Fintech underpins the 4th industrial revolution

In the November edition of Finance Monthly, Grow Advisors explained how the fastest growing application in fintech today is online lending. In this month’s edition they highlight some discussion that took place at the 2016 World Economic Forum in Davos, including fintech’s important role in the 4th industrial revolution.

Just days ago at Davos, the WEF sent out a message that resonated strongly with fintech.

“We stand on the brink of a technological revolution that will fundamentally alter the way we live, work, and relate to one another. In its scale, scope, and complexity, the transformation will be unlike anything humankind has experienced before. We do not yet know just how it will unfold, but one thing is clear: the response to it must be integrated and comprehensive, involving all stakeholders of the global polity, from the public and private sectors to academia and civil society.” Klaus Schwab, Founder and Executive Chairman, World Economic Forum

Relevant topics of today, including the Internet of Things, Robotics & Artificial Intelligence, Big Data and Mobile Telephony will play increasingly significant roles in fintech and the next generation platforms.

Previously we looked at different verticals targeted by fintech in the context of innovative start-ups arising out of the 2008 global financial crisis. Most notable were crowdfunding, peer-to-peer loans, digital payments and robo-advice. Today the context is wider, finance is changing and so is almost every other sector. The disruptive context discussed at Davos was supported by world leaders and business champions alike.

At the outset, let’s first define fintech, a buzzword which covers a vast area. Fintech is perhaps best defined across two strands, as follows:

Emerging fintech – disruptors with small innovative firms disintermediating incumbent financial services with new technology.

Traditional fintech – facilitators with larger incumbent technology firms supporting the financial services sector.

Innovation of course transcends both strands. Start-ups such as Lending Club, TransferWise and Klarna fall into the first category; others such as OpenGamma, FundApps and Suade Labs, in the second. Generally start-ups in the first category seem to be getting more airtime. However, though both disruptors and facilitators make up the fintech sector, it can be argued that the divisive line between the two is slowly thinning.

Finding your place in the fintech ecosystem

Startups who start as ambitious disruptors increasingly discover that in order to scale, they must accept a transition to facilitator. B2C wealth advisors like Nutmeg in the UK, who initially lambasted high fees embedded in traditional fund management, were seen accepting investment and partnership from Schroders, a traditional fund manager. Several wealth manager startups followed a similar route. Or peer-to-peer lender Lending Club, who initially built a technology to dis-intermediate banks, accepted a $150M lending facility from Citigroup. Funding Circle, who also built a technology to remove banks from business lending practices, pioneered referral agreements with traditional lenders such as Santander, to accept and review non-qualifying loans.

“The examples illustrate the symbiotic and essential relationships between the disruptors and the disrupted. Everyone is looking to establish their position in the ecosystem”.

Further, incumbents understand that new age technologies are not necessarily going be developed in-house, but in part engineered in innovation laboratories outside of traditional financial services. Goldman Sachs seem to be an outlier, with Lloyd Blankfein recently admitting that financial services giants will have to ‘try to disrupt [them]selves’ in order to remain competitive, and we see this in Goldman’s investment in a white-labelled peer-to-peer business lending platform. Others less brave such as Barclays, opt instead to set up accelerators or in the case of Santander Innoventures, venture capital arms.

Whatever method incumbents choose to disrupt themselves, it is clear the relationship between startups and incumbents is increasingly inter-reliant. We would argue each give the other a raison d’être.

Not everyone shares that view. While it is easy to discuss paradigm-shifting crowdfunding, peer-to-peer lending, digital payments and robo business models, scrutinised as part of the wider financial services landscape, these remain relatively small. However, what we do see is incumbents taking note.

“On the road to financial transformation, these sectors are setting the trail, with commercial and business models replicated across other financial services”.

What’s driving the change?

More than challenging a few business lines within traditional financial services, these startups are challenging a status quo in financial services. A status quo that has created a disenchanted and distrusting generation of consumers asking for more transparent and accessible financial services.

The 2008 crisis sowed the seeds for disruption in financial services. While regulation is often seen as the source, having forced financial institutions to replenish their solvency base and exit costly and less manageable business lines, it is certainly not the only driver. Globalisation and advancements in digital technology have been rightly credited as important drivers, with the former often enabled by the latter. Yet, perhaps the most interesting cultural phenomenon is that we have a customer demographic that is so disenchanted with traditional services that it is (literally) building its own.

“Not only is this an age of financial disruption, but an age of financial empowerment”.

What happens next?

The result is that incumbents have witnessed an attack on their value-chains spearheaded by individuals empowered with the tools to do so and who see an opportunity to significantly enhance the chain itself. Most individuals have honed-in on particular pain points along the value-chain, and thereby created cost-efficiencies by linking services and features together using APIs.

Parts of the value-chain have been, and continue to be broken down into stand-alone units, becoming areas of specialisation for fintech startups, creating a healthy competition for the parts or links. The market for each link is not yet perfectly competitive and over time we will see winners emerge.

What remains to be seen is whether financial incumbents will be stripped down to their bare minimums, retaining only those parts of the value-chain required to run their day-to-day operations. The telcos faced a similar predicament in the 90s and continue to do so today. In such an environment, financial institutions would have a plethora of partners, with various non-core parts of the value-chain, be it in back office, middle office, legal or compliance, outsourced to specialist providers, very likely SaaS companies. At Grow Advisors, we are already advising clients on how to leverage this shift in business strategy.

In recent years, the greatest rewards of digitisation that have taken place in the value-chain are those that are de-facto data-driven. Successful fintech companies in credit scoring, loan underwriting and risk-based wealth management exist all around the world and the reasons for this are clear. Where data needs to be analysed in accordance with a set of strict rules and protocols, computers can iterate infinitely times faster than humans. And in an environment where customers value speed and delivery above all else – sometimes even cost – this becomes even more crucial.

It would certainly be interesting to see digitisation in less data-driven areas of financial services. Yet we are still probably some years away. To think about digitisation in areas such as M&A (where the client delivery is highly project-based and deal-specific) or Discretionary Asset Management (at the institutional level, where the ‘discretionary’ element typically involves acting on human investment views) would require a longer study. On the surface, even M&A projects involve highly formulaic, data-driven valuation methods, and certain areas within asset management are in fact risk management functions (take the ALM function of insurance companies) use protocol-driven methods to manage duration risk using data. While it may be foolish to believe technology can totally revolutionize financial services, it is equally foolish to believe that it will not. What we are seeing is an evolution, a natural progression, and the impact will be long lasting. The winners will be those who embrace change open-mindedly and conscientiously.

We’re positioned to enable change.

These industry developments give rise to the need to inform, enable and help change in the marketplace. As Klaus Schwab stated, the transformation will be unlike anything mankind has seen before. Finance and financial services will play a central role in transition and only by doing so will it live up to the expectations many in the industry have. To deliver the services required by an increasingly online world will require collaboration, openness to change and the foresight to invest now.

As a global pioneer and leader of digital finance, The Grow VC Group is championing an industry-wide awakening and acclimatisation of disruption in financial services. Our consulting and advisory unit Grow Advisors offers professional services aimed at fostering and growing the use of digital finance around the world. From funding solutions to marketplaces and co-investment models, we help disruptors and incumbents alike, to set business strategy and deliver technology solutions.

Grow VC Group and Grow Advisors were both recipients of Finance Monthly fintech firm of the year 2015.

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