FinTech – exaggerated hopes or justified enthusiasm?
Reed Smith trainee Anne-Marie Trachmann on why we should expect great things
After attracting more than US$50 billion of investment in the sector since 2010, FinTech has become a buzzword of late, although that is not to say it doesn’t have its critics.
This article examines the current criticisms of FinTech, and argues that we can nonetheless expect great things.
What is FinTech?
‘FinTech’ can mean any technological innovation or invention in the financial sector. Well-known examples include cryptocurrencies like Bitcoin, peer-to-peer lending or crowdfunding platforms, robo-advisers who manage investment portfolios, stock trading apps or all-in-one personal finance management and budgeting tools.
Some instances of FinTech involve Distributed Ledger Technology (DLT). This enables all participants in a network to have linked identical copies of the same ledger without any one ledger being the central or master one. The ledger can be set up so that any participant can make changes to it, with any change being reflected in all copies in minutes, or even seconds. Inherent in this technology are cryptographic keys and signatures to control who can make what changes. The best-known sub-type of DLT is probably blockchain.
Accountancy firm KPMG reports that investment in venture capital-backed FinTech start-ups fell 49% in the second quarter of 2016, while deal volume dropped by 12% when compared with the first quarter of 2016. This mirrors the increase over recent months of criticism about the sector. Many of the concerns voiced by critics, and those who suspect a bubble, fall under one of the following categories:
“It’s not FinTech that does the job”
Much of FinTech is complex, and there is some confusion over what the technologies can or cannot do. For example, one major benefit that is expected to materialise due to the application of blockchain is cost savings.
This hope is well-founded in as far as blockchain eliminates the need for each market participant to verify transactions by reference to its own separately kept ledger. It may also cut industry participants out of the process whose current main function is to enable trust between transacting parties. This is because blockchain enables transactions to take place simultaneously that would previously have been conducted in sequence, thereby reducing counterparty risk and a firm’s capital requirements.
Despite these real advantages, blockchain is sometimes praised for procuring benefits that it does not enable or cannot reasonably take credit for, such as a significant reduction in instances of fraud or an improvement in the amount and comparability of shared information. As the Financial Times points out when discussing recent announcements by members of the fishing industry that they will implement blockchain, the increase and standardisation of information sharing between market participants or even with the public may benefit an industry, but you do not need blockchain to get there.
“Concerns over asset quality”
No amount of clever information processing and storage can cure defects in the quality of the underlying asset, or fraud/flaw in verifying its value at the point of rendering the asset digitally available for trading.
Reasons why FinTech is nonetheless deserving of its hype
Different risk profile
The ‘FinTech revolution’ is different from other booms based on new technologies.
For once, the notion of the small and agile start-up disrupting a game played by long-established giants does not tell the whole story. Financial institutions across the industry are exploring FinTech and seeking to capitalise on its potential. This not only reduces the statistical failure rate of FinTech businesses, but also testifies to the potential that even the most established industry players see in FinTech. This may also explain the reduction in investment in FinTech start-ups referred to above: one does not (anymore) need to invest in a start-up in order to get a slice of the FinTech cake; the big players are also developing FinTech products.
Even where start-ups are concerned, Forbes contributor Falguni Desai notes that FinTech start-up founders, on average, bring a decade more experience with them than the founders of start-ups in other sectors. Often, these are entrepreneurs with a profound understanding of what they are proposing to tackle. In fact, those who have converted to the FinTech industry include some of the elite of the traditional banking world, such as Lawrence Summers, former US Treasury secretary.
Regulators are aware of the difficulties of starting up in a highly regulated industry. Initiatives taken by regulators include the creation of “sandboxes”, i.e. regulation-light spaces in which to operate; specific initiatives such as those taken by the Financial Conduct Authority (FCA) as part of “Project Innovate” (essentially, tailored advice and potentially special permissions); and promises of financial support, such as that by the Monetary Authority of Singapore to spend S$225m (US$166m) over five years in support of FinTech innovation.
Vast number of potential users
One of the most exciting aspects of FinTech could be what it can do for the empowerment of small sums of money and their owners. By this, reference is made not only to the abounding opportunities of applying FinTech to developing economies, but also to the ability for each of us to maximise the use of retail customers’ money. An example of this is the mobile app Moneybox, which can round up the price of any purchase made to the nearest pound and place the spare change in a previously selected investment fund. Another example is crowdfunding platforms, such as SyndicateRoom, whose selling point is that their users can invest on the same terms as the most powerful investors.
Unsurprisingly, FinTech is neither risk — nor trouble — free, and there are misconceptions about what it can do. Its potential in creating value is nonetheless substantial, and is increasingly embraced and driven forward by the financial sector as a whole. We are right to expect great things.
Anne-Marie Trachmann is a trainee at Reed Smith. She studied law with German law at the University of Oxford and a masters degree at Oxford Brookes University.