Where in the world might fintech be headed?
In the second of a two part series, Mouro Capital’s Manuel Silvez explores where fintech could be going after a turbulent year so far.
Mark Twain famously responded to rumours of his own demise that: “reports of my death have been greatly exaggerated.” In my last article, I suggested that something similar may be happening to fintech: despite some turbulent times, the market is still very much alive, if not quite kicking.
So that begs the question ‘where is fintech headed?’ Well, in short, and while we may still see some casualties of the current climate, I think we’ll see continued innovation and new growth opportunities driven by broader trends underpinning long-term innovation in the industry, under a much healthier investor-to-investee relationship.
All of this comes with a hefty dose of disclaimers that we can still expect significant volatility for the foreseeable future at least. But let me explain.
After a pessimistic start to 2022, there’s been something of a tide change in the second half of the year and, here, it’s perception that matters over performance. The kind of FOMO that drove the fast cash characteristics of only a year or two ago has rationalised, and the market has entered a more reflective period.
Investors are in ‘wait and see’ mode, circling the industry to discern who the most future-proof companies will be and what it will take them to grow into companies that define their generation.
But crucially, the cash is still there. PE funds globally are sitting on more than $1.2trn in dry powder: the industry term for uninvested capital.
While some of that money is concentrated in funds that may shift away from the asset class, you can still reasonably expect a significant slice of it to enter the market over the next three to five years. Fintech has stepped up to become a growing portion of the innovation ecosystem over the past years, so it will likely attract a substantial part of the available investment.
What is changing, is the relationship dynamic. The market is returning to a kind of long due diligence, where relationships are built before companies begin raising money. The 24-month ‘zero to IPO’ phenomenon looks now long gone, as investors and entrepreneurs are courting again to see if they are a good long-term match.
That change to a closer investor/entrepreneur partnership model will help correct some of what overheated the market and eroded discipline.
Funds will know what they’re buying and where their growth comes from. Innovators will get better direction on where to focus their energy and resources, and better understanding all round should deliver another boost in confidence, which is good for everyone.
And after a period of generalist asset manager dominance, sector expertise is back on trend. We see that in the quality and depth of due diligence. Also, in structures coming back to term sheets, so as to align incentives, boost good governance and calibrate risk through, among others, post-closing conditions against specific business milestones. This is refreshing after two years in which many deals were closed in just 14 days with very little digging for information and much less challenge.
Overall, this better understanding and calibration of risks and rewards should make for sounder business models, built on wiser and more collaborative decision-making, a push for efficiency and cost rationalization and a drive to profitability. And, against this context, that dry powder will make a real difference: having ready funds at the right moment to back the right teams and strategies can, and will, generate outsized returns.
So where might those funds be headed?
Well, in a nutshell: it’s all about fundamentals. Money will flow into businesses that support fundamental change in the industry or address the new challenges and opportunities derived from that transformation.
Here, you can point to overarching trends around generational shifts and technological transformation, but also new regulatory challenges that come with them, and the crucial role financial services will have with regards to sustainability, creating opportunities for entrepreneurs and investors alike.
Client expectations are changing too. Over the next 10 years, baby boomers and Gen X – some 50 per cent of the current workforce – will start to retire and begin the gradual transfer of about $84trn of wealth to their children, who expect speed, convenience, experience, authenticity, and transparency from service providers. Traditional financial services still don’t offer that, which paves the way for new entrants to target the demographic and their burgeoning spending power.
All this is supported by new technology paradigms working their way into the industry. The utility of artificial intelligence to unlock value in the vast swathes of customer data is already a given: you can see examples in smarter, personalized sales, advice and recommendations, new types of underwriting, more automation and lower cost of customer service interactions, to name a few.
And we have only started to see the impact that blockchain – primarily associated with the cryptocurrency frenzy so far – can have at scale in building low-cost financial infrastructure, like real time transaction settlement, asset tokenization, smart contracts, money movement, and digital identity.
Many other applications remain untapped, and we will see what some of the ‘frontier technologies’ coming to market, like quantum computing, can do for the industry in complex calculations and process improvements, from fraud prevention to risk-adjusted portfolio management and capital allocation.
All this paints a broad picture of the enablers of a new fintech landscape, but what of the industry it underpins? Emerging societal and technological changes will continue to drive innovation in sectors that have, so far, been slow to embrace them. Insurance, for example, has been sluggish because access to regulatory capital has hampered new entrants from competing at scale with incumbents, who benefit from years of claims data in mature product niches.
As new risk categories emerge, like climate and cyber risk, incumbents’ existing toolkits become less useful. Disrupters, backed by technology and drawing information from alternative data sources from IoT or complex data platforms, can gain underwriting advantages to become next-gen carriers or support incumbents in defining the risk to make it more insurable. In this context, technology is both an enabler and a creator of new markets, which makes it attractive to the long-term investor.
But with change comes risk, and the transformation of the financial services industry inevitably sits alongside an evolution in compliance requirements. Already a firm fixture before the market downturn, new regulation will undoubtedly come to the fore once more to strengthen industry oversight as it evolves.
This creates as many opportunities as it does regulatory hurdles, and Regtech spending is predicted to reach $130bn in 2025, up from just $33bn in 2020. No doubt money will flow to innovators trying to deliver new technologies to facilitate compliance with onboarding and KYC, disclosure requirements, measurement, reporting, and data sharing.
Linked to this is sustainability, itself the subject of regulation but, more importantly, such a priority for current and future generations that no industry can shy away from doing their part. Indeed every sector, finance included, will need to contribute and adapt under increased scrutiny of procurement and supply chains, as well as shifts in terms of investment allocation.
While sustainable finance is still in its relative infancy, there are significant untapped opportunities at the intersection between ESG and re-commerce or circular business models, where finance and technology will drive a real, positive impact, and where they can expect to reap the rewards. This is prime investor territory, both in terms of delivering outsized returns, but now coupled with contributing to the solutions to problems facing our planet and society.
And sustainability seems like a fitting endpoint. Because, as with any endeavour, the goal of fintech is durable —renewable! — long-term performance that transcends any seasonal peaks and troughs and always looks to the next data series.
However accurate my individual assessments here turn out to be, what we’re seeing now is the refinement of fintech and the emergence of a robust set of industry players who will shape and transcend the future of our industry for many years to come.
The views and opinions expressed are not necessarily those of AltFi.