Protect Core Business, Modernize & Expand
Thus far, technological changes to CMI have been subtle and isolated, but incumbents must guard against shifts in the broader industry — including other incumbents incorporating fintechs, as well as large technology companies operating largely outside finance — that render established ways of doing business obsolete. Examples from other industries include digital cameras displacing an enormous industry for processing traditional film, or Internet streaming replacing chains of stores renting videos and DVDs. While the industry is not likely to face a Blockbuster moment any time soon, CMIPs must recognize the disruptive potential of fintechs and how they might reshape a CMI’s structure and value chain.
The technologies used by fintechs provide many opportunities for modernizing existing capital markets’ offerings through efficiency gains, higher levels of customer experience, and executing the current business in new ways. Cloud processing can generate savings over traditional internal information systems, automation and robotics built into trading, clearing; and settlement operations can lower costs and create efficiencies and DLT applications, which while still novel have definitely arrived.
Fintechs are generating many new ideas from which CMIPs can draw a range of new revenue sources. These include demand for products such as better-informed market analytics, trading in new asset classes, expanded algorithmic trading, capital and collateral efficiencies and risk mitigation.
Much of the current focus has been applied to existing processes and activities like the following:
1. Advanced analytics-based data: About 25% of CMI fintechs are active in this area. The availability of more data, and new and more efficient ways to mine and visualize it, results in more sophisticated products and greater demand. Among others, natural language processing and machine-learning techniques are being applied to develop more precise smart beta products for asset managers, and unique data streams for the sell side.
2. DLT for new market structures.
3. Regtech and risk management: Following the global financial crisis, the regulatory climate has become more complex, and banks and brokers are seeking compliance systems to handle order capture and post trade compliance. Asset managers, too, face a greater compliance burden.
4. Ecosystems: The wave of innovation by fintechs, and their willingness to partner with incumbents, creates opportunities to develop ecosystems where customers can access a wide range of services and products through one entry point.
Capturing the Fintech Opportunity
CMIPs have a significant opportunity to draw on CMI fintech specialists. But given the usual constraints on available investment and time, to fully capitalize on fintechs, CMIPs need to establish knowledgeable and committed teams and a framework for selecting fintechs that offer the best fit.
Investment should be approached in three steps: Ensure that leveraging a fintech solution is the best option, determine which type of technology creates the most distinctiveness and fits best with internal processes, and which is most sustainable.
For many CMIP firms, investing in fintech will be an attractive choice. An efficient and high-return approach to the fintech opportunity will require understanding the fintech ecosystem and building relationships, building internal capabilities, and finally partnering with and investing in fintechs. CMIPs can adopt many different approaches to developing relationships with fintechs, each requiring differing levels of commitment. These range from collaboration efforts and joint ventures to various degrees of investment (see “What works best,” right).
Working with startups can be challenging for large firms. Although the relationships can result in a positive learning experience, tangible products are often slow to materialize, frustrating companies accustomed to hitting predictable schedules.
Firms that can devote considerable resources to fintech may consider a corporate venture capital approach that invests in multiple targets, with the shared goals of leveraging their technologies and a return on financial investment. Such an approach, however, calls for still more specialized talent to properly manage the effort, and a more tolerant mindset toward the rate of success, or failure, of technological experimentation.
Fintech in capital markets has lagged its counterparts elsewhere in finance, and in some areas the technologies and benefits seem far off. But the level of investment in CMI fintech is gaining to the benefit of the early movers. Those incumbents that do not recognize its effect on their business, and fail to take a proactive stance, face a future that will be shaped by their peers and competitors. For investment in fintech, time is of the essence.
There are roughly 700 fintechs in various stages of development across the CMI value chain. An unfocused investment approach would be both unmanageable and expensive, and while fintech start-ups will not ultimately own the industry, over time, the typical CMIP will likely benefit from dozens of fintech innovations. Thus, fintech investments and partnerships must be chosen wisely. Fintech is not a strategy, but a means to reach strategic priorities.
This feature is a condensed version of “Fintech Decoded: Capturing the Opportunity in Capital” produced by the World Federation of Exchanges (WFE) and McKinsey & Co.