Fintech continues to be one of Canada’s hottest technology sectors. From the number of newly formed startups to the countless technology conferences targeting financial services, Fintech whispers can be heard not only on Bay Street but also across Canada. An increasing number of startups are building applications that are unbundling, eliminating, improving or re-imagining existing financial services including payments, lending, capital markets, banking infrastructure, insurance and investment management. In fact, investors have deployed over $730 million CAD in Canadian Fintech startups since 2015. However, Fintech startups have yet to pose a significant threat to the Canadian financial institutions. This blog outlines our thoughts on the current state of the Canadian Fintech ecosystem and emerging trends.
Funding environment remains robust
The Canadian Fintech ecosystem is on track for a record funding year. Investment in Canadian Fintech startups hit an all-time high in 2017, with $304 million in funding as of October 2017. Three segments account for majority of VC Fintech investment activity in Canada: personal finance & wealth management, lending and billing & invoicing.
[OMERS Ventures considers Fintechs to be technology companies that aim to compete with traditional financial institutions in the delivery of financial services. Source: Pitchbook; amounts are stated in $CAD; 2017-YTD data as of Oct 31, 2017. “Other” Fintech categories include Insurance, Institutional & capital markets and Blockchain & cryptocurrencies.]
However, before Fintech cheerleaders get too excited, it is worth mentioning that four companies (Wealthsimple, Wave, Sensibill and Borrowell) accounted for approximately 60% of VC funding this year. In other words, a vast majority of funding went to a handful of companies operating with established brands and reasonable levels of business scale.
Consumer focused Fintech startups need partnerships to succeed
There is no doubt that consumer adoption of digital financial services is accelerating. A vast majority of VC backed Fintech startups have been focused on direct to consumer financial services (e.g. mobile banking, lending, etc.). Superior user experience (e.g. ease of onboarding), cross-platform offerings and lower fees are key motivations driving these startups targeting core consumer financial services offerings. In response, financial institutions are attempting to leverage their vast scale and infrastructure to offer their own digital products in order to protect their core consumer offerings.
Leading Fintech startups are partnering with larger financial institutions by integrating their products and/or receiving direct investments (e.g. Power Financial’s investment in Wealthsimple and Borrowell). Partnerships with financial institutions are helping Fintech startups grow their brand and acquire customers more efficiently. Without these strategic investments and relationships, most B2C Fintech startups have faced sub-scale business economics due to the high cost of customer acquisition. Hence, startups have adjusted their aspirations from disrupting financial institutions to cooperating with the incumbents.
On the flip side, financial institutions are entering into partnerships with startups to strengthen their digital capabilities and enhance customer experience to create a win-win-win proposition.
SMB banking is next
One segment that has yet to see market upending innovation is SMB banking. There are over one million small and medium sized businesses (SMB) in Canada. Servicing the SMB segment has always been a major challenge for larger companies, whether in financial services or in other industries in general. Some industry estimates place SMB customer acquisition costs for incumbent financial services companies at over $1,500 per customer. SMB customers are highly fragmented and difficult to find, and price sensitive given the fluid nature of their businesses. Yet there are so many of them and they can be a valuable customer set for startups to build their services around. In the broader Fintech world, numerous Canadian technology companies have successfully built businesses around this target set: Shopify most notably as the online engine powering small retailers, but many others including Wave (accounting), Plooto (money transfer), ThinkingCapital (lending) and League (insurance/benefits services) (Disclosure: OMERS Ventures is an investor in both Wave and League.)
Despite the successful launches of the technology-based services to the SMB segment, digital business banking remains the domain of the incumbent financial institutions. The SMB segment represents over $20 billion in banking services in Canada. Technology innovations such as increased mobile adoption, the availability of reliable and cost-effective cloud computing and storage capabilities, adoption of SaaS business model and micro-targeting of digital ad platforms such as Google and Facebook will change this. We have seen the emergence of SMB focused banking solutions in other countries, such as Tide in UK and Seed in the U.S., and we expect this trend to accelerate in Canada.
AI in everything
Canada has garnered global attention as home to some of the world’s leading Artificial Intelligence (AI) talent. AI is a key technology trend that has drawn significant investment by the world’s leading technology companies and AI’s impact will be profound including in financial services. While AI driven Fintech applications are in the early stages of their development, they may only be as good as the underlying data sets. Existing Fintechs with proprietary customer data will look to integrate AI into their existing workflows, while AI specific startups will look to build strong AI talent pools and software capabilities. Financial institutions have a huge advantage over startups given their immense library of data sets. Hence, AI startups may have little data leverage. Regardless, Fintech startups should expect Canadian financial institutions to open up the floodgates on AI proof-of-concepts (POCs) and services/consulting contracts over the next year. It is too early to tell if any of the potential Fintech AI POCs/use cases will see eventual commercialization but exciting innovations lie ahead. Again, in this context, we see further partnership between incumbent financial institutions and the startup universe, versus any significant incumbent market share erosion.
Blockchain is still nascent
It is true that we have yet to see Canadian financial institutions embrace blockchain technology beyond POCs. And scalability, interoperability, implementation complexity and regulatory uncertainty are hindering enterprise adoption. But if the recent surge in digital currency prices is any indication, we are in the midst of something special. Whether its pure speculation or market participants waking up to digital currency as an emerging asset class, our long term view on blockchain startups remains bullish (more on that in our next blog). As the blockchain community figures out the technology’s kinks in the medium term, the technology will have a pervasive impact on the way the world operates in the long term.
In summary, Fintech startups have yet to make a significant dent in the Canadian financial services sector. This is perhaps no surprise, as other mass-market consumer services remain the domain of large companies. However, Fintech innovation is not fading away — many consumer-oriented companies have gone on to partner with larger companies to accelerate growth. And financial institutions are beginning to work with startups to power existing and new financial products. Moreover, a ‘challenger’ group of Fintech startups are making progress in addressing needs of SMB customers, a segment often perceived as unprofitable by the large incumbents.
All in all, we remain bullish on the Fintech industry. The future will be more digital, decentralized and autonomous. Fintech is not dead — rather, it is entering the market behind the scenes and remains in its infancy.