A fierce battle between Wall Street and Silicon Valley’s technology industry is taking shape, with the prize being which combatant will control and shape the pace and direction of financial innovation.
Most observers are likely to place heavy bets that it’s the technology world that will emerge as the winner. Venture capital firms and big financial institutions have backed startups to the tune of tens of millions of dollars, betting that their niche expertise, the lower levels of regulation they confront and the opportunity for technology to disrupt the traditional ways of doing business will more than justify the valuations created as a result. Big-name former bankers have turned down the chance to stick around running Wall Street institutions, opting instead to head some of these startups. Now they are concentrating on shaking up the world their former employers inhabited by pioneering everything from digital currencies and payment technologies to online lending platforms.
It is starting to cut both ways, however. Citigroup has launched a somewhat hush-hush division, Citi Fintech, with the goal of making mobile banking more accessible and appealing to its clients, and has recruited a former top PayPal executive, Carey Kolaja, to become its chief product officer. In an even more secretive venture, rumors are spreading that JP Morgan Chase has built and staffed an entire department in Delaware dedicated to simulating testing the consumer’s experience with various new digital technologies.
Investing in fintech
Meanwhile, the dollars involved continue to grow. Total global investment in fintech ventures tripled in 2014 over 2013, hitting $12.21 billion compared to a mere $4.05 billion the prior year, according to data from Accenture. (Data for 2015 aren’t available as yet.) The same year (2014) saw the IPO of Lending Club on the New York Stock Exchange: its $8.5 billion valuation made the company the biggest technology IPO of the year and told the world that fintech had come of age.
Among Lending Club’s biggest backers was Canaan Partners, one of a growing number of New York venture firms with an interest in fintech. Investing in the Series A round, Canaan kept faith with the online lender through tough times and reaped the rewards; today, Lending Club is only one of 16 fintech companies in which Canaan has invested.
Canaan Partners, meanwhile, is far from the only Silicon Alley firm to be scrutinizing the landscape in quest of transactions. Indeed, more than a third of the 35 men and women named by Institutional Investor magazine as being the most significant financiers fueling the fintech boom are based in New York, including the CEO of the Partnership Fund for New York City. That entity helped to popularize the very term “fintech”, when it launched an accelerator, the FinTech Innovation Lab, in the city in 2010.
Fintech for the asset management industry
For now, however, many of these firms have stuck to the tried and true fintech models: companies promising to offer new crowdfunding models, to break the big banks’ stranglehood on lending, to delve into the still murky waters of bitcoin, digital currencies and the blockchain, and the ever-popular arena of mobile payments.
What have been slower to appear on the scene – aside, that is, from the myriad variations on the robo-adviser idea, or the concept that investment management can be automated – are new fintech companies focusing on ideas that be as revolutionary for the asset management industry as the new lending and payment models seem likely to be for traditional banks. That’s not to say that some might not be en route, however.
One aspect of asset management firms’ operations that might benefit from the fintech revolution is investment research. After all, the ability to analyze data rapidly and accurately and to draw from it the conclusions that steer portfolio managers in the direction of unique and distinctive investments – the kind that will generate alpha and that their peers will overlook – is what it’s all about. Being able to analyze more data, and to do so cost-effectively, has the potential to enhance both absolute and relative performance. As big banks, facing new liquidity rules, have stepped back from providing support to the bond market, Algomi (financed in part by New York-based SenaHill Partners, along with many big banks) has stepped into the breach. Its Honeycomb system helps sales teams match orders for otherwise hard-to-fill bond transactions, something that fixed income managers, who have been grousing about a dearth of liquidity for years, could find a boon.
Some products also will be able to help their users steer clear of big minefields: just ask hedge fund titan Steve Cohen (the model for a main character of a new US television series that began airing this month, “Billions”), who has just agreed to a two-year ban on managing external capital for failing to supervise employees who pled guilty to charges of insider trading. Digital Reasoning has signed deals with compliance teams including that at Cohen’s company; the fintech business uses military-grade intelligence software to detect when something is awry. That’s the kind of product whose most immediate market may be at hedge funds, but that other asset management firms may well find appealing as well.
Small asset managers outsource to start-ups
Meanwhile, smaller asset management firms who can’t afford the hefty price tag associated with accessing costly data sources – subscriptions to Bloomberg, Thomson Reuters, Morningstar and others can be very pricey – can turn to startups like Airex or Symphony instead, and buy only what they need, on an à la carte basis.
On a more sophisticated level, look for fintech startups to start developing tools that will measure performance and break down its components (based on research done in behavioral finance). Odds are that these innovations will be rolled out first in the alternative asset management space, where managers collect larger fees and where they more vulnerable to redemptions by investors who expect outperformance in exchange for those big fees. Eventually, though, new data analytics and performance monitoring tools will make their way into the long-only asset management industry; big data analytics will be the wave of the future for all segments of the market.
The sectors that have the biggest need for change (the bond market) and those where size of the market opportunity is greatest, with the solution being most obvious (at least in general terms), as is the case with mobile/digital payments, were logical first movers as technological innovation began to make its way into finance.
Moreover, now that we’re in what Santander Innoventures and Oliver Wyman dubbed “FinTech 2.0”, it isn’t just a matter of what will happen, but how it will happen. Market participants shouldn’t stand by waiting for one of the venture backed startups to suddenly change the world single-handedly. Indeed, rather than trying to squash these potential rivals, there are a growing number of signals – such as the increased willingness to themselves finance the challengers – that Wall Street institutions and giant asset management firms might be more inclined to partner with them. That’s the way that real, revolutionary change will take place. And it’s only a matter of time.