppliers of financial services about the aggregated actions of their customers, so that they can generate predictive analytics and offer more tailored, convenient services to users.
Cost comparison websites save time and simplify the process of going into each offering, finding what you’re looking for and then deciphering what’s best for you.
As a result, the growing customer demand for fintech services is likely to rise and rise, in the main. Let’s now look at two specific case studies of where fintechs are highly solution-focused.
Fintech Case Study 1:
ETFs in response to a lack of outperformance on the part of actively managed funds
This October 2016 article from the Financial Times describes how almost all US, global and Emerging Market funds have failed to beat their benchmark since 2006.
This has been a problem for decades now. Indeed, financial analysts and traders who are exceptionally well informed, highly educated and have access to all sorts of software can achieve gains higher than their benchmarks. However, these gains are not necessarily passed on to the owner of the assets: when you take the analysts’ and traders’ fee out, investors may be left with just the benchmark performance or worse. That fee can be a percentage of AUM (assets under management) and sometimes a percentage of the outperformance too.
Back in 1972, Vanguard asked a great question. Which is more important to investors: to outperform the market, or to make money? If it is the latter, what about simply delivering the benchmark return very efficiently for them? As long as they are making money, most people are happy to track the progress of the markets, and have little interest in constantly doing better than the markets. The “index fund” was born. An index fund is a fund of stocks that are held with a view to providing the investor with the market return.
An actively managed equity fund manager is paid a lot of money to find stocks that are offering particularly good value and/or are set to grow their earnings (and hence share prices) at a pace that is faster than the benchmark. They invest a lot of time, money and resources into doing so and are held to account (in terms of the return they got and the risk they took to get it) against that benchmark at the end of the period.
A passively managed equity portfolio manager is paid a lot less to buy the stocks that fit the index. There isn’t any research apart from finding out what stocks make up the index and the focus is solely on delivering this performance as efficiently as possible. They invest very little time, money and resources into doing so and are held to account (in terms of tracking error) against the benchmark at the end of the period.
This was the market’s answer to that problem!
In 1993, the next wave of innovation came, in the form of challenging another assumption. Why do investors need to buy a mutual fund in order to have access to index funds? What about listing these funds and letting investors buy and sell them directly?
The “Exchange Traded Fund” was born: a fund that tracks an index listed on an exchange.
An investor wanting to buy an index mutual fund needs to go through a financial advisor (and must select a fund only from what they can offer), who subsequently gets a commission for selling it. After filling out a range of forms, they take a unit of a fund. If they want to find out the value of this, they must wait until the market closes because it’s only valued once per day. They may have to leave the money locked away for a while or else pay early penalties if they want to cash in on the holding beforehand. On leaving, they need to fill out more forms and then they get their money.
An investor wanting to buy an ETF can do so directly, picking from the almost 7000 funds available, through their stockbroker who simply receives a transaction fee for executing the trade. There isn’t any form filling, the fund is priced continuously throughout the day and hence, the investor can check the value at any stage at all. They can sell at any time by executing another trade.
ETFs are much cheaper, transparent and more convenient than mutual funds.
This incremental innovation has been hugely successful as evidenced by the latest statistics at the time of writing:
(Note: ETP (exchange traded products) is an umbrella term to include ETFs)
- The Global ETF/ETP industry had assets of US$4.103 trillion at the end of May 2017
- ETFs and ETPs listed globally gathered record net inflows of US$48.26 Bn as of May 2017
- May marked the 40th consecutive month of net inflows.
- Year to date, a record US$283.91 Bn in net new assets have been gathered. At this point last year there were net inflows of US$91.45 Bn.
Fintech Case Study 2:
Roboadvisors in response to the ban on commission based selling
In 2012, the Retail Distribution Review banned commission based selling to retail investors. This followed on from a similar development in Australia and India. The rationale behind this made excellent sense.
If I’m sitting down with a financial advisor who has a range of products that they could sell me and one or two of them have a higher commission than others, then they’re naturally going to be incentivised to sell me that one. Therefore, a ban on commission based selling was introduced with a view to eliminating product bias.
- The RDR has initiated a move towards increased professionalism among advisers.
- The ban on third-party commissions has reduced product bias.
- Charges for retail investment products have been falling post-RDR
- The market is adjusting to offer advice which is more tailored to consumers’ demands.
- Those consumers who are receiving full advice now are more likely to be receiving better quality advice due to advisers being better qualified and the reduction in product bias.
However, there is one issue. Commissions have been replaced with fees and let’s think through the consequences of that. If I have capital of €10,000 and it costs €1500 for the full service of an investment consultation, then 15% of my capital is gone before I ever implement any of the advice.
“RoboAdvisor” was introduced as a method to offer smaller investors a low-cost method of obtaining investment advice: a RoboAdvisor is an algorithm that asks you to input the information you would give to a financial advisor (e.g. income, return objectives, risk profile questions, etc.), processes the information and then generates a portfolio. There is a range of traditional investment houses that offer this service now and a cost comparison analysis highlights the cost effectiveness of the offering. For example, a (comparatively) expensive RoboAdvisor would incur an annual fee of less than $20 per year on a $5000 portfolio and an inexpensive RoboAdvisor would incur a fee of $36.39 on a portfolio of $35000.
It’s natural to ask what returns the RoboAdvisors are offering and this is dynamically tracked at Senzu. In the same way that some active managers outperform the market and some don’t, as discussed above, the same can be said for RoboAdvisors. However, it’s important to mention that many of them simply hold a host of ETFs, so there is a huge drive towards cost compression in the entire industry.
At this point it is important to mention Mifid II (The Markets in Financial Instruments Directive): this new piece of regulation is going to be implemented in January 2018, after many drafts. It includes the following paragraph in Article 12:[blockquote style=”1″]Member States shall ensure that investment firms providing investment advice on an independent basis or portfolio management return to clients any fees, commissions or any monetary benefits paid or provided by any third party or a person acting on behalf of a third party in relation to the services provided to that client as soon as reasonably possible after receipt.[/blockquote]
(It’s interesting to note that this piece of legislation has been some time in the making – I’ve been keeping an eye on it since 2012)
In other words, a ban on commission-based selling is coming to Europe in a few months. There is growing interest in this sector with successful traction in the US market: Robo Advisers now account for 1% of the market and BI Intelligence projects that it could represent up to 10% of global asses by 2020. This is backed by a PriceWaterhouseCoopers report, highlighting the finding that almost half of wealthy investors under 45 not currently using Robo-services would consider using them in the future. It will be very interesting to see how these figures materialise and what happens during the next crash, when people want to turn to a person with their emotional reactions to the market and the computer says no…
How to get involved in fintech: 7 ways
As you can see, fintech is poised to change the way we transact money even more than it has already done. While today, we may see paying with our smartphones as innovative, there are many more momentous changes gathering pace. Now is a great time to get interested and involved in fintech. That being said, do you recognise yourself in one of the seven profiles below?
I have a fintech idea…
There are a range of programmes designed to welcome your idea, help you test and validate it, cultivate its progress and expose you to investors. For example, the NDRC and Enterprise Ireland can potentially present you with exciting opportunities!
I would like to read more about the area
McKinsey has compiled a range of thought leadership pieces in a comprehensive report, FinTechnicolour: The New Picture in Finance. This publication covers digital financial services, partnerships, Internet of Things, data analytics, banking on the cloud, machine learning, blockchain and much more.
I want to keep an eye out for the rising star companies
The Financial Times has an annual awards ceremony and the coverage of that can act as a proxy for what’s moving from marginal to mainstream. For example, in that report, I found that the US and China account for $9 out of every $10 invested in fintech, that Venture Capital investment in blockchain rose by 20% last year and the largest ever single tech funding round in history, valued at $4.5 billion, was to the payments arm of Alibaba.
I want to keep an eye on what’s under the radar
I look at BetaList as a good barometer of where startups interests lie. Given that the profiles of those listed are in beta testing mode, they haven’t been fully unleashed on the market and offer a keen observer a good insight into commercialised innovation, before everybody else sees it.
I might like to invest in a fintech business
There are a range of organisations now that act as a broker for investors and investees. One of the largest and well-known for equity in Ireland is the Irish Investment Network. Of course, there are peer-to-peer debt financing companies available now too including Grid Finance and LinkedFinance.
I’m in business and would like to find new opportunities in this area that dovetail with what I do currently
The Enterprise Europe Network is the largest business network in the world and has incredible capacity to bring companies together in synchronicity. They have a huge database of businesses with collaboration opportunities to offer to others as well as partnership events, like a large fintech event in 2016 in the Netherlands.
I’m interested in shaping policy
The European Commission has a facility to draw upon the views of experts when it’s designing policies evaluating proposals, monitoring actions as well as preparing, implementing or evaluating programmes and design of policies. If you register and are approved, this could lead to a paid contract.
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