Appetite for disruption
Financial technology is upending supply chains and payment systems around the world, but has yet to disrupt major capital financing. Will it ever transform the primary capital markets?
Barely a week passes these days without a senior investment banker leaving for a financial technology start-up. With jobs less secure and bonuses down, it’s clear that many capital markets bankers see brighter opportunities in the fast-growing fintech industry.
“I see traditional banking being impacted by technology big time,” said Lesi Zuo, who left Standard Chartered at the end of June after a 20-year career in structured finance.
“The way of analysing risk absolutely has to change, and will change, given the capability of modern technology. It’s not because technology firms know how to do better, it’s because technology enables them to do better. That’s revolutionary in my view.”
Zuo, who plans to set up a new venture with funding from China’s Tencent Holdings, is not alone in swapping a career in Asia’s traditional capital markets for fintech. Duncan Phillips, formerly head of Asian debt syndicate at Citigroup, joined Ipreo, which develops software used in fixed income trading and bookbuilding. Huang Ho, former head of internet finance at China Construction Bank, joined Alibaba affiliate Ant Financial. Alex Ypsilanti, former head of quantitative and derivative strategies at Morgan Stanley in Hong Kong, has founded online wealth management firm Quantifeed. Around the world, other examples abound.
While interest is running high, the fintech revolution has yet to disrupt traditional capital financing. According to a 2016 report from Boston Consulting Group, out of roughly US$97bn in venture capital that has poured into fintech since the consultancy started tracking the data in 2000, only US$4bn has gone to companies engaged in the capital markets.
“The way capital moves will fundamentally change. It’s just a question of time. Regulators are worried about participants in some of these new platforms, but they will eventually get comfortable.”
Most VC investors still seem to be chasing their ‘Uber’ moment, as the Boston Consulting Group puts it, in other words upending the finance markets altogether. This has led to swathes of investment in peer-to-peer lending platforms, remittance companies, robo-advisers and crowdfunding sites that are gradually chipping away at the incumbents’ market share in retail banking.
“I tend to think with regards to fintech in the capital markets, the efforts are more collaborative,” said Qin Xu, partner at BCG. “The effects are different compared with retail banking or other parts of commercial banking because the capital markets are more heavily regulated and tend to be dominated by large, established institutions. Disrupting these types of organisations is a much more difficult task.”
Bankers, however, are growing wary of the new competition.
“The way capital moves will fundamentally change. It’s just a question of time,” said Farhan Faruqui, CEO of ANZ’s international operations. “Regulators are worried about participants in some of these new platforms, but they will eventually get comfortable.”
OVERBOND TO ORIGIN
The number of companies taking on the banks in Asia’s primary markets is small, but globally a few start-ups are at least taking aim at some of the existing market infrastructure.
One example is Overbond, a Toronto-based company, which launched two years ago and last year raised C$7.5m (US$5.79m) in seed funding. The company aims to connect corporate and government issuers with investors and dealers through its central platform. It also updates users with bond pricing information and news.
Another example is Origin, which is based in London and was founded by former Nomura traders Raja Palaniappan and Robert Taylor. The company acts as a marketplace for frequent medium-term note issuers and investment banks by providing a platform that allows issuers to update their terms and access multiple dealers.
“If you look at post-trade, for equities, we’re settling at T+3, and in some cases it’s T+2 now. It’s 2017. That’s insane.”
Origin completed its proof of concept in May and went live in June with 30 borrowers and nine dealers currently using the platform. Co-founder Palaniappan has told IFR he expects to expand into Asia in the second half of the year and aims to eventually provide a benchmark for the global MTN market. However, he stops short of suggesting that the company could ever disintermediate the banks.
“It’s definitely a tool to help banks, to make them more efficient,” he said. “We don’t believe disintermediation in the capital markets will work. It takes a lot of time to build an entity that has all the necessary approvals along with a strong-enough balance sheet to replicate what a dealer can do.”
Deutsche Bank’s chief executive John Cryan was probably the most frank among industry leaders when he talked about how banks prior to the financial crisis had pioneered a number of complicated and exotic financial products, but were still employing large numbers of contractors for data inputting and other mundane tasks.
However, the deluge of regulatory reforms introduced following the financial crisis has squeezed returns for banks, forcing them to streamline processes, particularly around settlement. The most talked-about innovation in this regard is blockchain, the distributed ledger technology that emerged with the advent of the cryptocurrency bitcoin.
Three main consortia are developing the technology in conjunction with banks: the Ethereum alliance, which is backed by Microsoft and Cisco; Hyperledger, which was set up by the Linux Foundation; and, probably the best known of the three, the R3 consortium. All are working on applying the technology to the capital markets to improve settlement times.
“If you look at trading, the actual matching in any asset class, whether it’s FX or equities, is down to milli or microseconds,” said Charley Cooper, managing director at R3. “That’s pretty fast already so isn’t really ripe for redevelopment, but if you compare it to post-trade, for equities, we’re settling at T+3, and in some cases it’s T+2 now. It’s 2017. That’s insane and so there are definitely opportunities to improve these processes.”
One challenge for the developers of these technologies is interoperability. The argument often goes that unless all banks are using the same platform, it is difficult to envisage how blockchain would work except in a closed-loop system or through the government or regulator picking winners, thereby blunting the impact of the technology. However, R3’s Cooper said this is something that the three main consortia are all working on.
“I don’t think that’s much of a danger,” he said. “If you look at the internet, it’s multiple different networks that learned to communicate with one another through shared standards and protocols and we view the evolution of distributed ledger in the same way.
“It’s why we open sourced our technology and we have good relationships with Ethereum and others. It may take a few years before the technology is adopted across most markets but it will happen.”
BANKS AS PARTNERS
Banks have woken up to the potential of technology to reshape investment banking, and many are partnering with fintech companies to develop these technologies through their accelerator programmes.
“It’s difficult to say broadly why banks have been willing this time around to pour resources into looking at these technologies,” said Niall Cameron, global head of corporate and institutional digital at HSBC. “It could be because the initial reaction to fintech was that it was highly disruptive.”
“I expect to see the role of intermediaries changing, where you go from a bundled cost to distribute a bond to an unbundled one. Issuers and investors will select services they value most.”
Last year, Commonwealth Bank of Australia completed the first trade-finance deal between two unrelated banks using blockchain technology for the US-headquartered cotton trading firm Brighann Cotton.
In January, the Australian bank created its own blockchain implementation for the debt capital markets.
The technology got its first outing in the issuance of quasi-government bonds for the Queensland Treasury Corporation and, although it still requires regulatory approval before other issuers can use it, Sophie Gilder, head of blockchain at CBA, expects blockchain to transform the role of banks in the capital markets.
“The technology has huge potential to strip out time, cost and risk in relation to issuance and settlement, and by enabling counterparties to connect directly, you can increase efficiency and automation,” she said.
“What I expect to see is the role of intermediaries changing, where you go from a bundled cost to distribute a bond to an unbundled one. Issuers and investors will select services they value most.
“This won’t happen overnight, but we’re trialling these technologies to stay ahead of the curve.”
One advantage banks have over fintech start-ups is scale, which creates opportunities for them to partner with promising ventures or, in some cases, buy them outright. In addition, the higher barriers to entry in the capital markets mean that there are few companies that are likely to be capable of challenging their dominance.
“To be an effective disruptor, companies need to be a sufficient size because the type of business that’s done is more complex,” said HSBC’s Cameron. “In the capital markets space, it’s difficult for small companies to be disruptive and once they get to a certain size, they are often acquired.
“If you also stand back and look at which markets are ripe for disruption, they tend to be those where there are more simplistic transactions going on. As you move up into the capital markets space, the transactions become more complicated and it becomes much harder to automate, so there are less commoditisation opportunities.”
Nevertheless, technology can create entirely new types of products or asset classes that banks may not yet be able to predict, says Bain & Company partner Thomas Olsen.
“I think a lot of people are underestimating the impact of these new technologies,” Olsen says. “It’s the derivative of these back office improvements that’s the interesting point.
“As an analogy, you could say that the electronification of trading was just a process improvement, but it enabled all kinds of things to happen, including algorithmic trading.”
THE BANK OF TOMORROW
While most fintech companies operating in the capital markets aim to exploit a particular niche, more established technology firms may be capable of wholesale disintermediation.
“If Alibaba or Google were to get into the investment banking business, they would be faced with the same issues, which drive down the return on equity and makes it difficult to know why they would want to get into it in the first place.”
The emergence of giant technology firms like Alibaba and Tencent in the payments market has raised the prospect that these companies may pose a threat, but so far these firms have not showed much ambition beyond the retail space.
“When people talk about disruption, they often say the real risk is from big tech,” said Bain’s Olsen. “They’ve got the brands, they’ve got the technology. If Elon Musk can disrupt Boeing at making satellite rockets, it would be strange to ignore these big tech companies. But, I think that’s relatively far in the future as even the large tech firms would have to overcome the years of expertise and trusted models to directly disintermediate established financial market infrastructure.”
Origin’s Palaniappan echoed these thoughts, noting that post-crisis regulations have driven down ROE at many of the world’s biggest banks to single digits.
“If you look at investment banks, they suffer from their own inefficiencies, which maybe a large technology company could resolve. But investment banks have to deal with regulations and capital requirements. If Alibaba or Google were to get into the investment banking business, they would be faced with the same issues, which drive down the return on equity and makes it difficult to know why they would want to get into it in the first place.”
Bankers, however, say they cannot afford to ignore the threat from more streamlined, technology-driven institutions.
“Some banks are in denial, and those banks will be subject to extinction, in my view,” said Faruqui at ANZ. “It’s not about removing the problem, it’s about learning to sleep with the enemy.”
“The digital revolution is happening now and it’s unstoppable.”
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