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Over recent years there have been many changes in the financial technology space. We have seen an explosion of FinTech debutants (such as Muse, Zopa, GoCardless, Tide, Form3 and Sonovate), offering new and exciting innovations and enhanced customer journeys. The promise of Open Banking has fuelled much of this innovation under the PSD2 directive, and now conventional banks are mandated to allow access to customer banking data.
We have also seen technology companies such as Marcopolo and Inviou seeking to imagine new solutions based upon Blockchain technology. Several digital banks have entered the market, providing slick customer journeys without the impediments of outdated legacy systems. Cloud computing and open APIs (Application Program Interfaces) have offered more agile deployment options to enable blended solutions by aggregating complementary technologies to provide enhanced services.
Many banks with ageing, antiquated core systems have sought to play in this space through partnerships, investments and internal innovation teams to disrupt from within - to challenge the status quo of usually conservative, slow-moving and risk-averse mindsets. Banks continue to face the challenge of complex in-house systems that are too deeply embedded to simply 'rip out and replace'. It is a ticking timebomb for many as obsolete technology becomes increasingly problematic to support and develop. Regulators require these institutions to have stable financial systems. Notwithstanding regulation, the reputational damage of system outages or security breaches is a constant worry.
We have also seen banks and investors wager on early-stage technology businesses with seductive growth stories and much promise. There has been a speculative mood buoyed by confidence that some, if not all, of these businesses, will succeed. We have also seen changes in the established software provider space, with several mergers and acquisitions as companies seek to consolidate markets. On-premises, upfront licence models have been superseded by the provision of software on a subscription basis, with Software-as-a-Service (SaaS) now becoming the market norm.
Additionally, the implementation of the General Data Protection Regulation (GDPR), coupled with heightened cyber-security attacks, has created new pressures on all businesses, with data leaks of confidential information attracting extensive financial penalties. Criminals seek to extort financial rewards by exploiting vulnerabilities to steal data or blackmail organisations using ransomware or impairing online services through denial-of-service attacks. According to Accenture's State of Cyber Security Report 2021, cyber-attacks increased by 31% in 2021, with an increased share of IT budgets directed towards cyber security investments.
Hardening regulation and increased data security concerns have led to mandatory ISO27001 and SOC-2 compliance for technology providers seeking to serve the financial services sector. Financial institutions can ill afford to put their reputation and security in the hands of suppliers that do not attain the highest levels of security compliance.
With the COVID-19 pandemic and the macro global instability brought on by war in Europe, the only thing certain right now is uncertainty. With inflation at unprecedented levels and the forecast of recession, the global economic outlook looks bleak. The financial services sector, and the technology providers that serve it, will be stress-tested to new levels over the months and years ahead.
With so much change, what lies in store? What are the future trends we are likely to see, and what could be the consequences of technology decisions in the current climate?
FinTech: record highs and record lows
According to a KPMG report titled the 'Pulse of FinTech', a total of $210 billion of investments was recorded in global FinTech in 2021. In previous years the market has been hot, and valuations have been high as investors have competed to deploy a seemingly limitless volume of capital.
Many tech entrepreneurs have come into the financial technology market with new ideas to bring disruption, and several fledgling businesses have been successful. Raising money from investors has been relatively easy, as businesses focused on growing revenue over profits, with compelling growth stories to fuel investors' appetite for future returns.
However, investors' attitudes are changing - and not only due to the current economic climate. Currently, there is a significant amount of vapourware in the market or business concepts that refuse to achieve scale. It has made investors savvier about the market as they scrutinise potential investments more closely.
When considering the macroeconomic and regional factors, confidence is low for new market entrants. A Financial Times article from July 2022 reported an average 50% drop in the share prices of recently listed FinTechs, effectively wiping out $500 trillion from the valuation of once high-flying financial technology companies. Additionally, the cumulative market capitalisation for FinTechs has fallen by $156 billion in the first six months of the year alone.
Recently, payments company Stripe marked down their share price by 28% - a decision which saw $21 billion wiped off the company's valuation. Last valued in March 2021 at $95 billion, Stripe was valued at $74 billion in July 2022.
The market will bounce back, but weaker or underfunded technology firms may struggle to survive as cash reserves are consumed, with no clear sight of sufficient revenues to balance the books. We have already seen banks bailing out fledgling partners to protect their commercial interests. Making the right technology choices will be challenging with so much volatility.
Banking on the Network Effect
Many FinTech entrepreneurs have shied away from the need to create profit-generative business models and instead seek to create value through data acquisition and market penetration - getting as many customers as they can onboard, even if it means effectively providing their technology for free. The network effect is everything.
The value is not in how much money they can make from the technology or service but in the value of the network, connections, and the data it generates. Founders' and early-stage investors’ value is realised later when the business is sold, with the acquirer seeking to leverage the customer base for another purpose or by monetising the data in some shape or form.
Such a strategy is perfectly valid, but what if the customer base is more challenging to grow and, despite all the efforts, the business depletes its cash reserves and is unable to raise more funds? Businesses fail when they run out of cash, it doesn’t matter if they are good or bad. No doubt some contenders in this battle for customers will run out of steam, but which ones?
Software and technology: buy, build, buy-now or hybrid?
The pros and cons of the build or buy argument are well documented, and there could be a case or rationale for either option. That said, building fantastic software takes time, money and skilled engineers supported by good domain knowledge. As many reading this article may be aware, there is an unprecedented skills shortage in the technology space. Inexperienced or average talent will give you an average product, and attracting and retaining the best talent in this space is costly.
While not a new concept, we have recently seen some lenders go the route of buying or investing in FinTechs. Whether to bail out, take control of the development roadmap or for other reasons, lenders must manage these relationships closely as software can be presented superficially and with little substance beneath the surface. Once committed, there could be a significant expenditure of time, resources, and cost if the software is incomplete, lacks robustness or has an absence of any tangible delivery.
Conversely, for FinTechs there is the issue that if a bank invests in them, they could derail their direction or impede the opportunity to sell to other banks or financial institutions. Would any business buy technology from a vendor if that has the potential to expose their customers, intellectual property, or inner workings to a competitor?
There will be a growing trend and a gearing up towards a hybrid approach that brings reimagined financial solutions to life through Open Data, Open Partnerships, and Open Systems via APIs.
Effectively this hybrid model couples the benefits of high-quality technology, with customisable user journeys, built to the banks’ specifications and fully integrated with new and legacy systems. It allows lenders to have greater control over security and how the software is updated and maintained, secured on tried and tested solutions with ongoing support. The hybrid model also offers the benefits of the right functionality for a solution - much faster and at scale - while keeping resources and costs in check.
For lenders, the key will be working with stable partners who have a vested interest in the success of their technology and have a clear product roadmap - ensuring their solution is consistently updated with fixes, features and new functionality. Unproven or unwritten software runs the risk of hitting obstacles that can derail the investment. Is the software robust? Can it scale to deal with the required volumes? Will it meet the current and future regulatory and security requirements? Will the software be successful and generate investment with a strong cohort of customers?
Emerging technologies are the future, but which ones?
The technology sector will always have a degree of hype around emerging technologies, often portrayed as game-changers that will revolutionise the financial markets. Blockchain is an alluring technology that has received much attention over recent years, with the promise of decentralised, trusted networks offering a single point of truth. It began to receive attention with the invention of the cryptocurrency Bitcoin, which has existed for more than ten years. In the world of finance, there have been numerous projects launched that use blockchain as the underlying technology with limited success.
The consortium we.trade, based upon IBM’s Hyperledger, sought to revolutionise trade finance. Although it was supported by 12 European banks, it struggled to gain traction and ran out of cash earlier in 2022, having failed to raise sufficient investment. It reportedly lost $8,6 million in 2020 alone, no doubt consuming tens of millions of dollars in its short existence. Several other blockchain initiatives have failed or are likely to fail, with vested interests and competition being a barrier to standardisation and interoperability,
That said, trade finance is heavily paper-driven and ripe for digitalisation. The recent Digital Negotiable Instrument initiative (DNI), pioneered by the International Trade and Forfaiting Association (ITFA), has recently driven changes to English law. Previously, paper-based instruments, specifically promissory notes and bills of exchange, may be exchanged digitally - in the UK, Lloyds Bank was the first to complete a transaction using a digital promissory note. The concept of electronic payment undertakings (ePU) has an exciting future as it combines technology under an open and legal framework.
The financial sector is eager to experiment and take risks regarding emerging technologies. But lenders and investors need to be cautious and remember the proverb, "all that glitters is not gold."
There are incredible opportunities currently being explored in the financial technology space that seek to create solutions which speak directly to a customer's needs. There will always be challenges to gaining adoption, and the future is likely to progress through evolution rather than revolution.
Article written by: Kevin Day & Iain Gomersall
First appeared on: TRF News