If ever there was an industry overripe for disruption it was financial services. With its arcane fee structures, drawn-out decision-making processes and the sheer opaqueness of its operations, the sector has long been almost impervious to change. But from wealth management to foreign exchange and insurance to payments, a range of factors is shaking this crucial category - which accounts for almost 10% of the UK economy - to its foundations.
The first of these is the combination of a tidal wave of technology rolling through the industry, enabled by Big Data, and a constructive regulatory attitude toward peer-to-peer transactions - creating online marketplaces which remove ‘the middle man’. The effect of this has been the arrival of more user-friendly business models, which strip out fees and introduce visibility.
Second, of course, is the ongoing financial crisis, which is squeezing both savers and borrowers and, if anything, accelerating the process of industry transformation. If you look at verticals such as wealth management and personal investing, the current zero percent interest environment has placed a spotlight on the fees and charges that customers are burdened by, as well as the lack of transparency they have hitherto faced. The credit crunch has dragged all these issues to the forefront of consumers’ minds, as they search for solutions to their savings and investments quandaries.
With banks losing much of their capital - forcing them to ration credit, just as growing numbers move online - the industry’s tectonic plates are shifting. This is translating into an explosion of new business models, which are being created at a furious pace, leaving the sector’s incumbent providers caught in their wake. At Index Ventures we are tracking a rapidly growing cohort of entrepreneurs, who are building start-ups in the broader financial services space, simply because of the almost unprecedented opportunity it offers.
Where perhaps even five years ago, many of these new businesses would have been simply offering their services as technology vendors to banks and insurance companies, today they have nothing less than the financial services institutions themselves in their sights - and the fact that banks are cutting their budgets is only speeding up this trend.
One such target for this new wave of companies, is the slow and opaque multi-trillion dollar asset management category. Index has invested in Wealthfront, which serves the retail investor who is fed up with the layers of fees, lengthy lunch appointments with their wealth manager, receiving statements arbitrarily and not having an ability to control where their funds are directed or how they’re allocated. Along with its (few) competitors, Wealthfront is a truly disruptive Silicon Valley-based business, originally aimed at the new wealth created by the Internet industry, but, as a first step, going nationwide across the U.S., where all its services are offered online. The customer can choose their level of risk and their funds are then invested and allocated in low cost ETF investments.
Similarly our recent investment in Novus, a portfolio analytics company founded by technologists and data scientists to enable top hedge funds, sovereign wealth funds, endowments, pensions and other institutional investors generate higher returns, shows how perceived wisdom can be turned on its head. The pre-existing model held that successful fund managers will generate better returns in the future, whereas in reality, statistics show that past performance has a negative correlation with future returns. In attempting to remove the emotion from investing and replace it with cold data, Novus is creating a machine that peels back the onion layers of where, how and why returns are made by managers.
Another model gaining rapid traction is peer-to-peer financial services. Foreign exchange/currency transfer is an area infamous for its historically complex and eye-wateringly high fees, where customers invariably trade at a hugely disadvantageous spread. Index-backed TransferWise utilises peer-to-peer technology to slash costs by matching sellers of one currency, and buyers of another, with the opposite pair on the other side. By effectively creating a real-time marketplace which matches supply and demand, the company is able to charge a far tighter spread than the banks and foreign exchange services. For the increasingly mobile and Web-native workforce, put off by the hassle and lack of transparency of banks, it is a slick, cheaper and more customer-friendly online alternative.
The peer-to-peer model is also freeing up lending - a sector yet to recover from the ravages of the credit crunch. Funding Circle has removed the ‘man in the middle’ from the equation by creating a digital marketplace, which matches lenders with borrowers, invariably SMEs. Not to be confused with sub-prime borrowers, who struggle to obtain any form of credit, Funding Circle’s typical customers are highly-rated businesses. However, they also do not have the time to go through the bureaucracy of a three-month bank manager-led process to obtain a loan, when it can - and should - happen far more quickly.
And it’s not just traditional banking that’s under threat from digital upstarts - even the staid old world of insurance is in the firing line. For car insurance, for example, new models are emerging which are offering improved premiums to better risks by charging a variable, bespoke premium, based upon metrics such as miles driven. (This cannot be done from within the pre-existing insurance industry because premiums charged today are calculated via a blend of safe and unsafe drivers, and the business depends upon making money on the average.) One company we have invested in - San Francisco-based MetroMile - uses mobile, cloud and data technology to reward drivers who drive fewer miles. Charging variably in this way, enables companies to build business from the ground up and will ultimately consign the one-size-fits all model to history.
The payment space is in a state of technological leap-forward too, with a great deal of buzz surrounding companies operating around the ‘front end’ and how we can now connect our cards to wallets and mobile phones. But innovation is also reconfiguring the ‘back end’ of the business - which is seeing customer-led convergence between mobile, online and offline channels. In this area, we have invested in a company called Adyen, which is delivering on its great vision of unifying a single merchant back end, across the full payments value stack.
Controlling that whole chain on behalf of the merchant, across every channel, is all done through next generation technology which sits in the cloud, giving merchants a level of control, visibility, unified reporting and fraud/ID management that would have been unimaginable just a few years ago.
Ultimately if you look across traditional financial services, pent-up demand from corporates and individuals alike, is driving innovation at a truly extraordinary rate. Today’s tech-literate customers expect transparency, multi-channel access and specially-tailored rates. Businesses that cannot offer those services - whether taking or accepting payments, extending loans, or providing insurance or wealth management products - are doomed to lag behind and, eventually, fail. Against a backdrop of such far-reaching upheaval, two things are certain: no aspect of financial services will be immune. And this is just the start.