Is Fintech finally growing up and becoming part of the mainstream technology contribution to financial services, or is it still the disruptive child seeking to impose its concepts of innovation on an outdated and unwieldy industry? More importantly, can it be profitable?
Like with so many things it depends who you talk to. But at a roundtable debate in London I attended (under Chatham House rules so none of the protagonists could be identified) the clear majority of a wide cross section of mainstream bankers, Fintech disrupters and experienced industry watchers gave the impression that financial technology innovation is entering a new phase of maturity. And with it, raising fresh concerns about its ethical and moral direction.
This was echoed in a timely speech yesterday by the governor of the Philadelphia Federal Reserve Patrick Harker, who said it was time for Fintech firms to start embracing regulation. In fact he said that these start-up firms should actually want to be regulated as this would not only build trust in their products and services, but would avoid the potential for more penal retrospective regulation.
He said the explosion of investment in Fintech since the 2008 crisis meant that this segment of the industry had yet to experience a reversal or downward cycle. At some point he said “Trust will be shaken,” adding “What Fintech outfits don’t want is regulation that comes in after a crisis. That type of regulation almost always fights the last war and that could mean tighter strictures and less room for innovation after the crash at the end of a credit cycle.”
Our London debate also heard that Fintech needs to continue to have a serious business case to survive. As one pointed out, “The low-hanging fruit for Fintech’s is cost reduction. But once that is achieved it becomes a zero sum game.”
The example of High Frequency Trading was cited by some as at such a crossroads. “So long as there was money on the table the HFT’s used technology to take it, for the benefit of themselves and their customers. Now that everyone who is interested in this space has caught up the zero sum game has begun.” It was pointed out that many HFT’s are now turning to Big Data and analytics as means to generate Alpha due to meeting the law of diminishing returns.
However, by conceding that they are now moving over to compete with hedge funds, who already lead in this space, it is expected that natural competitive forces will prevail. As another suggested, this was the case with the Oakland A’s baseball team as chronicled in Michael Lewis’ “Moneyball.” They had one season of glory (well near-glory as they lost in the World Series final) before everyone else caught on to the analysis they were using to differentiate themselves and afterwards it was once again a level playing field.
So how do so-called new technologies like Big Data and analytic capabilities continue to deliver the “mousetraps” the industry leaders need to stay ahead? Is there still a business model for genuine capital creation, or is it just dog-eat-dog? There were real concerns that the combination of Big Data and ever-more sophisticated algorithms and analytics are merely creating a future that they will be front-running themselves in what will become a self-fulfilling prophecy. “Is it really predictive analytics,” asked another, “Or just a matter of cause and effect.” I have to say there was healthy cynicism throughout the room and no gratuitous fawning at the feet of newly-funded start-ups.
The discussion shifted to insurance and more concerns were immediately expressed that an industry founded on the principle of mutualisation of risk could be seeing its very business model threatened by the rise of Big Data that seeks to use machines to become ever more discriminatory in the way it deals with customers. “Markets benefit from non-discrimination. Good drivers subsidise bad drivers, that’s the way these markets work,” said one. “But the more insurance starts to break into behavioural analysis, the more it risks becoming more discriminatory and exclusive. This would not be a healthy departure.”
Of course the use of AI and machine learning can bring specific and tangible benefits to banks, particularly when we get back to the focus on costs. Likewise in areas like trade finance, which is still awash with paperwork, greater automation and the potential injection of DLT/blockchain could produce significant future gains. However, there were widespread concerns that there is too great a rush in some areas to use robotics and predictive analytics to replace human capabilities.
One speaker from a major IT vendor said that, because of those concerns, they had shifted from using “predictive” capabilities and described them rather as “cognitive”. By doing this they believe they acknowledge the wider social and ethical considerations and position AI as being a complement to more effective human decision-making rather than an alternative. But it is not a universal stance.
“While it is great to be able to augment the cognitive capabilities of humans with Big Data,” said one “there is strong evidence that many financial institutions are jumping at the opportunity to employ Bots to reduce headcount.” No signs of moral scruples there when it comes to saving money.
The focus shifted to Fintech’s younger cousin, Regtech, which several saw as now being the primary focus of investment in technology innovation. Again the costs imposed on banks by recent and forthcoming regulatory initiatives were seen as the main driver for adoption. But there were questions raised as to whether the benefits that are created by either Fintech’s or Regtech’s are being passed on to customers.
The question was asked as to whether a lot of this “innovation” was rather designed with regulatory arbitrage in mind, so as to develop ways to circumvent new rules – or at least maximise the gaps from inefficiencies and contradictions inherent in many of them. Which, rather nicely, takes us back full circle to what the Fed’s Harker focused on in his speech last night.
Some said that this is likely to be more of a US problem than one for the UK or EU, as the more prescriptive nature of US laws meant that there was more traction for regulatory arbitrage to exploit. Whereas on this side of the Atlantic, the adoption of a more principles-based approach to financial rules means that there was “more wriggle room” for both banks and regulators to establish best practise, but not avoid the implications of it.
According to KPMG, global investment in Fintech dropped back to $24.7 billion in 2016 from a staggering $46.7 billion the year before. Perhaps that shows investor enthusiasm is waning, or perhaps just a new realism that Fintech is not the holy grail some portray it be. Either way, it certainly shows it is going to be tough to deliver a return on the more than $100 billion wagered in recent years. I am sure those deep pockets don’t believe it is turning into a zero sum exercise.
And finally, yes blockchain did get a mention. But the consensus was that both Blockchain and the Crypto currencies that are driven by it will remain firmly on the fringe until they prove their ability to scale and meet the challenges of real markets instead of theoretical ones. As one said, “For now Bitcoin is about as much legal tender as a Scottish pound note.” I am sure that one went down well north of the Border, where they might need a new currency in the not-too-distant future if some protagonists get their way. Deep fried Mars bars anyone?