Fintech in 2017: Huge Risks But Also Breakthroughs
Editor's Note: This post originally appeared, in slightly different form, here.
It is this time of year again where many of us willingly and willfully make fools out of ourselves trying to predict the future of the fintech industry. The momentous electoral events we have witnessed and those coming up in 2017 remind me that, even more so for the next 12 months, macro risks will rule and influence the state of financial services and fintech. I will limit myself to comments pertaining to the U.S. and Europe.
I have already attempted to decipher a Trump presidency in a previous post, see here. Suffice it to say there will be winners and losers in the five sectors of the industry – lending, capital markets, asset management, payments and insurance. Regtech may be impacted the most if the U.S. experiences a wave of deregulation. Although I still ascribe to a secular and long-term trend toward regulatory harmonization, we may see deviations at the margin, especially within sectors that are more domestic than international by the nature of their activity. I would not be surprised if U.S. domestic lending regulation, compliance and enforcement are loosened while European consumer protection remains tight, for example. Another area where one may see changes at the margin would be domestic payments.
Still, when it comes to such sectors as capital markets, cross-border payments and interbanking activities, I do not expect much deviation from one jurisdiction to another and certainly no loosening up when it comes to clamping down on illegal activities and fraud. Hence, cybersecurity, AML/KYC and reg/compliance ecosystems in those areas should attract plenty of investment and operational activity. On another regulatory note, 2016 was the year of the U.K.'s innovation "sandbox" known as Project Innovate. The Financial Conduct Authority initiative was so popular that it led to more than eight regulators launching their own copycat initiatives.
I will make three predictions in the sandbox space for 2017. First, regulatory sandboxes will be renamed – sandbox is just a poor name everybody dislikes. Second, the U.S. and the European Union will see their own "sandbox" initiatives launched (where in the EU is a mystery) as hybrid collaborative efforts between regulators, technologists and incumbents. Third, there will be more collaboration at the "sandbox" level between regulators. Be that as it may I also expect the FCA to build on its early success in this space given its clear leadership and first-mover advantage (same for MAS, the Singapore regulator).
I continue to worry about alternative lending or marketplace lending, as rising interest rates will benefit banks first and, while there is some room to increase the cost of lending, in a competitive market with regulatory oversight there is a limit to how high the cost of borrowing can go. And banks' cost of capital will not rise as fast as those of alternative lenders. Therefore, the next 12 months will prove delicate for this industry. I expect banks flexing their muscles and acquiring some platforms, as well as mergers between alternative lenders while the weakest competitors close up shop. Whether this pattern will evolve in sync across the U.S and Europe, I do not know. On the other hand, infrastructure spending, if it is on a massive scale in the U.S., will have a positive impact on lending, and fintech lending actors will benefit. One might even see fintech startups funded on the basis of infrastructure services, for example.
In the retail asset management sector we have witnessed a wave of consolidation in the U.S., notably with robo-advisers. Most incumbents have placed their bets and the few remaining independent startups have survived, so far. We have yet to see consolidation in Europe. I would not be surprised if a European incumbent or two makes an acquisition. I remain interested in robo-adviser models, especially those that will make effective use of ETFs, microinvesting or microsaving, and build a social layer that enables high engagement. I think there is still space for these types of models. Additionally, there is still much to be done to modernize incumbents. And, to date, few fintech startups with a business-to-business model have emerged in asset management. Some are due to pop up.
In the payments sector, I will go out on a limb and call for the rise of micropayments platforms in 2017, most probably powered by a distributed ledger technology. Most startups addressing micropayments have failed so far but it is only a matter of time before a startup or an incumbent hits the right note. Given the rise of machine-to-machine (m2m) and person-to-machine (p2m) transactions along with the Internet of Things, and the continued growth of peer-to-peer, as well as the explosive growth of other types of activities (such as eSports), it is only a matter of time before micropayments make it big. Other than micropayments, I continue to be interested in business-to-business (b2b) payments and services to small to midsize enterprises.
As for the blockchain ecosystem, 2016 was a fascinating year. We now have a pretty good picture of the landscape with up to 10 companies being the potential winners. Most of these winning companies have opted to open-source their code, either collaborating with standards-setting bodies or working as a consortium with many incumbents. Other than a few financing rounds for some of these leaders, I do not expect much investment activity. Indeed, I expect many casualties – acquihires or even outright failures for the other weaker competitors. 2017 will be a year of consolidation in the distributed ledger technology space while the winners will go about deploying their business quietly. I also expect the start of patent wars in the blockchain space. Most serious contenders have filed patents – incumbents and startups alike – and it is only a matter of time before some try to enforce these patents. Sooner rather than later is my bet.
On a more general level, I expect five fintech-related themes to pick up steam in 2017:
• All of the business we have seen created and funded in fintech over the past eight years will be revisited with an AI component – be it machine learning, deep learning or other. This is bound to happen as AI is sweeping the business world. If mobile is eating the world, AI is the chef that is orchestrating the menu. Whether in lending, asset management or any other sector, I expect to see much activity in this domain and this includes new fintech startups getting funding. The trend is inevitably moving toward cognitive financial services firm.
• The convergence of software robotics, AI and automation will be applied at scale in what is called robotics process automation for banks and insurance companies alike. This is a pure business-to-business play for sure, and I expect this sector to be a fertile investment ground.
• Platforms and ecosystems will continue to take shape as various banks further build their API strategies, their marketplace strategies or even their bank-as-a-service strategies. Whereas 2016 was the year industry thought leaders spoke about platforms, 2017 will be the creative phase for these types of business models. Some startups are already picking up funding. Expect more over the coming 12 months. One should note that platform business models require standards and interoperability. As such, I expect the beginning of standardization and open-sourcing in the field of bank-as-a-platform or bank-as-a-service, in a similar vein to the movement we have seen in the blockchain space.
• The messaging platforms wars will be in full swing as Facebook, Apple, Google, Microsoft vie for dominance and expand their respective ecosystems. I expect more financial services incumbents to jump on the bandwagon and more startups to build their own apps. The lure of reaching millions of users – customers and potential customers – is strong. To me, AI-powered chatbots fall in this category. Few will be successful on their own and most will want to align with at least one messaging platform. You can bet that the bots within the messaging platforms that will win the day will enhance, accelerate and simplify.
• Finally, 2017 will be the year of digital identities. By that I mean most of the investment activity will be focused on identity business models. Some may consider this field not part of fintech. They will be wrong. There is no identity without trust and vice versa. I view digital identities as the cornerstone of the future of financial services industry. I expect the investment pace to pick up in the identity space.
A few random thoughts in closing. Should a Trump presidency usher an era of instability and trade wars, we will undoubtedly encounter currency wars. Should the EU further weaken in 2017, currency turbulences will be exacerbated. Should the renminbi further weaken, capital flows leaving China will accelerate. Therefore, it is not inconceivable that cryptocurrencies will benefit, notably bitcoin, along with its ecosystem. In this macro case figure, and assuming legal and regulatory issues are sorted out with the Securities and Exchange Commission, I expect much activity with Initial Coin Offerings (ICO) in 2017.
Finally, I expect subdued venture investment activity in Europe and the U.S. in aggregate, especially in the first year of a new U.S. administration that is still an unknown for many.