Validating FinTech Trends in a VC Fund
A glance under the hood at how we validate certain future trends in a VC fund…
In February, OpenOcean, a deep tech venture capital fund hosted a FinTech breakfast roundtable at the Modern Pantry in London. Special shoutout to the stakeholders representing promising FinTech startups and leading corporates (see list of companies present at the end of the post). We have decided to give our DataSeries audience the opportunity to look behind the scenes of how an Investment Thesis-driven Venture Fund is validating certain trends within a chosen vertical.
Niklas, our COO at OpenOcean has moderated the session which touched upon shifting value chains in banking, challenges in RegTech, the possible change of golden banking standards and the kind of innovation that will come out of Open Banking.
See below some of the insights:
Long-standing value chain models are being transformed by new entrants who restructure the way value is delivered to the customer. The large amount of capital and infrastructure required for longer and more complex value chains are no longer required when significant stages are eliminated or shifted to different participants in such a way that the economics are dramatically changed. Incumbents with longer value chains provide ample targets for new entrants to reconceive how, when, and by whom value is created and delivered. Amongst the new entrants are Neo Banks that have managed to grab a small piece of the market by fixing obvious customer pain points and are on track to challenge traditional banking institutions with more complex tasks.
Perhaps in one of many responses, we have seen a massive trend where almost every incumbent has invested in an Open Banking platform in 2019. Have these investments been successful and is this move enough? The product that Neo Banks are currently offering is well received, but there seems to be a slight confusion. Are they trying to become a bank or a tech company? Neo banks are VC funded businesses and are largely not in the lending business. Once they start lending successfully to SMEs and adapt a traditional banking model, then arguably…it can become more interesting. The SME lending sector suffers from the burden of the untimely and complex credit-seeking process. For banks too, credit underwriting and identifying SMEs with reliable credit history is a time-consuming process, which in turn has led to a situation where the relationships have started to dwindle. This huge gap in the market has given birth to a new breed of solutions that specialize in SME lending by providing a structure to their credit flows, enabling them to seek credit faster.
We are seeing an ultimate test where Goldman Sachs is in advanced talks with Amazon to finance small business loans to their e-commerce platform. Over 1.9 million SMEs, content creators, and developers in the US alone work with Amazon and it had more than $863 million in outstanding SME loans at the end of 2019. Amazon is evolving into becoming a trend analyst by better understanding which of their clients needs lending. Paypal has also been lending, however, they only use 3 months old data for its credit risk analysis, which fuels their massive interest rate. Is the tech giant stepping into a traditional vertical rather quietly?
Many incumbents are still thinking of companies such as AWS or Apple as commercial partners rather than competitors. Will we see a paradigm shift?
For RegTech firms, rise in investment is due to businesses having to cope with increasing levels of regulations that have come into force between 2012 and now, including Anti Money Laundering, Know Your Customer, the second Markets in Financial Instruments Directive (MiFID II), Basel III, the Second Payment Services Directive (PSD2) and GDPR. Beyond simply meeting regulatory requirements, many RegTech firms enable businesses to access the ‘big data’ that holds the potential to address many compliance concerns and provide valuable insights into their business. Many incumbent financial services firms have begun to develop a variety of RegTech tools in-house. According to a Thomson Reuters survey of over 500 compliance and risk professionals, “RegTech has started to shape compliance. More than (52%) of respondents considered that RegTech solutions were affecting how they managed compliance in their firms with almost a fifth (17%) reporting they have already implemented one or more RegTech solutions. The global RegTech market size was valued at $2,87 billion in 2018 and is anticipated to expand at a CAGR of 52.8% from 2019 to 2025 (in the VC world, we love these kinds of numbers). With such an enormous growth rate, many current hurdles need to be overcome in order to achieve success:
Based on the last point above, a more philosophical question has been triggered: ‘Will we see a Golden Standard within banking that will be replaced by a startup?”
Currently, there are many “market leaders” out there that offer vertical-based solutions that incumbents are using. We might see a shift where many of the current solutions will be replaced by an orchestration startup, which will offer better solutions with more perks attached to it (something similar to Salesforce).
Based on the current M&A activities concerning “infrastructure connecting” startups, we certainly will see a golden player evolving. Whether this is OSS (OpenSource Software), that’s very unlikely due to compliance issues, as many quants who are/would use OSS solutions are simply not allowed to offload some development with the OSS community. Incumbents have strict IP regulations and are very cautious about their internal network usage and who gets access to it.
Open Banking ultimately refers to the underlying financial technology, born alongside a new regulation — the second ‘Payment Services Directive’ (PSD2) — which came into force on January 13th in 2018. The regulation will see the banks’ previous monopoly on their customer’s account information and payment services being challenged; 3rd party organizations are now competing with banks for access to customer data. Probably the main concern surrounding banking was how very closed their environments were. Now that legislation is forcing them to open them, or at the very least expose their API (Application Programming Interface). They’ve had to make huge changes to their architecture because of this rather different approach. Luckily, this will strengthen the position of financial start-ups, and should invite widespread development and innovation in key areas such as online and mobile payments and account information services. With the introduction of open banking, data will become increasingly vulnerable to attack as it passes through an open interface; this could happen on any customer’s device. It is still early days for TPPs, but the way is paved for significant change in the way we understand payment services. We are still yet to see the exploitation of opportunities and innovation coming out of this sector.
Some of the quotes that made us think:
- “When RegTech connects with data … it’s a way of creating transparency. It’s a disruptive approach to solutions that rests on a few key themes: efficiency, minimizing risk and improving quality”
- “Technology has always been part of Finance, but rarely is there a technical leader sitting in the c-suite executive department of an incumbent”
- The ultimate test: “Goldman Sachs is in advanced talks with Amazon to finance small business loans on their e-commerce platform”
- “Incumbents are not very complaisant as they don’t want to be first movers and fail. They’ve got the stamina to observe and gather substantial insights before moving. It oftentimes depends on the risk appetite they’ve got.
- Insight QNLP: “Applied category theory has provided compositional NLP with mathematical foundations that share similarity to those of quantum theory, suggesting that quantum computers provide a natural setting for compositional NLP tasks”
- “A common cultural challenge many incumbents are still facing is in linking a successful bridge between the ‘tech’ department to operations and strategy. It is still a rarity to see a ‘techie’ at a c-level position”
For February’s FinTech breakfast roundtable we’ve had representatives from the companies below:
Startups:
- Fractal Labs | Passfort | BeyondMinds | Katana Labs and Yields.io
Corporates:
That’s all folks, till next month’s edition 👋
