Where do You Place Your Bets?
This week, the FT stated that “capital markets fintech ventures attracted less than half as much equity funding last year as they did in 2015 and 2016.”
They were quoting this report from Boston Consulting Group (BCG), and their choice of headline could be considered a concerning development for our sector. Weak investment undermines growth. A lack of capital suggests the fintech bubble is deflating with start-ups and scale-ups, who often require large amounts of investment in their formative years, finding funds harder to come by.
Whilst the funding landscape is certainly changing, it isn’t failing. Amongst the headline news of a funding slowdown, there is also a lot of good news to be drawn from the BCG report.
A slowing of funds
The slowdown in funding has been particularly steep amongst venture capital firms and tier one investment banks, who invested $30m in capital markets fintech companies in 2017, compared to $46m in 2016 and $87m in 2015. This drop off may seem a concern when you consider that since 2010, year-on-year investment growth in fintech has been strong and reasonably consistent.
Tier one investment banks have focused more on investing in internal projects, over making large external investments. This has been supplanted in part by investments by smaller investment banks, from the second and third tiers, who tripled their investments between 2016 and 2017, from $20m to $60m.
Industry-wide, it’s fair to say that investment into innovation is below where it needs to be. BCG says, “Investment banks have underspent on innovation. CTB (change the bank) spend has been flat, and CTB-to-revenue ratio has been lower than that of non-bank liquidity providers.” The report thinks this is due to the millstone of legacy IT systems being hard to shift away from. Legacy is an innovation killer, and, as we all know, big banks are deeply tied to the tech they’ve been using for decades.
Smaller banks know they can compete with slower-moving tier one incumbents by investing in innovative technology that can prove very profitable over the long term. This long term commitment to innovation is good news for our industry, as change is driven from the bottom up.
Return on Investment
As the source of capital markets fintech investment changes, the focus of that investment is changing too.
According to BCG, capital markets fintech investment is now concentrating on efficiencies and cost savings in “less-commoditised business lines such as fixed income, currencies and commodities”. Compared to equities, these assets are currently less automated, requiring more human interaction, so technology is able to have a greater impact. While these business lines are harder to automate, an agile company who is willing to test, iterate and develop this technology will thrive.
BCG found that “investment in fixed income, currencies and commodities can produce productivity gains three times higher than the same investment in equities.” With the equity trade process almost fully automated, there are fewer gains from building further technologies in this space. Gains are found in producing technologies that address more fragmented processes, such as fixed income deal origination in the primary part of the value chain. Up to this point, there has been limited investment and thus innovation within these niches. Hence, going forward, this is where the big opportunities lie and it is where investors will get more bang for their buck.
How will this affect Origin?
Investment doesn’t always equal productivity and future returns. In fact, excessive investment pumped into a niche often results in a ‘bubble’ in that part of the value chain. Further, a pretty good indicator of where opportunities lie is to look where the bulk of the funding isn’t going. It’s in these quieter corners that smarter products end up being built and greater change is affected. The hurdle rate for success is higher, the innovators have to be smarter, and the products only survive if they achieve real customer traction.
That is what we are concentrating on at Origin. Given the huge investments made over the last decade into equity-based fintech, and into functions such as execution and post-trade, we believe that productivity and returns will come from building products that are best placed to extract the remaining “juice” from innovation. That’s why we’re laser-focused on the primary part of the value chain in fixed income. Both of these niches have seen limited investment since 2010 when the fintech boom began and we believe, this is where the opportunities lie.
While total funding for capital markets fintech in 2017 may have slowed, innovative companies and forward-thinking banks should not have cause for concern. In fact, given the scope of the opportunities still out there, the current funding landscape just confirms to us where we should be placing our bets.