Fintech represents the intersection between finance and technology.
Market participants may be providers of technological solutions that deliver innovation to traditional financial services companies, or they may be companies delivering innovative financial services offerings that disrupt the existing financial services market.
What unites Fintech players in the pursuit of modern ideas and business models to initiate the digital transformation to all factors of the heavily regulated financial services industry.
Today’s Fintech market has been characterized by a period of significant growth. However, it is, furthermore, a cramped space in which participants need to have a clear competitive edge to survive. As the market matures survival or failure can increasingly be ascribed to success in certain important areas. These are:
– Getting regulatory compliance right;
– Making the right partnerships at the right time on the right terms; and
– Driving adoption by ensuring an outstanding user experience.
Banks, card schemes and acquirers and payment processors are the traditional players in the payments landscape. New entrants focus on allowing the “friction” out of the payments process and include providers of mobile payments, contactless and e-wallets. Trends in this area include further developments with biometric identification, implementations of platforms using distributed ledger technology and broader use of big data to halt fraudulent payments.
One of the more progressive areas of Fintech to take off, insurtech is now gathering steam. Investment is being driven in particular by established insurers investing in new market entrants, and hot areas of technology include blockchain and smart contracts, data analytics and Internet of Things applications which can assist with risk identification and mitigation.
Cloud and big data have already rung the changes in the investment management industry but a recent change has come with the application of machine learning and artificial intelligence – and thereby the arrival of the Robo-adviser.
Crowdfunding (both equity and reward-based) has represented an established part of the early-stage company market, particularly for consumer-facing companies for which engagement with investors is all part of the spectrum of engaging customers. Platform-based tech has also facilitated the rise of syndication of early-stage investment, particularly in the angel market where a syndicate typically allows less experienced investors to co-invest with more established leads.
For many, Blockchain is the perfect example of the evolutionary power Fintech can have on process optimization. But Regtech is another subsector of the process efficiencies market to receive significant investment and interest. Regtech applications considered to save organizations time and money by automating processes to ensure regulatory compliance. They additionally offer the possibility of more accurate compliance efforts and better reporting to supervisory authorities.
Deposits and lending
Peer-to-peer or marketplace lending is the most prominent example of the impact of Fintech on deposits and lending. This part of the market has matured to show a particular interdependence among established players and recent entrants, with P2P lenders, for example, picking up the portion of the SME lending market in which banks, on the whole, had preferred not to participate since the financial crisis. P2P lenders have turned to established institutions in other ways also, such as by pushing out parcels of loans to hedge funds and other institutional investors through their online marketplaces (something that has arguably given P2P platforms broader exposure to the credit cycle than the “pure” P2P model).
Regulatory compliance is fundamentally important to Fintech companies and can obtain a key competitive advantage, but navigating the relevant regulatory regimes is a significant headache for many.
Most Fintech companies will have typically undertaken a comprehensive analysis of their business model against applicable financial regulation to fully understand what can be achieved without becoming a regulated entity, or, conversely, to help them seek proper licenses or approvals. However attempts to map regulation can be complicated by the fact that it can be very hard to properly assess whether innovative unique products fall within the regulatory regimes and if they do, how the various requirements might apply. This problem is compounded for Fintechs scaling internationally, where different regulatory approaches in other jurisdictions can create additional hurdles (albeit the UK’s “Fintech Bridges” initiative is one example of attempts to mitigate such problems).
Regulatory uncertainty makes business planning very hard, and indeed the financial and compliance cost of regulation has been sufficient to see some new companies exit the market. A clear-sighted assessment of regulatory risk is fundamental to Fintech’s ultimate success.
Dealing with data
Data is central to the business models of many Fintechs, whether they are focusing on retail or investment banking.
Companies that can derive business insights from financial services data can spot and enhance new opportunities and reduce possible risks. Unlocking this value is however dependent on far more than clever algorithms and exponential processing power. It is also essential that companies in this space build and properly maintain the trust of consumers and other stakeholders. As a result, key concepts of security and transparency are important industry principles in the Fintech sector – for both reputational and compliance reasons.
There is a significant regulatory activity in this area. Aside from the obvious legislative changes affecting data management and cybersecurity, such as the implementation of the new General Data Protection Regulation in Europe, a shift to open banking is a further complication on the data horizon. The new European Payment Services Directive (PSD2), the UK’s recent retail banking market investigation from the Competition and Markets Authority and the promotion of data sharing by the Monetary Authority of Singapore are all examples of how regulators over the globe are focusing on data as an effective way to bring change to the traditional vertically integrated banking model.
Such innovations need considerable sophistication from data owners and processors. To be specific, there is tension among the concept of open innovation as a route to bringing new players into the market, and the appetite for more control and ownership over data (as an important business asset). Intellectual property concerns, as well as privacy considerations, loom large here. The growth of new data handling models may also foster a “co-creation” environment in financial services where partnerships (eg JVs, strategic alliances, etc.) might be the perfect method to bring diverse parties together.
The development of innovative software and technology by Fintech companies has been crucial to the rapid growth in this sector. Legal protection for such innovation is integral to success in the Fintech sector, but the availability of adequate protection varies from jurisdiction to jurisdiction. While business methods were in the past believed to be patentable in the U.S., this has become increasingly difficult through recent case law.
In Europe, at the same time, they are per se unpatentable unless they can be indicated to solve a ‘technical problem.’ Given these difficulties, Fintech companies must consider carefully the availability of other IP rights, such as copyright and trade secrets, as well as protecting themselves through contractual arrangements with their customers, key employees, suppliers and/or other third parties.
A key challenge in areas such as blockchain is how to balance the protection of ideas and technology with the desire to encourage industry-wide adoption. Where there may be so-called “network effects” from the latest technology, the timing for seeking to register and/or enforce intellectual property rights is important. Done too soon and the risk is that innovation is stifled, left too late and it is possible to be locked out of the market by peers and competitors.
The importance of intellectual property to Fintech companies may also make them a target for patent trolls, which may cause business disruption unless the Fintech enters into licensing discussions or is prepared to fight a claim in the courts.
Collaborating, investing and acquiring to bring innovation into the business Many established financial institutions recognize the benefit that financial innovators are bringing to the market. Often financial institutions look to partner with emerging technology players to speed up the innovation cycle.
A fundamental question is what form that collaboration might take. The heat in the Fintech market is driving M&A as companies buy in technology and skills or combine with peers to build scale, but commercial collaborations are also a popular route to achieving these goals. Equally, corporate venturing may offer a way to connect with early-stage companies to assess potential technologies, exert a degree of influence on the future direction of the emerging company and be in a prime position to acquire or license technology if it looks to be shaping up well.
To make a success out of any of these transactions, both parties need to determine how to accommodate the objectives and needs of what may typically be two very different organizations. This relationship dynamic impacts deal negotiation, the due diligence process (including the all-important regulatory due diligence), and how the commercial aspects of the deal are structured.
Sources of funding
The environment for growth companies is changing. A rising number of private companies (and particularly “unicorns” – those with valuations of over USD 1 billion) have completed either more private funding rounds or larger private funding rounds (or both). This enables these companies to fund direct growth rather than capital investment from injections of necessary cash from private investors.
The group of potential investors participating in late-stage private company rounds has also expanded. This area is no longer solely the preserve of traditional venture capitalists; we are seeing sovereign wealth funds, asset managers and hedge funds, as well as corporate venture funds, participating in this section of the market. These investors are entering the market for reasons that range from straightforward portfolio diversification through to opportunities to spot and nurture emerging talent and key innovation to build research pipelines.
With more companies staying private longer, and with a broader range of investors operating in this segment of the market, how do companies decide which funding option is right for them? One key criterion is aligning the investor’s timetable for the exit with the company’s growth plans. Another consideration will be planning for a liquidity event in the future – whatever funding options are considered presently must not have the effect of making it harder to, for example, gain access to the public markets at a later date.