Decoding Fintech & Capturing the Opportunity in Capital Markets Infrastructure

May 10, 2018 08:30 AM

Innovation Across the Value Chain

Both survey respondents and McKinsey’s Panorama Fintech database observe fintech solutions supporting innovation across the value chain, creating opportunities to enhance revenues, reduce costs and create a better experience for market players. 

Fintechs are altering traditional access to capital models in several ways:

1. Providing crowdfunding offerings that raise equity and debt for smaller firms, and are open to both retail and institutional investors. 

2. Developing platforms that create new connections among issuers and investors, focusing on nontraditional asset classes such as real estate, cloud capacity, venture capital, and private equity, as well as cryptocurrencies. 

3. Deploying new technologies for the direct issuance of equity and bonds through distributed ledgers, reducing costs, frictions and settlement times in new issues. This challenge is likely to have the biggest effect on the industry and incumbents. In particular, DLT networks are facilitating ICOs, which issue digital tokens to investors that can be traded online.

Although few survey participants see much of a threat to access to capital from fintechs, their momentum in this arena could create a true disruption, given the B2C nature of most of the offerings. This could leave traditional exchanges exposed to a direct and indirect loss of listings, as well as the associated trading volumes. Solutions built on DLT may present a revenue risk to incumbents, as what is issued on DLT will stay on DLT, through the stages of trading, settlement and corporate actions (see “Distributed ledger technology, a game changer,” LINK HERE). Fintechs could also capture a first-mover advantage in emerging asset classes, owing to their greater agility, convenience and insight into customer needs. 

Trade Execution 

A substantial share of fintechs active in the trade execution space have focused on facilities for trading new asset classes, led by exchanges for cryptocurrencies and algorithmic trading strategies. In more traditional markets, fintechs are aiming to introduce greater efficiency by enhancing computational power, leveraging quantum computing, realizing trading systems with very low latency, and offering broad views of order books across markets in real time for improved price discovery. Survey participants saw trade execution as the second most active area of fintech innovation. 

If DLT is broadly accepted in trade execution, it may bring substantial efficiencies through bilateral trading between participants in decentralized markets. 

Survey participants say that fintechs are most active in the clearing, custody and settlement parts of the value chain, and see the most innovation in these areas. Streamlined processing and settlement result in a combination of reduced operating costs, and less need for capital. Early forecasts held that applying DLT to these areas would save the financial world billions in operating costs. McKinsey estimates that for OTC derivatives alone, there is a value generation opportunity of $4 billion to $7 billion. 

Despite the estimated size of the opportunity, to date there have been few tangible results. DLT might have taken a significant step forward, however, in December 2017, the Australian Securities Exchange (ASX) announced that it would replace its existing equity clearing and settlement systems with a DLT-based system.

Regulatory compliance solutions, a subset of post-trade services, has also evolved, with regtechs bringing big data, machine learning and AI to increasingly demanding regulatory and compliance regimes. These technologies enable the implementation of automated, standardized approaches for more complex tasks such as customer onboarding and know-your-customer-requirements, anti-money laundering compliance, trade surveillance, fraud and cyberattack detection through forensic analytics, and the preparation of compliance and regulatory reporting. Regtechs also offer technology for managing collateral and counterparty risk for more efficient use of institutions’ capital. 

CMIPs have begun to develop advanced regulatory solutions and have turned to regtech firms for enhancements through natural language and machine intelligence. They are also developing trade-reporting systems that meet the newly implemented MiFiD II regulations for firms that internalize their equity trading. 

Fintechs are also finding, gathering and processing data, and in some cases creating new revenue sources. WFE members surveyed ranked the importance of innovations in data analytics on a par with those of trading technologies. 

Operations & Technology

In a show of hands at McKinsey’s 2017 Sibos Securities Services CXO Roundtable, 44% of attendees cited automation and robotics as the industry’s most important and effective no-regrets move. CMIPs adopting automation benefit from fewer errors and can rapidly scale their operations in response to changing market volumes. A number of players have started automating components of complex workflows — those which are not susceptible to full straight-through processing — by optimally allocating tasks to machines versus humans, and thus materially improving productivity and promoting process transparency.

McKinsey estimates the potential cost reduction from automation and robotics at scale can reach as high as 20% in the aggregate, depending on the pre-existing level of automation. Estimated savings are relatively minor — up to 10% — in areas that require frequent intervention and handwork, such as client service and back-office management. But as tasks become more repetitive, in areas such as custodian services, maintenance of client reference data and collateral management, cost savings can rise from 15% to 25%. The greatest efficiencies — estimated between 25% to 50% — are in areas where work is highly repetitive, but not yet automated, such as reconciliations, confirmations, settlements and payments.

Identifying the Fintech Opportunity

It is too early to know the full extent of fintech’s effect on capital markets during the next five years, but if some of the most disruptive technologies reach wide-scale adoption, fintech could be an evolution that becomes a revolution. For CMIPs, however, it is essential to understand that fintech, in itself, is not a strategy. Instead, it is a means to a strategic end — a collection of new tools and technologies that have to be tested and thoughtfully introduced into each CMIP offering. 

The fintech environment is highly complex, and populated with potential business partners and acquisition candidates, enabling cost savings and opening up of new revenue sources. From the survey participants’ point of view, the advantages of fintechs are their agility with technology and the singular product focus of early-stage businesses. Surprisingly, they do not regard fintechs’ ability to attract top talent or their being subjected to lighter regulation as core advantages (see “Biggest advantages,” below). 


Page 2 of 3
About the Author

Nandini Sukumar, WFE CEO; Siobhan Cleary, WFE Head of Research and Public Policy; Matthias Voelkel, Partner at McKinsey; Markus Röhrig, Partner at McKinsey; Roger Rouhana, Associate Partner at McKinsey and Christian Schaette, McKinsey Knowledge Expert. @thewfe @mckinsey