Technology has long been the engine driving capital markets efficiency — both for investors in the markets, and for the capital markets infrastructure providers (CMIPs) that operate the exchanges and other trading venues, central counterparties, securities depositories, index providers and data and analytics companies.
More recently, fintech companies are bringing new technologies to market even faster and with a greater impact. Hundreds of fintechs are focusing their development on capital markets infrastructure (CMI), and while CMIPs recognize that fintech will have a significant influence on the industry, many remain unsure of which technologies to adopt and to what degree, and how best to engage and interact with fintech companies (see “Capital markets infrastructure,” below).
The role and importance of CMIPs in the markets has grown in the past decade — along with their revenues — owing to changes in the regulatory environment (a push toward mandatory central counterparty [CCP] clearing of over-the-counter [OTC] derivatives or ever-increasing reporting requirements), in the investor landscape (a higher profile for buy-side firms) and in customer behavior (an increasing call for data and analytics solutions).
In the coming years, many CMIPs will seek to protect their businesses, and achieve even higher levels of efficiency, service provision and growth through innovation and adoption of new technologies, some of which may prove revolutionary. These technologies will come from current technology leaders that tailor their services to CMI applications, from firms’ internal development and from the new generation of fintechs.
Here we evaluate the fintech landscape within the CMIP industry, potential uses of the new technologies across the industry value chain, and some of the areas likely to see the most innovation. Although growth in fintech investment across the broader financial services sector has slowed since 2015 due to investor caution during a more uncertain macroeconomic environment, the growth trajectory of CMI fintech has remained steep, and likely has yet to reach a peak.
We have identified four fintech themes shaping the CMI value chain. Some of these themes increase productivity and lower costs, while others generate new sources of revenue.
1. The use of advanced analytics and artificial intelligence (AI) is set for rapid growth, as the amount of available data circulating through capital markets grows amid increasing interest in the application of advanced analytics to market, financial and economic data.
2. Distributed ledger technology (DLT) is applied to a range of CMI operations (see “Distributed ledger technology, a game changer,” LINK HERE). Use cases include clearing and settlement, alternatives to the traditional markets for access to capital (initial coin offerings [ICOs]) and new digital markets.
3. Fintechs will bring greater efficiency through innovative technologies such as cloud and quantum computing — for example, in the sphere of matching technologies — while driving depth in traded markets and expansion toward new asset classes.
4. Post-trade services will gain in productivity through the application of automation and robotics. A separate branch of regulatory tech firms (regtechs) will bring efficiency and uniformity to risk management and regulatory reporting.
The fintechs most active in CMI are smaller start-ups. Here we define CMI-related fintechs as companies founded since 2000 that are unlisted, employ fewer than 1,000 people, and operate outside the areas of robo-advisory, brokerage and foreign-exchange trading. Most are developing products as components within the CMI industry, and appear to be mainly interested in working together with existing providers, rather than in poaching their customers.
Still unclear, however, are the interests and intentions in CMI of the global tech giants, such as Amazon (AMZN), Google (GOOG) and Microsoft (MSFT), and whether they might venture into the core of the industry at scale. Given their great capital resources, deep data pools and world-class analytic capabilities, their entry could significantly change the CMI landscape. Most CMIPs believe that it is either these tech giants or incumbents working with fintechs who have the greatest disruptive power.
We surveyed the membership of the World Federation of Exchanges (WFE). Respondents were largely positive about the potential of fintechs, and were unanimous in expecting enhanced productivity or new revenues from incorporating their technologies in their businesses (see “Survey methodology,” below). None saw fintechs as a threat, but instead viewed them as potential partners and enablers of growth. They acknowledged, though, that the extent of the impact is difficult to ascertain.
CMIPs follow various routes to bringing fintech into their organizations. Some firms surveyed reported relying on more than one, depending on their view of the size and importance of the opportunity.
Development of internal capabilities: Most of the survey participants have established one or more internal groups dedicated to studying the global fintech landscape. Only a few indicated they were aggressively developing new technologies themselves, as this is a resource-heavy approach.
Collaboration and joint ventures: 40% of the WFE members surveyed believe that collaboration is the most efficient approach to fintech, followed by joint ventures at 25%. The primary reason cited is a shortage of resources, inhibiting the development of their own solutions. Moreover, the speed of innovation is rapid, and diverse talents are needed for internal development.
Minority or majority financial investment: Of the 46 WFE members surveyed, 11 said they are investing in fintechs through minority stakes, while 10 said they use majority investments (multiple choices were allowed). Most innovations may fail, but one or two are likely to become success stories, WFE members said.
Outright acquisition: Just 9% of survey participants cited acquisition of fintechs as the most effective approach.
The fintech landscape is evolving at an accelerated pace as new firms and innovations enter the market while others drop out, and ideas are rapidly developed and deployed. One approach to a successful CMIP fintech strategy calls for a “portfolio of initiatives” where incumbents invest in multiple fintechs of different sizes, time horizons and objectives — some with a short-term focus aimed at enhancing the core business, and others with longer-term objectives based on a smaller number of revolutionary ideas. With so many fintechs in the market and more to come, a structured approach is essential to identify the technologies best suited to a CMIP’s strategy and operations. It is also important to determine which projects to develop internally or through reliance on fintechs, and what form the relationship and investment in fintechs should take.
Fintechs and the CMI Value Chain
The McKinsey Panorama Fintech database covers more than 6,000 of the 12,000+ fintech innovations in the global marketplace. Based on their activities and technologies, about 700 fintechs are relevant to the CMI industry. Through steady growth totaling 277%, this number has almost quadrupled since 2010, and has outpaced other areas of fintech within financial services, such as corporate banking, with growth of 186%, and payments with growth of 184% (see “Fintechs indexes,” left).
We look at where fintechs reside on the CMI value chain, and analyze the technologies they rely upon. The distinction between location on the value chain and technologies used in development is essential to a full understanding of the CMI fintech universe. Certain technologies, such as DLT, are a component of CMI fintech products and services, rather than end products in their own right. In other instances, significant product innovation can be achieved without the use of new technologies — one prominent example is crowdfunding platforms that have emerged in the last several years.
Fintech-led innovation can be found in all five major parts of the CMI value chain.
- Access to capital: Creating innovative ways to reach and serve issuers and investors and broadening the range of asset classes offered
- Trade execution: Gaining new efficiencies.
- Post-trade services: Bringing simplification, automation and improved security to incumbents’ operations.
- Data, analytics and information services: Developing new techniques to mine and interpret data to its full potential.
- Operations and technology: Creating greater cost efficiency, lower latency and reduced operational risk.
According to the McKinsey Panorama Fintech database, the density of fintechs is greatest in access to capital, at 37% of all CMI fintechs, followed by trade execution, data, analytics and information services and post-trade services. By contrast, WFE members perceive little fintech activity in access to capital (3%), and ranked post-trade services as the most active (see “Fintech activities focus,” below). The difference in emphasis is understandable, however, in view of the broad media attention during the past few years to developments in blockchain and other DLTs, as well as the high-impact potential of the technology, particularly in the post-trade realm of clearing and settlement. Moreover, in separate interviews, WFE member executives mentioned that investment in post-trade technologies has historically lagged investments in other parts of the value chain, and currently draws greater attention than access to capital.
While the boundaries among fintech technologies may blur, the solutions they deliver can be grouped in four categories according to Panorama: Advanced analytics and AI (see “Advanced Analytics and AI” page 35), followed by DLT (including blockchain), cloud and quantum computing, as well as a small number in automation, and robotics (see “Leading fintech technologies,” below). By and large, WFE members’ assessments of fintechs’ technology deployment aligns closely to the observed state of the market.
Bucking the Trend
Following rapid growth in overall fintech funding in 2014 and 2015, global capital raising plateaued in 2016 at about $14 billion. Investors seem to be tuning out the hype around fintech with greater scrutiny of actual results. Furthermore, the offerings of the current crop of start-ups are less innovative than earlier entrants, raising the bar for entrepreneurs trying to win investors.
Investment in CMI fintech has, however, continued its rapid growth, reflecting the variety and novelty of the offerings. The funding rounds from 2015 and 2016 were exceptional, at $1.3 billion and $2 billion, respectively (see “Global investment,” below). This growth was mainly driven by a handful of large individual transactions.
The largest investment went to Lufax, a peer-to peer lender in China, at $1.7 billion. Other considerable commitments went to Darktrace (machine learning-enabled cyber-threat detection) and Dataminr (aggregation of news and market data). CMI fintechs should continue to draw significant levels of investment, as both nascent and more mature solutions emerge across the CMI value chain, leveraging a wide spectrum of technologies.
In 2017, a new means of funding start-ups — initial coin offerings (ICOs) — raised more than $2 billion. According to an analysis by CB Insights, ICOs have surpassed venture capital as the biggest source of funding for companies developing blockchain technology. While ICOs can have great potential, regulators around the world are mostly skeptical, and have warned investors of their short track record and high risk.
Fintechs: Friend or Foe?
At most points in the value chain, fintechs are potential partners to incumbent CMIPs rather than competitors. Within post-trade services, 90% of fintechs aim to provide services to incumbents; that is, they have business-to-business models. This finding aligns with the results of the WFE survey, where 75% of participants saw fintech offerings as being aimed at CMIPs rather than their customers (90% for WFE Asian members).
However, at the front end of the value chain, in the “access to capital” portion, 82% of fintech business models have a business-to-consumer focus, and therefore represent more of a threat to incumbents.
Overall, WFE members see potential for fintech integration rather than incursion: 61% of survey respondents envision fintechs becoming integrated into their franchises and generating new sources of revenues, while 37% expect to benefit from greater productivity. Only one survey participant saw fintechs as direct competitors, and none thought that fintechs might bring disintermediation.
Moreover, the consensus opinion was that less than 20% of the industry’s current revenue base was at risk to fintech encroachment.
In separate interviews, however, executives at some of the WFE members in Europe and the Americas did note that the industry’s clearing and settlement processes, as well as capital-raising activities, are vulnerable to new competitors, and that incumbent firms will need to counter fintech innovation to maintain these core franchises.
The Impact of Large Technology
Efforts in bringing new technologies to CMI are not limited to those small and new fintechs dedicated to the capital markets. Further innovation in CMI could also come from large technology companies such as Amazon, Google and Microsoft, which already serve CMI and the broader set of financial players through, for example, cloud services. In some cases, they have also enriched their capabilities by integrating and partnering with smaller specialists. Google, for instance, collaborates with data-wrangling experts Trifacta for its Google Cloud Dataprep product, while Microsoft acquired Maluuba, a specialist in deep learning for speech and image recognition, to enhance its AI capabilities.
A little more than 40% of survey participants see large technology companies echoing the moves by Apple (AAPL), Alibaba (BABA) and Amazon (AMZN) into financial businesses, and becoming important potential disruptors in the CMI market in the coming five years. Others expect incumbent CMIPs (39%) or start-ups (20%) to have the largest effect within the next five years.
Large technology companies are nimble and possess deep pockets and considerable other assets — access to issuers and retail investors and proprietary information — that could be leveraged to their advantage in the realm of CMI.
Moreover, for large technology companies, CMI might rank high in the opportunity space when compared to other financial services verticals: The industry is highly digitized and rich in data, and some areas, such as information services, are lightly regulated compared to adjacent financial services sectors. Also, the new entrants would not be burdened with incumbents’ legacy platforms.