Disruption and disintermediation – these words capture the opportunity inherent in new technology. By disrupting traditional industries, tech-based newcomers can take swathes of market share from old-fashioned incumbents. Much of this is done through disintermediation – cutting out the middle men. We see this all around us, as Amazon menaces traditional retailers and Uber revolutionises the way we get about town.
One industry that presents an obvious target for technological revolution is finance. Bloated, slow-moving and widely distrusted in the aftermath of the 2008 crisis, the mainstream financial industry certainly looks ripe for disruption. Moreover, the financial sector contains layer upon layer of intermediaries. But its complexity, regulation and sheer scale also make it far more daunting than simpler sectors such as retail. Thus far, the big banks and financial services firms have appeared relatively resilient to the threat that young, dynamic financial technology companies represent. So is ‘too big to fail’ also ‘too big to disrupt’?
The answer, of course, is no. A quiet revolution is already underway. Here, fintech is the term that encapsulates the threat for incumbents and the opportunity for investors. Fintech – financial technology – is a concept that’s been around for the best part of a decade, but has yet to deliver the sort of massive disruption that we’ve seen in other industries. But there is a difference between the way that tech companies have broken up other industries and how fintech firms are looking to disrupt the world of finance. Most importantly, fintech start-ups aren’t trying to replace banks and insurance companies wholesale, but simply to do bits of their business better. This ‘parts rather than whole’ concept is crucial to understanding the opportunity that fintech presents.
Rather than swallowing up the financial industry whole, as online retailing has devoured much of the high street, fintech companies and concepts are nipping at the heels of the big banks – and are set to bite out increasingly large chunks.
Lending, for example, is an area where fintech has massive potential. That potential is already being realised through the phenomenon of peer-to-peer lending. One of the effects of the financial crisis was a massive tightening up by the banks in an effort to reduce risk. This has made them far more reluctant to lend to smaller businesses and individuals than in the past. In turn, that has allowed tech companies to establish lending platforms that go a long way to disintermediating the process of connecting lenders to borrowers. This not only answers a pressing economic need, but has facilitated the advancement of technology-enabled risk assessments. The use of data is an important part of this: technology companies can use broad swathes of information to assess risk dispassionately, avoiding some of the biases that hamper risk assessment at traditional banks. More accurate risk assessment provides greater security for lenders, creating a virtuous circle through the matching of risk appetite to lending risk.
We have reviewed several opportunities to invest directly in these peer-to-peer lending platforms which match borrowers and lenders in such an intuitive and well-thought through way. We hold a position in Ratesetter, which allows lenders to choose the rate of interest they wish to charge and is planning an ISA launch which, subject to regulatory approval, will offer investors increased tax-efficiency when providing loans via its platform. The business has a high quality and ambitious management team. Its solid business model is underpinned by a conservative approach to risk, a diversified funding profile and a clear focus on the quality of both lenders and borrowers.
These platforms are not only benefiting from the high-street banks’ current reluctance to lend, but are also more in tune with the way that people want to borrow. The convenience of remote access and increased speed, combined with distrust of traditional banks, is making the branch-based model look increasingly outdated.
Our funds have also invested in P2P Global Investments. This is a company that invests in a range of online peer-to-peer lending platforms and loans. It uses a proprietary technology system to seek out the highest quality loans available on these platforms. To manage risk, it targets a diversified portfolio of loans to both consumers and businesses across multiple geographies. It can also often invest in the platform providers directly. This leaves it well placed to deliver a stable and attractive income stream to its shareholders. Another of our portfolio companies, VPC Speciality Lending, takes a similar approach.
Companies like Provident Financial and Non-Standard Finance are also exploiting the absence of competition from high-street banks. Although these firms aren’t primarily driven by technology, they are making increasing use of mobile technology and customer analytics to ensure that they maintain an edge over their more traditional competitors.
Another portfolio company that combines some traditional aspects with a fintech approach is Purplebricks. The company is a ‘hybrid’ property agent, combining an online platform that allows people to upload details of their properties with a team of flesh-and-blood agents. It operates 24/7 and is well placed to significantly disrupt the UK’s traditional estate agency business model – indeed it is already doing so. Its ‘clicks and mortar’ approach (or ‘clicks and bricks’, if you prefer) has enabled PurpleBricks to outsell all the UK’s other leading online agents put together. We have been impressed with the management team’s ability to deliver to its ambitious growth plan thus far and, with an intensive focus on the quality of service that it provides to its customers, we expect the hybrid approach to deliver continued strong growth in the years ahead.
Meanwhile, the so-called ‘challenger banks’ have sought to disrupt the very core of the traditional banking world. This is of course a vast market, so even a tiny market share from these disruptive new businesses can create a profitable and attractive business. The latest challenger bank to gain regulatory approval is Atom Bank, which we invested in at a very early-stage as it sought the regulatory permissions needed to launch. We have been very impressed by its innovative, customer-focused, digital business model which is not subject to the legacy trust issues and inflexible infrastructure that holds back established banks in the UK. The high-quality Atom team has made significant progress already and we are increasingly confident that the company is extremely well-placed to deliver strong long-term growth.
In many ways, fintech is already part of the furniture. You can already use Apple Pay on your iPhone to get through London’s Tube barriers, for example. And many people are familiar with crowdfunding platforms, which allow creative projects to obtain start-up finance. We currently invest in Seedrs, which brings a similar approach to equity investment, opening up venture capitalism to anyone with an internet connection that is willing to invest some spare cash.
Fintech firms do, of course, face significant challenges. Financial regulation is clearly a hurdle, especially given different regulatory jurisdictions around the globe. And the complexity of traditional financial businesses is a challenge too – albeit one that fintech companies are set to overturn through taking on parts, rather than the whole, of the incumbents’ business model. By ‘unbundling’ the operations of a traditional bank, fintech companies aim to unravel this complexity and are able to deliver a simplified, more ‘user-friendly’ service to their customers.
Ironically, some of the other main threats to fintech companies are technology-related. Cybersecurity, for instance, will be a major concern. The banks may be distrusted, but fintech companies need to demonstrate that they deserve to be trusted with clients’ data. Furthermore, many fintech developments are likely to impose severe demands on the available internet spectrum. Both of these challenges are, however, as much a problem for incumbent financial services companies as they are for the fintech challengers, if not more so. It is potentially much easier, for example, for a new business to embed the latest technologies to reduce cybersecurity threats, than it is for an existing business to retrofit them.
The Confederation of British Industry expects the UK’s fintech sector to be worth £300 billion by 2020. The investment opportunity is undoubtedly attractive. But perhaps the most exciting aspect of these disruptive technologies is that their implications are not yet fully understood. Our aim is to back the most exciting of these quiet revolutionaries as the enormous changes they are making begin to play out.