When it comes to the FinTech sector, the headline numbers really only tell half the story. Drawing meaningful conclusions from FinTech investment figures requires looking beyond the headline-grabbing unicorn funding rounds or megadeals and focusing on the steadier investment activity that is the bedrock of the sector and provides the context underpinning the mega deals.
Stripping out exceptionally large deals from the numbers reveals that investment activity in the global FinTech space for H1 2019 was up by approximately 28% compared to H1 2018. This, in an environment of slowing Chinese investments, looming global trade wars and political uncertainty in Europe, requires some explaining – especially in relation to the UK, which is facing its own unique challenges.
The growth is being driven in part by the stage in the investment lifecycle in which many FinTech businesses find themselves. The first year of a real explosion of FinTech investment was 2014 (that being the first year where the amount invested was a material multiple of that in the prior period). Much of the current investment therefore represents investors holding faith and following the money as businesses start to transition from account and user acquisition towards profitability.
A case in point is that of the challenger banks in the UK, which emerged between 2014 and 2016 following the loosening of banking licence regulation in 2013. Several of those banks have concluded sizeable funding rounds this year, but the lower cost of account servicing savings which challenger banks enjoy as compared to the established banks have been pushed hard and those rounds will be predicated on the challenger banks being able to monetise their accountholder base. This might be by either the tried-and-tested method of selling loans (which may be challenging in a period of economic uncertainty), or perhaps a more novel strategy.
Of course, not all areas of the FinTech sector are at the same stage in the business lifecycle as the challenger banks. But capital deployed in this space can choose where to sit. It may be that businesses that are being forced to articulate a long-term strategy for profitability are more attractive in the current climate than those still very much in the growth stage – where a return on investment is predicated on an acquisition in a few years' time.
AISPs and PISPs
Account information service providers (AISPs) and payment initiation service providers (PISPs) form a FinTech subsector still in its relative infancy. These companies owe their existence to the second Payment Services Directive (2015/2366), which came into force in January 2018.
Faced with competition from other subsectors, are these companies still able to raise capital? This certainly seems to be the case, even in an environment where there is an increased focus on the level of access that third parties have to consumers' personal data.
One factor that has helped this continued ability to raise capital has been consumers appearing to be more comfortable than anticipated with trusting their personal data to service providers without a "bricks-and-mortar" presence. Already 12% of people in Britain have an account with a digital-only bank (although how much of their banking is done through these accounts is another matter). AISPs and PISPs are therefore undoubtedly benefiting from the warming up of the market by the challenger banks, although it remains to be seen whether the concern of data protection officials in relation to certain cryptocurrencies on consumers' behalf will have a cooling effect on this acceptance.
There are other factors contributing to the momentum of these businesses. As we enter a period of increased economic uncertainty and belts tighten, consumers may gravitate towards AISPs such as market comparison businesses. The revenue generation model of these businesses, which charge a fee per successful migration or product uptake, is clear and scalable. Likewise, for PISPs dealing with consumers who are increasingly frustrated at the number of providers of services that they end up dealing with, businesses offering a consolidation service for a fee are proving increasingly attractive. As an added bonus, these API-driven businesses by definition are close to established banks, which continue to be persuaded of the merits of partnering and deploying venture capital that gives them a "cap table" with an in-built potential exit.
What else is shaping the FinTech sector?
Other FinTech sub-sectors face a tougher time, amid considerable macroeconomic headwinds. Peer-to-peer (P2P) lenders have made progress in their recalibration of lending side of the equation, with banks and more conventional debt providers being the ultimate lenders (as opposed to individuals). But finding borrowers is increasingly challenging, as investors retreat to less risky propositions in preparation for anticipated macroeconomic challenges. Meeting these challenges requires an increase in marketing spend, which can quickly become the P2P platform's version of banking legacy systems' overheads, reducing their competitive advantage.
Outside the regulatory and macroeconomic environment, other drivers will also shape the FinTech market in the coming year. Two separate technologies which may now be past the point of unhelpful hype and into the realms of useful application are AI and Blockchain technology. The former is a key component to robo-adviser propositions which saw a flurry of investment in early 2018. The FCA's publication in May 2018 of its paper "Automated investment services – our expectations" has also raised questions for robo-adviser operators on how best to deal with compliance expectations. The stable of regulators who have published compliance guidance is steadily growing, which should provide a degree of regulatory clarity to help the deployment of these services. Development of AI will also help accelerate the presence of these businesses in the wealth management arena.
2020 may be the year in which Blockchain technology finds a FinTech home beyond the world of cryptocurrency and initial coin offerings, as FinTechs look at the wider use of distributed ledger technology, particularly in security custody and asset administration. Equity capital markets will enter 2020 after a year of subdued activity, especially at the smaller end of the listed markets. This is in part due to investor wariness, but it also reflects the fact that an increasingly large proportion of capital from private equity houses, has reduced the opportunities to invest in listed companies. Businesses that can utilise Blockchain technology to facilitate access for under-served investor classes will no doubt provide a lift to the equity markets in this context and may well therefore find themselves receiving increased overtures from investors.
As a new decade approaches, it no longer makes sense to talk of FinTech as a single homogenised market – if it ever did. FinTech is a complicated ecosystem. And, with sub-sectors and areas with different levels of maturity, FinTech faces disruption from new innovators as much as it itself disrupts.