Today’s most promising technologies such as blockchain, cloud computing, AI, and machine learning will revolutionise business models in the financial services industry with new products and delivery channels. Will incumbent financial firms and today’s leading banks develop the right strategies to deploy these technologies successfully? Or will today’s technologies enable fintech entrants to upset industry leaders with distruptive business models?
Predicting the technological futures for exchanges and clearinghouses will be challenging, but that did not stop a three-person panel from offering their visions of the future at the WFE's Technology Conference in Umeå, Sweden. I was joined by Brad Peterson, Executive Vice President and Chief Technology and Chief Information Officer with Nasdaq, and David Saul, former Senior Vice President and Chief Scientist of State Street Corporation, to take a brief look at the past for a better insight into the future.
Technology: a disruptive history
Rapid implementation of new technology is a hallmark of the financial markets and investment industry. After the invention of the telegraph in 1837, commodity and financial prices in different cities, which once lagged by days or weeks, were set simultaneously as markets connected telegraphically. The foundational technology of the telegraph stimulated further innovation and spawned businesses that moved the financial industry forward. In 1867, the stock ticker service was introduced, and in 1870 Western Union launched its money order service with quicker funds availability than the post office and other alternatives at the time.
Technological discontinuities such as the telegraph, the PC, and the internet have caught many leading firms off guard. In 1990, sales of the Encyclopedia Britannica, which each sold for about $1,400, peaked at 120,000 sets. In 1996, Encyclopedia Britannica laid off its remaining sales force, which had been 2,300 employees, and stopped selling the 32-volume set door-to-door. In 2010, 244 years after its first edition, the last physical Encyclopedia Britannica was printed. The crowd-sourced Wikipedia, available at no cost on its website since 2001, contributed to Britannica’s demise.
At the 1998 PC Expo in San Francisco, then Merrill Lynch Vice-Chairman John Launny Steffens said: “The do-it-yourself model of investing centered on internet trading should be regarded as a serious threat to Americans’ financial lives.” Within a year, online broker Schwab’s market capitalisation hit $25 billion and overtook Merrill’s with its 18,000 commission-charging financial consultants.
Not every disruptive approach succeeds. A much-heralded effort to computerise the trading of large blocks of stock, Optimark, raised $350 million in venture funding and opened in January 1999. Its black box market model used rapid auctions and a patented matching engine to generate trades. Many expected it to erode liquidity on the New York Stock Exchange, and NYSE membership seats that had been selling for more than $2 million dropped to $1.2 million in September 1998. Peak daily volume on Optimark only reached 1.2 million shares in September 1999. Optimark closed in September 2000, and NYSE seats rebounded in value to $2.5 million.
Even the best crystal ball would have struggled to predict the rapid rise of Wikipedia to displace Encyclopedia Britannica, or how quickly online trading disintermediated retail brokers. And yet, technological innovation is again at the precipice of revolutionising the financial services industry.
A gateway to better financial decisions
Peterson highlighted the need to use technology to improve financial lives for moderate- and low-income households. In its 2018 survey of 5,000 U.S. households, the nonprofit Center for Financial Services Innovation (CFSI) found that only 28% of Americans are considered “financially healthy.” Some 44% of respondents said their expenses exceeded their income in the past year, and they used credit to make ends meet. Another 42% said they have no retirement savings at all.
Connectivity and tech-driven inclusion are the answers to improving households’ financial health according to Peterson, who sees equity investing as the most attractive destination for savings, but accessible only to affluent households. While low- and moderate-income households have access to smartphones, few have investment accounts to hold stock.
Phone access, subshare investing, and downside limits with put options could provide the gateway to better financial plans and decisions. The legacy cost model of the investment industry means small accounts are not profitable, but new entrants and smartphone access will enable households to achieve attractive returns and become better savers and investors. Peterson also identifies low-cost fund transfers as a critical gap in the financial industry’s offerings. Small value remittances are critical in working class families, but costs remain high, and new technologies are capable of disrupting the movement of money among consumers. While Facebook’s recently announced Libra cryptocurrency is only in the conceptual stage, it or a variant could be a solution to moving money efficiently across borders for less affluent households.
Breaking away from complex systems
Saul pointed out that realising the promise of the new technologies requires breaking away from the industry’s fragmented and complex data ecosystems. Saul recommends leaders push for centralised, industry-defined standards and harmonisation. Those standards will lead to interoperability and improve the scalability of banking systems so firms can move off inflexible legacy platforms. Better practices for enterprise data management are needed for this transition to occur. Blockchain and cryptocurrency technology are held back by negative scalability, Saul pointed out. Users need to develop trust in new financial services business models that utilise smart contracts and scale efficiently as their scope and volume of use grows. Recently, Saul outlined a set of data management practices in a white paper titled “Strategic Data Tenets.”
Today’s most hyped technologies are creating new opportunities and will disrupt investment firms, exchanges, and clearinghouses. The internet altered the landscape of several industries such as encyclopedias and retail brokerage in the recent past. Developing strategies today to introduce blockchain functionality, and machine learning and other AI initiatives will provide a platform for enhancing business models, creating more value for customers, and enabling financial institutions to avoid being overtaken by more technologically savvy firms.