“Banks should create Fintech ‘validation labs’ instead of innovation ones”

Interview with Mark Beeston, Founder and Managing Partner of Illuminate Financial Management

Collaboration between traditional financial institutions and new Fintech firms is often considered the landscape of tomorrow’s financial industry. However, the path towards that scenario is not always clear. That’s why some partnership structures to connect early stage business to some these incumbents are flourishing.

Today, we talk with Mark Beeston, the Founder and Managing Partner of Illuminate Financial Management, a London-based venture capital firm -with an international reach- exclusively focused on making these connections on the capital markets financial technology arena.

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So Mark, why create a VC firm only focused on the Fintech capital market segment?

I set up Illuminate because I believe we are at a moment of generational change in terms of capital markets infrastructure driven by industry deleveraging, increasing regulation and the compliance environment. Illuminate was established to help fund and bring to market capital markets for fintech companies that are originating solutions to the new problems; if only they can get their potential clients to connect with them. As such we only invest in those cases in which our network of industry contacts and strategic partners can be helpful to these startups. That’s one of the reasons why we don’t invest in more consumer driven fintech such as mobile payments, peer-to-peer, and challenger banking.

When you say ‘network of industry contacts”, do you mean banks? Helping Fintech solution providers to partner with them does not seem like an easy task.

Our bank contacts and partners are of course important but it is not only about banks. If you are selling in the capital markets’ Fintech space, then banks are an important part of your target base, but you may also want to deal with buy-side firms of all kind and sizes and quite possibly the big infrastructure providers too: think exchanges, clearers, data vendors and others.

Of course, large tier 1 financial institutions are difficult to sell to for a lot of reasons. First, if you are a large organisation and here I mean with ten of thousands of people across many different geographies, it is just tough to qualify the organisation and access the person or people that are the decision-makers against the problem that your solutions are trying to solve.

Beyond that, these big financial corporations can seem virtually impenetrable to the small vendor because once you find the right person the first thing they will ask is ‘who are you’ which is not an unreasonable question, particularly if you are trying to sell them something mission critical. And then, the second question will be: “how do we know if you are going to be here in three years time?”

Would you say is it a matter of risk aversion then?

I would say it is more a natural size problem, since large organisations are not naturally well structured to connect with the consumer from small ones. For example, we all know that the procurement process at a large organisation can be particularly arduous since they are optimised for ensuring that other large vendors are well controlled and managed. These are a very different set of priorities than those required to onboard younger, earlier stage solution providers into your organisation.

Besides, I think that a lot of the decision-making processes in large institutions have become quite opaquely syndicated. So even if you can find the right person, it is highly unlikely that such a person is the sole decision-maker. And it also happens pretty often that the individual that you are selling to in the large institution also won’t be 100% sure about how many other people they have to sell that decision to in order to get the final sign off.

But this is not a criticism of the banks. It’s just difficult. We see them also trying to address this and that’s one of the issues that we try to tackle when we work both sides of the financial markets community.

And would banks acquiring these companies be the final goal?

At the early stage, certainly not. It’s all about sales so we are focused on a three-stage process that would end up with the adoption of the vendor’s product. For me, these are the three main stages: 1) There’s innovation, which is what the entrepreneurs are doing; 2) there’s validation, which is why you need the contacts at the institution; 3) there is the adoption of the product.

Of course, the ultimate exits for these companies will most often be through consolidation, so although acquisition is not our primary goal, the vendors we fund and assist are unlikely to get acquired unless there is a useful adoption step.

I guess that the solution goes beyond banks’ creating innovation labs then…

All large institutions are creating Fintech innovation labs. They all have heads of innovation. They all get on a plane and go out to the west coast to see what innovation culture looks like. I think that in many cases, this approach risks missing the point as we believe that there is more innovation than ever before — and there are more challenges that need solutions adopted against them than ever before. However, it is the validation and the subsequent adoption steps are broken.

For that reason, I strongly suggest that there should be fintech validation labs, not innovation ones. This innovation component seems to suggest that if you buy enough bean bags in the room with the right people, then they will have great ideas that the bank will implement.

For us, the trick is to survey the landscape and bring the business closer to the innovation problem that is already there. And that doesn’t need to be done in a lab. In fact, it probably needs to be done a lot closer to the desk of the problem owner; either in the front, middle, or back-office. And that’s what we’ve been doing: trying to connect the best of the 1100-plus companies we’ve seen (since we set the business up) with the correct people: be that buy-side or the sell-side so that they can validate those technologies and decide whether to adopt.

How does retail fintech differ from capital markets fintech in this sense?

I think in the retail arena banks should have a healthy fear and respect of innovation but this fear cannot translate into running away, but almost running towards it. You need to be at least as innovative as the rest of the community, either by creating your ideas or by investing or collaborating or acquiring the early stage entrepreneurs because those are the people that could ultimately disrupt elements of your business model. And that could be said similarly of the asset or wealth management space.

I think the disruption on the capital market side is much more about disrupting processes to the benefit of the incumbent institution rather than disrupting the incumbents themselves. If Ford decides to launch a 10 billion dollar or euro bond, it’s not going to get funded on a peer to peer platform; it’s going to be syndicated by wholesale market participants. You need to harness the innovation that will help to manage and process the syndication better, reducing its risks and costs. So it’s a different approach based around finding better enabling technologies to support the business rather than disrupting it.

And do you think that the industry is prepared for the adoption step you mentioned before?

I think is quite hard actually to measure how well it has taken off although the industry is putting an enormous amount of effort into that engagement, through all those laboratory initiatives.

At Illuminate we have our strategic partnership structure to connect early stage business to some of our partners, and I think the pace of that is increasing. Three years ago, the banking world, and the capital markets world was broadly not ready for a fully cloud-delivered set of tools. Now, this is changing. In fact, our industry is becoming much more ready for a micro-services type architecture which will allow early stage fintech just to deliver the best in class components of tomorrow’s operating environments. And I think the more adoption of those services you get, the faster the pace of change and adoption will also become.

A further driver is that financial organisations are more and more pressured to change their cost model — and they are crying out for solutions. On the one hand, they have more regulatory requirements to comply with perhaps than ever before i.e. MIFID II, Best execution, Research Unbundling, BCBS 239, FRTB9, Basel 3, etc. On the other hand, their cost model is also unsustainable since it often only scales up with volume but cannot scale down with decreasing volume which importantly, these new technology delivery models can deliver in a way that traditional enterprise software models cannot. The combination of these two factors — regulation and costs — suggests to me that we are at our adoption inflexion point, and such adoption will get faster and faster from here on.

But not every bank is at the same position in this race.

Sure, it varies dramatically, not only from one organisation to another but also from one senior manager to another within the same organization. But again, I think most of them are increasingly opening the doors to a cloud-delivered model, which means that we are definitely seeing the groundwork being laid for large organisations being more open to adoption.

You do see organisations where they are introducing fast tracking to fintech. Many have realised the methods that they use to deal with established vendors like Bloomberg or Thomson Reuters do not work when we talk about of solutions providers to companies of 10, 20 or 30 persons.

And why are many banks are still reluctant to this in-house validation and adoption approach? Is it a matter of organisation culture?

Culture is one of the main reasons. That’s why you see so much “west coast” corporate tourism going on, with people getting out of their organisations and looking for the entrepreneurial culture that they can put in a bottle and take home.

But these types of organisations are not comparable. West coast startups are often driven by a singular-minded personality that is pursuing some ideal, whether it be the connectivity of Facebook, or the travel to Mars by SpaceX. It is very difficult to replicate that in a 300-year-old financial institution where the CEO might be the 28th steward of that company.

So, I often say that in many cases there are very few people inside the organisation that really understand what is like to be a vendor and particularly a small vendor at that. So, if you want to change innovation culture, it starts from the top down. If you made me the head of innovation of a bank tomorrow, I would literally send out an email that reads: “If you are director level or above, I want you to spend an hour a week validating new technologies in our space and send me your results.” That validation step needs to be enshrined in the culture and the organisations that get that right will see real transformation appearing across their businesses.

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Originally published at www.kantox.com on April 11, 2017.