Fintech: Revolution and regulation
Technology has been encroaching into financial services territory for more than half a century—from ATMs in the 1960s to the introduction of electronic market trading in the early 1980s. However, interest in companies that propagate technological innovation in the industry has boomed in the past few years, throwing fintech into the mainstream. Last year, a number of fintech deals shook up assumptions about how financial services work. These included deals such as exchange and marketplace operator ICE acquiring financial data vendor IDC from private equity firms Silver Lake Group and Warburg Pincus for US$5.2 billion, and DH Corp’s decision to purchase financial software maker Fundtech for US$1.25 billion. Away from billion-dollar acquisitions, early-stage investors are also increasingly looking to provide seed capital to exciting new fintech opportunities. In Q1 2016 for instance, overall venture capital (VC) funding in the US fintech sector increased 70 percent compared to the previous quarter, reaching US$1.7 billion, according to a report on fintech VC trends published by KPMG and CB Insights. Fintech deals are not just limited to incumbent industries or VCs, either. Large financial institutions are also buying out startups rather than just purchasing minority stakes. For example, in August 2015, BlackRock, the world’s largest fund manager, acquired California-based “robo” advisory firm FutureAdviser for US$150 million. In March 2016, Goldman Sachs’ Investment Management Division announced it would acquire digital retirement savings platform Honest Dollar for an undisclosed sum. And in April, US financial services firm Ally Financial acquired digital wealth management company TradeKing Group for US$275 million. “There are tremendous opportunities establishing themselves,” says White & Case partner Kevin Petrasic. “We will see significant transactional activity involving various entities, some of whom may have great funding while others have insufficient funding, or they may have a lot of money but not necessarily a great idea, or vice versa.”
Payments’ progress
Fintech has the potential to completely transform the financial services industry across the entire supply chain, from the consumer-facing aspect of handling transactions to the nuts and bolts of accounting practices. Focusing on the former, the payments segment of fintech has seen an astonishing rise. According to data provider Pivotl, 47 percent of all fintech M&A last year related to payments systems—and with good reason. Financial information firm Markit forecasts that the total value of mobile payment transactions will rise by 210 percent to US$27.05 billion in 2016, up from US$8.71 billion in 2015. In Petrasic’s view, the payments sector may help “socialize” the transactional M&A experience, simply because it is far more familiar with this kind of technology. “Payments has been on the cutting edge of technology in financial services for some time, and in many respects, it continues to lead the way in fintech,” says Petrasic. “The segment has been besieged with interest from players in a wide variety of sectors, from banks to tech and telecoms companies. The companies that develop the best tech-based solutions could lock in a huge competitive advantage.” Established firms are looking far and wide to lock up this edge as well. For instance, in July, MasterCard invested an undisclosed sum in India-based online payment gateway solution Razorpay. As well as affecting subsectors, fintech is also eschewing wider industry norms to shake up financial services. Banking, for example, has seen a host of startup companies launch in the past few years looking to lock horns with larger, more-established players by competing on consumer-sensitive issues such as fees. In response, many larger institutions are looking to snap up these young competitors early on. Spanish banking giant BBVA, for instance, purchased American start-up Simple in 2014 for US$117million, and added to its portfolio last year by buying a 29.5 percent stake in British digital-only lender Atom for £45 million.
New kids on the blockchain
While not as developed as the payments subsector, blockchain could enliven the fintech M&A market in the coming years. The technology has garnered interest because of the way it decentralizes the control of data—therefore making it more secure, drastically cheaper and faster by decreasing the transaction costs and eliminating intermediaries. “There are so many different products and services that can be built using blockchain,” says Petrasic. “Kansas-based CBW Bank, for instance, has tremendous blockchain capabilities.” Investment so far in blockchain has been small compared to the payments sector, but increased VC activity in the space points to brighter things in the near future. A KPMG/CB Insights report from March found that investment in bitcoin and blockchain rose from just US$3 million in 2011 to US$474 million in 2015. While outright acquisitions in the blockchain space have been limited, major financial services players are still keen to keep abreast of its development. This is particularly noticeable among both US and foreign banks, which are exploring the technology’s potential with tremendous interest. In September of last year, for example, nine of the world’s largest banks—including Goldman Sachs, J.P. Morgan, Barclays and UBS—joined forces with fintech firm R3 with the goal of creating a framework for using blockchain technology in the markets. “Banks that are multiple sizes larger than CBW are cautiously exploring blockchain,” says Petrasic. “But they’re all at different points along the learning curve, with many still far from any actual implementation.”
There are tremendous opportunities [in fintech M&A] establishing themselves. We will see significant transactional activity involving various entities.
Kevin Petrasic, Partner, White & Case
Whose rules?
While the excitement surrounding the investment and M&A potential in fintech is understandable, several factors have caused consternation among would-be investors. For example, while these breakthroughs offer a wealth of opportunities, companies have to be mindful of the regulatory implications, as governmental agencies play catch-up with each new development. In March, for example, the Office of the Comptroller of the Currency in the US issued a white paper to launch formal discussions between regulators and fintech industry leaders. And while Republican Congressmen and women are looking to promote a legislative package covering fintech called “Innovation Initiative”, laws specifically covering modern financial services technology are still in their infancy. “A challenge for regulators is that they have to make sure that the day-to-day is taken care of while looking ahead to address new developments,” says Petrasic. “That includes considering ways that regulations may need to be adjusted to facilitate innovation but also to manage emerging issues related to cyber security and consumer protections.” Another regulatory curiosity fintech investors should consider is that while fintech exists in somewhat of a regulatory vacuum, the financial services industry it is looking to capture is one of the most heavily regulated in the world. How this gap will be bridged has yet to be decided. “Just in the banking context at the federal level, there is the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency—as well as various other offices of the Department of the Treasury—and the Consumer Financial Protection Bureau,” notes Petrasic. “There are also regulators in each of the states. All of these players have very important roles in regulating financial services companies, but their roles often overlap.”
False startup
Regulatory uncertainty may cloud the direction of fintech’s future. However, examples from the burgeoning industry’s past suggest that, rather than focusing on what legislation may do to hamper it, investors need to pay more attention to the viability of some areas of fintech. One key representation of this is the once-vaunted marketplace lending sector, which accrued major interest in the past few years. However, recent developments and performance from some of its key companies have cast a shadow over its viability. For instance, Lending Club stock plummeted in 2016 when its CEO resigned following an internal probe that found the company had knowingly mis-sold faulty loans to an investor. Elsewhere, marketplace lender Prosper cut ties with loan-referral websites LendingTree and Credit Karma in June, suggesting a slowdown in appetite for peer-to-peer loans. This came after the company’s loan volume fell by 12 percent in the first quarter of 2016. Even more glamorous segments of fintech have seen companies struggle. Square, for example, one of the most high-profile fintech payments companies on the planet, saw its share price fall to US$9.27 by July 1 after opening in November at over US$13. Over the next few years, fintech M&A is likely to proceed in a stop-and-start fashion, but, ultimately, it is likely to be a source of significant activity that could reshape both the retail and corporate segments of the financial sector.
Banks that are multiple sizes larger than CBW are cautiously exploring blockchain. But they’re all at a very different point along the learning curve and further away from any actual implementation.
Kevin Petrasic, Partner, White & Case
Venture capital funding in the US fintech sector during Q1 2016 increased 70 percent over the previous quarter, to US$1.7 billion 47 percent of all fintech M&A in 2015 related to payments systems The evolving regulatory landscape and past fintech performance will likely have an impact on current and future M&A activity
Meet our partners