Innovations in Capital Market for Institutions and retail customers

The capital market is an important part of the global financial system. It is critical in easing the movement of cash between investors and borrowers, giving chances for investors to earn returns on their investments, and allowing businesses and governments to obtain resources for long-term investment plans.

The role of institutional investors in bridging the funding gap in these sectors has not yet completely realized in many Emerging Market Economies (EMEs), as they confront significant hurdles in the development of essential capital market tools. Some of the major challenges have been summarized below:

1. Challenges affecting the enabling environment: These include the challenges related to the state of development of fixed income markets, specifically the lack of a deep and liquid government yield curve with long-dated maturities, well-functioning money markets, credit rating and research analysis services, and robust market infrastructure, including payment systems, central securities depositories, and custodians; and (ii) challenges in the macroeconomic environment, tax framework, and regulatory framework.

2. Challenges affecting the availability and offering of the instruments: They are primarily related to I a lack of a robust pipeline of high-quality investable assets, whether infrastructure projects or SME-related assets; (ii) limitations in the legal and regulatory framework for the instruments themselves, particularly frameworks for securitization and closed-end funds; and (iii) limitations in the offering regime through which they can be placed, including challenges related to the robustness of the information provided to investors and intermediaries such as banks.

3. Challenges affecting institutional investors’ demand for these instruments: They primarily relate to I rigidities and misalignment of incentives in institutional investors’ investment frameworks, which limit their investment in “alternative” assets and incentivize short-term investment, (ii) compounded by many of these investors’ limited risk-analysis capacity in EMEs, and (iii) a lack of mechanisms to align their risk-return appetite, specifically the absence of regulatory guidelines or industry standards that identify simple, transparent and comparable structures that could facilitate investors’ understanding of the risks imbedded in the instruments, and the absence of risk sharing mechanisms such as guarantees.

These difficulties are being met through the use of new technologies and digital disruption in the capital market arena, as mentioned in the next section. Strong leadership and accountability will be required for the creation and implementation of the relevant strategies and action plans.

Innovative products to the rescue

In recent years, several new and innovative products have emerged in capital markets to cater to both institutional and retail customers. These products aim to provide new investment opportunities, enhance liquidity, increase efficiency, and leverage emerging technologies. Here are a few examples:

1. Tokenized Assets: Tokenization is the process of transforming physical assets, such as real estate, fine art, or commodities, into digital tokens on a blockchain. These tokens reflect ownership or fractional ownership of the underlying asset. Tokenization allows for fractional investing, increases liquidity, and broadens investment alternatives. Tokens that are fungible in nature, such as cryptocurrency or gold ingots, are now the most prevalent use of tokens that exist on DLT/Blockchains. Fungible indicates that each unit of an item or commodity is interchangeable with any other unit. As an example, one kg of pure gold is interchangeable with any other kilo of pure gold. However, a new DLT/Blockchain application concept is creating a lot of noise and gaining traction: the tokenization of real-world assets.

Fig.1: The diverse advantages of Tokenized value chain

1. Exchange-Traded Funds (ETFs): ETFs have been around for a while, but they are ever evolving and offering new and inventive methods. New forms of ETFs are developing in addition to typical index-tracking ETFs, such as smart-beta ETFs that use alternative weighting algorithms, thematic ETFs that focus on certain investing topics, and actively managed ETFs that have the flexibility to make investment decisions.
2. Peer-to-Peer Lending Platforms: Platforms for peer-to-peer lending enable direct financing between people or organizations. These platforms eliminate the need for middlemen such as banks, allowing borrowers to access funds at cheap rates while offering lenders favorable profits. Peer-to-peer lending systems frequently use technology and data analytics to efficiently link lenders with borrowers.
3. Cryptocurrency and Digital Asset Exchanges: With the emergence of cryptocurrencies, a plethora of exchanges have sprung up to enable the trade of digital assets. Investors may use these exchanges to purchase, sell, and trade cryptocurrencies and other digital assets. Some exchanges also include cutting-edge features like staking, lending, and decentralized finance (DeFi) protocols.
4. No and low commission: Retail brokerages with no or low fees have fast become the norm in most markets, with many brokerages now offering zero account minimums. Payment for order flow (PFOF) and tipping methods are examples of no-fee businesses. Low-fee models have lower transaction fees but compensate for them by collecting subscription, portfolio management, and foreign exchange fees.
5. Super-apps: Super-apps have risen to dominate the Asian fintech industry, allowing customers to access several functionalities such as investing, banking, and payments from a single location. The underlying technology has enabled financial services organizations to integrate other data sources and non-financial apps to give investors unified access.
6. Robo-Advisors: Robo-advisors are online platforms that offer automatic investing advice. They employ computers and artificial intelligence to provide retail investors with tailored financial advice and portfolio management. When compared to traditional financial counsellors, robo-advisors often charge cheaper fees and cater to customers with lesser investment amounts.

Fig.2: The Ecosystem of the Future

Essentially, a considerably thinner spine than investment banks now have, with heavy use of industry utilities and a varied variety of partners from within and beyond the FinTech ecosystem. The next investment bank is already taking shape. Now is the time for capital market organizations to develop, or risk facing a struggle to catch up in the years to come.

Conclusions:

The new innovative products have advantages and few disadvantages. Following are the Advantages and disadvantages:

Advantages:

1. Diversification opportunities: New and innovative products frequently present investors with more possibilities for diversifying their portfolios.

2. Potential for better returns: Some new and innovative products are designed to offer higher returns than standard investing alternatives. Alternative investment funds or structured products, for example, may provide innovative methods or access to particular markets with the potential for outperformance.

3. Technology improvements: New products in the capital market frequently use technological advancements, such as robo-advisors or online platforms, to improve the consumer experience. These technologies can help investors by streamlining investing procedures, improving accessibility, and providing real-time data and analytics.

4. Access to previously limited markets: Innovative goods can provide investors access to previously inaccessible or restricted markets. The emergence of exchange-traded funds (ETFs), for example, has made it simpler for regular investors to participate in commodities, overseas markets, or specialised industries.

Disadvantages:

1. Inadequate track record: New and innovative items may be lacking in a track record or prior performance data. This makes it difficult for investors to precisely gauge their risk-return profile, increasing the uncertainty involved with investing in these products.

2. Complexity and a lack of comprehension: Some creative goods might be difficult, incorporating sophisticated tactics or underlying assets. Because of this complexity, retail investors may find it difficult to completely comprehend the product’s mechanics, dangers, and possible hazards, increasing the possibility of making misinformed investment decisions.

3. Regulatory and legal risks: New goods sometimes operate within a regulatory framework that is incomplete or unclear. This can expose investors to regulatory and legal risks, such as future regulatory changes, compliance concerns, or unforeseen legal liabilities.

Finally, the capital market business is undergoing a surge of innovation in the products available to retail and institutional consumers. These technologies are redefining how investors access, manage, and develop their portfolios, from algorithmic trading platforms and robo-advisors to ETFs, tokenized assets, and sustainable investing alternatives. As technology advances and investor preferences shift, the capital market sector is expected to develop new and innovative solutions to meet the different demands and goals of investors across the board.

References:

· EY: Tokenization of Assets Decentralized Finance (DeFi) by Darko Stefanoski, Orkan Sahin, Benjamin Banusch Stephanie Fuchs, Silvan Andermatt and Alexandre Quertramp: https://assets.ey.com/content/dam/ey-sites/ey-com/en_ch/topics/blockchain/ey-tokenization-of-assets-broschure-final.pdf

· Accenture- The ultimate guide to product innovation in banking by Michael Abbott: https://bankingblog.accenture.com/ultimate-guide-product-innovation-banking

· McKinsey article- Synergy and disruption: Ten trends shaping fintech by ff Galvin, Feng Han, Sarah Hynes, John Qu, Kausik Rajgopal, and Arthur Shek: https://www.mckinsey.com/industries/financial-services/our-insights/synergy-and-disruption-ten-trends-shaping-fintech

· Builtin article: 94 Fintech Companies and Startups to Keep in Your Back Pocket by Alyssa Schroer: https://builtin.com/fintech/fintech-companies-startups-to-know

· Science Direct research paper- Digital transformation: A multidisciplinary reflection and research agenda by Peter C. Verhoef: https://www.sciencedirect.com/science/article/pii/S0148296319305478

· Financial Stability Board article- BigTech in finance Market developments and potential financial stability implications: https://www.fsb.org/wp-content/uploads/P091219-1.pdf

· HBR article- What Is Disruptive Innovation? By Clayton M. Christensen, Michael E. Raynor, and Rory McDonald: https://hbr.org/2015/12/what-is-disruptive-innovation

· Report by World Bank Group (WBG), the International Monetary Fund (IMF) and the Organization for Economic Cooperation and Development (OECD)- Capital market instruments to mobilize institutional investors to infrastructure and SME financing in Emerging Market Economies: https://www.oecd.org/g20/topics/development/WB-IMF-OECD-report-Capital-Markets-Instruments-for-Infrastructure-and-SME-Financing.pdf

· World Economic Forum- The Future of Capital Markets: Democratization of Retail Investing: https://www3.weforum.org/docs/WEF_Future_of_Capital_Markets_2022.pdf

· Capgemini- The Customer Engagement Imperative: https://www.capgemini.com/wp-content/uploads/2023/04/WRBR-2022-Report_web.pdf

· EY: Capital Markets: innovation and the FinTech landscape: https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/emeia-financial-services/ey-capital-markets-innovation-and-the-fintech-landscape.pdf