Fintech is Still a Big Deal (And It Has Only Just Begun)

Torys Quarterly: Sharpen Your Focus

Driven by the confluence of advances in technologies like sensors, processing power and deep learning (AI), it is predicted that the financial sector will see more change in the next 10 years than in the last 100 combined.1

Fintech investments reached US$22 billion in 2015, and global investment in fintech in the first three quarters of 2016 was US$18 billion.2

Rather than the continued proliferation of mobile apps, which propelled the last wave of the digital age, complex partnerships and policy will drive the next wave.3 Although the current iteration of fintech only emerged as a mainstream force over the last decade, the terms “FinTech 2.0” and “co-optition” are already being used to refer to the next (or arguably, current) phase of fintech that will be centered around partnerships and increased collaboration between fintech start-ups, banks and governments. Banking services will continue to evolve from their traditional infrastructure and product offerings to providers of a range of digital financial solutions for customers. Rather than waiting for these inevitable disruptions, many banks have been busy creating incubators, establishing venture funds, creating partnerships and acquiring start-ups.

Growth of digital wealth management platforms

One fast-growing subset of fintech is known as “digital wealth management platforms”. Big data and ever-increasing analytics capabilities are fueling and enabling the growth of digital wealth management services, and in turn, these capabilities offer a wider audience of businesses and consumers access to financial advisory services previously too expensive or inaccessible. Digital wealth management platforms use algorithms based on customers’ data and risk preferences to provide digital services, including investment and financial advice, directly to businesses and consumers via online or mobile tools. These platforms provide services such as portfolio selection, asset allocation, account aggregation and online risk assessments.

It is estimated that robo advisors will have $20 trillion under management by 2020.

Account aggregation services are provided by a growing number of bank and nonbank aggregators. The spectrum of functionality varies across account aggregation services. Many require users to share their account access information, such as passwords or PINs, with the aggregation service. A common secure standard for sharing information using app-specific authentication is expected to emerge as account aggregators become more mainstream and financial institutions begin to partner with, acquire or grow their own dashboards and improve functionality.

Robo advisors are automated investment solutions which provide automated portfolio rebalancing using trading algorithms based on passive investment and diversification strategies. Customers provide information through a self-assessment process that rates risk appetite and utilizes goal based decision making. There are many players in this cluster with some close to $1 billion under management. A report by AT Kearney estimates that robo advisors will have $20 trillion under management by 2020.4 Generally, robo advisory services offer services with lower asset management and trading costs than traditional providers.

All about APIs

The application program interface or “API” middleware platforms are key to the processing of opening, developing and enhancing financial services because they allow for a faster, more agile way to innovate and take advantage of existing technology. By linking apps and services transactions are made possible. For example, buyers and sellers transact over an exchange where each part of the service is provided by a separate entity and are linked using APIs.5 An API is a set of routines, protocols and tools for building software applications—think of them as a standard plug and socket for connecting software applications. Many of the key components of the future of banking services will be addressed through the use of APIs. For example, optimizing Know Your Customer checks, omni-channel delivery and personalized customer relationships.

New regulatory frontiers

Amidst the exponential change and opportunity, global regulatory authorities are working to translate and apply existing legal obligations and frameworks to new technologies, and introduce new or amended legislation with new and ever-evolving technologies in mind. So far, regulations related to fintech vary widely between jurisdictions as regulators try to balance multiple levels of regulation and the ever-present tension between innovation and prudent regulation. Japan’s recent “FinTech Bill” exemplifies the increasing attention global governments and regulators are paying to encouraging, and in some cases, requiring, collaboration between providers and banks.

Long-standing legal frameworks that rely on commonly accepted staples such as bank account agreements and fail safe mechanisms such as CDIC coverages are not designed to accommodate the rapid technological advances brought by fintech or offset the types of risks that new technologies bring. In the case of CDIC coverages, these coverages apply to insure eligible deposits at member financial institutions and operate to protect deposits in a scenario where a member financial institution fails, however these coverages were not set up to mitigate against large-scale fraud or data breaches relating to customer accounts.

A similar concern has arisen in the United States, where there is uncertainty as to whether bank customers will be reimbursed by the Federal Deposit Insurance Schedule (FDIC) if customer data were to be breached while stored or processed by a third-party fintech provider.

The most significant and ongoing regulatory and compliance issues are related to data protection, consumer protection, money laundering, IP and capital controls. Data security and regulatory compliance are the key issues for risk mitigation. The fintech industry is built on data and the sharing of data, which makes compliance with data protection regulations a significant consideration for both banks and nonbanks. As partnerships and collaboration between banks, nonbanks and governments increase, we can expect that fintechs with robust regulatory compliance mechanisms and expertise will have a significant advantage in the race to dominate global markets.

Conclusion

Is the rise of fintech a full-fledged revolution, or is it more accurately seen as a less dramatic, gradual evolution of financial services? What is certain is that fintech will continue to disrupt certain sub-sectors and give rise to new value propositions for consumers and businesses. As regulators, businesses, consumers and incumbent providers continue to react to innovation in the marketplace, we can expect new questions, challenges and opportunities to continue to emerge.

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1 The Fintech Book

2 The FinTech Book; KPMG and CB Insights

3 Steve Case, The Third Wave

4 AT Kearney. “Hype vs. Reality: The Coming Waves of “Robo” Adoption. Available here.

5 See "Embracing the Connected API Economy," The FinTech Book

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