Sustained innovation: fintech comes of age
Much has been said about the emergence of fintech in recent years, not least the notion that fintech firms, both established and start-ups, have the ability to depose incumbent providers of financial market infrastructure (FMI) services.
But recent evidence suggests that rather than work in opposition, these two camps can achieve more if they work together, leveraging each other’s skills to deliver services that mitigate risk, increase efficiencies and reduce the cost of delivering new products.
Before we explore this further, it is worth highlighting the common misconception that for fintechs to be innovative, they have to be disruptive. This is not the case: the term “disruption”, originally coined by Clayton Christensen, has been misused when discussing innovation.
Christensen distinguished between disruptive and sustaining innovation, suggesting the former occurs in situations where incumbents focus on improving their products and services for their most demanding and profitable customers, creating an opportunity for new entrants to target overlooked segments and gain a foothold by delivering functionality that meets their needs at a lower price and on lower margins. These entrants then move upmarket, improving their products until they start to deliver the performance that some of the incumbent’s mainstream customers require, while preserving the price and other advantages that drove their early success.
In contrast, “sustaining innovations” are improvements to products and services that better meet the needs of existing customers. They may be incremental enhancements to existing offerings or new ways of doing business, and they can be offered by both incumbents and new entrants. The key point is that they focus on markets that already exist. Most financial market infrastructures (FMIs) and fintechs are working on these sustaining innovations by offering new solutions to existing market participants.
In their efforts to bring innovative new products to market, both fintechs and FMIs face significant challenges. As a client base, financial services firms are not easy to sell to; identifying opportunities for change often requires deep knowledge of processes or bank economics. Budget cycles are rigid, especially outside the front office, and competition for resources between different initiatives is often intense. The practical hurdles of extended procurement and vendor risk assessment processes are high and rising, particularly if the product being offered requires data to move outside the firewall of the client firm, a common requirement for FMIs to operate.
In addition, tenures of senior people in banks rarely align with the sales and onboarding cycle for innovative new products, which can result in the sudden loss of a client sponsor that can take the process right back to square one.
Finally, the regulatory scrutiny within the financial services industry means that services must meet standards that enable their clients to fulfil the integrity and compliance standards required of their operating models which can significantly increase the cost to operate new services, a challenge when revenues are uncertain.
Fintechs and incumbents can collaborate to overcome these challenges by understanding that their respective strengths and weaknesses are complementary. Fintechs are agile decision makers; they can respond quickly to the needs of clients, pivot to new opportunities and sometimes use their capital structure to drive their product marketing and overcome network-building barriers by inviting early adopter clients to become shareholders. On the other hand, they may lack a proven track record to pass vendor risk assessments, persuade their clients to share sensitive data or be trusted with critical processes. They may also not have the financial stamina to stay in the game long enough to build successful networks.
In contrast, incumbents have the longevity, reliability, trust, established client and regulator relationships and, in theory, the financial strength to withstand long “go-to-market” phases. However, they can be risk-averse and slow to make decisions. This can lead to missed opportunities and a tendency to over-engineer solutions in new fields. In addition, well-established relationships with regulators do not automatically translate into approval for new ideas.
As such, fintechs and incumbents in the market infrastructure space should learn to exploit the natural synergies inherent to their relationship to overcome the obstacles found in moving from concept to production. This will allow the industry to create a radical new synthesis between fintech creativity and FMI reliability; recent examples include DTCC and Euroclear joining forces with a consortium of banks to invest in AcadiaSoft, or the Australian Stock Exchange taking a stake in Digital Asset Holdings before becoming the start-up’s anchor client (although the project is taking longer than anticipated).
It is clear that potential gains from fintech and market infrastructure collaboration are great, but to ensure success it is essential that each party knows exactly what it can bring to the table and that they recognise each other’s strengths and weakness. Only by working together and learning from each other can such partnerships deliver the operational efficiencies and cost savings so essential to their clients.
By Angus Scott, head of product, CLS