Analysis

Capital Markets: Innovation and the FinTech Landscape

How collaboration with FinTech can transform investment banking

By Ernest & Young

Foreword

Until recently, FinTech was mainly focused in the payments, remittance, peer-to-peer lending and equity crowdfunding sectors. But, over the course of the last year, we have seen an increase in activity in capital markets: solutions to complex front-, middle- and backoffice problems are emerging in the form of FinTech solutions.

Driven by a powerful blend of innovative startups and major technology players, the global FinTech industry is growing apace, using technology innovation to capture market share from incumbents in many areas of financial services. While the FinTech entrants’ greatest impacts to date have been at the retail end of the market, the opportunity for collaboration in capital markets is real and growing; this is great timing given the challenges faced mean that innovation has become mandatory.

The analysis and recommendations expressed in this report were produced by EY and informed and shaped by more than 40 stakeholder interviews conducted with investment banks and FinTech firms across the globe.

PART I: The “WHY”

Why collaboration with FinTechs will be core to the evolution of capital markets?

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If investment banks can take the right steps today, the outlook for the industry is much brighter than many commentators are currently suggesting. Some of the megatrends — ranging from the rise of emerging markets and the growth in entrepreneurship to the pervasive shift to digital — are likely to play nicely to the strengths of investment banks. In combination, these forces mean that hundreds of thousands of businesses will need access to capital and support in managing risk in the years ahead, with many of them growing into the global corporations of the future. So it’s important for investment banks to look beyond today’s downbeat industry mindset. A whole world of businesses is emerging that will need to be served, but isn’t being served today — and investment banks are ideally placed and equipped to fill the gap.

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Today, innovation in capital markets is no longer an option, but an absolute imperative, for investment banks to survive and thrive into the future. To sustain their business in the long term, they need to change the game. Continuing with existing operating models, business models and ways of working will not achieve that. So today’s capital markets firms face a stark choice between undertaking radical innovation or sliding toward irrelevance.

Collaboration — not competition — is the way forward

While FinTechs in retail financial services have often competed with traditional players by disintermediating them and taking their market share, the higher barriers to entry in capital markets mean rules of engagement are likely to be different. While some disintermediation opportunities exist, our view is that the better answer for both FinTech and incumbent firms is to collaborate rather than compete.

By building a better ecosystem, firms can reduce structural costs, comply more easily and effectively with regulation and, ultimately, become better providers of capital markets services to the end users of finance and the real economy. The concept of open innovation, whereby firms actively pursue external and internal ideas and paths to market, has already taken off in other industries, such as pharmaceuticals. Now, it’s the turn of capital markets to exhibit the collaboration gene.

PART II: The “WHAT”

What opportunities for collaboration are possible now and in the future, given the range of underlying technologies that are currently available?

There is no shortage of innovation ideas; the challenge is validating them

There are countless ideas for innovation being brought to market. The challenge faced by the investment banks is, therefore, validating which to actively pursue.

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There are opportunities everywhere, front to back, throughout the bank

Historically, investment banks have invested heavily in frontoffice innovation. During the boom years, little attention was paid to the middle and back office due to the healthy profit margins achieved. As a result, these functions have become heavily reliant on additional headcount and spreadsheets, and have not addressed challenges relating to underlying infrastructure. As FinTech offerings come on stream, new opportunities exist to transform the middle and back offices, especially through externalization and use of Regulatory Technology (RegTech) solutions to transform compliance. Innovation opportunities are also now available in the front office as Advanced Analytics and AI help to improve decision making, enrich insights and reduce costs.

Start with proven technologies before venturing into emerging ones …

In technology terms, we believe the best near-term opportunities for FinTech collaboration can be found in established areas such as RPA, Advanced Analytics, externalization of processes and services, and digitalization. While more maturing technologies such as AI, smart contracts and Blockchain have clear potential to be game changers further down the line; they will take a few more years to come fully to fruition.

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… but keep scanning the horizon and testing out new frontiers

It’s important for investment banks to stay involved in developments at the frontiers of innovation by testing out and piloting new technologies such as Blockchain and AI. While tangible results may take a while to achieve, firms need to be actively engaging in proofs of concept in order to determine which use cases are most viable.

PART III: The “HOW”

How investment banks and FinTechs might collaborate to create value for all parties.

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Clarity is vital for both investment banks …

In order to engage in FinTech collaborations that deliver truly transformational value, investment banks need to be clear about the innovation model that they’re going to operate. It’s important to accept that there’s no innovation without risk, and set the scope and mandate for innovation, procurement and, indeed, retained technology functions accordingly. Investment banks also need to work out how best to engage with FinTechs, given the contrasting size and cultures of their respective organizations.

… and FinTechs

For their part, FinTechs need to have absolute clarity on the purpose and need that they aim to fulfill, the problem that they are solving for the investment banks and other market participants, and the context in which they solve it. They must also know how best to approach and navigate their way through investment banks, in an industry where organizational structures are often complex and opaque, and where attention spans can be short.

Focus on business case — and IP

For any collaboration to deliver value sustainably, the FinTech partner must focus rigorously on building a credible business case — including the pricing model. And it must keep its IP “crown jewels” secure, an imperative that can present some tough choices about what information to share with whom and when.

The winners will be those that build the strongest ecosystem.

The successful investment bank of the future will look quite unlike many existing banks today. The retained organization will likely be stronger and leaner, augmented through external collaboration with FinTech firms, market utilities and managed service providers. The technology landscape will likely be modular and interoperable, and ultimately, simpler. The culture will be one of collaboration, not protectionism. Achieving this will not be straightforward. It will require strong leadership, governance, tenacity, and commitment; the stakes are high, and failure is not an option.

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PART IV: The “WHO”

Who is likely to play key innovation roles going forward?

Organizations offering FinTech innovation services to capital markets.

Our list of organizations offering or enabling FinTech innovation in capital markets does not claim to be exhaustive. But it does include over 130 diverse active participants in the FinTech ecosystem, spanning not just startups, but more established players that are pushing the innovation agenda.

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