A Peek at the Future

I spent the weekend at an invite-only financial regulation round table hosted by Jo Ann Barefoot, senior fellow at Harvard and a veteran of the financial regulation world. Jo Ann founded the Barefoot Innovation Group. Over the course of the weekend we discussed the symbiosis (interaction) of the old guard and the new in banking, lending, asset management and regtech (regulation technology). Here is what we learned.

Stages of grief and a distinction

It’s useful to distinguish between the very big subject of fintech – financial technology – and regtech – regulation technology. Fintech is larger because it’s about money – borrowing, transferring, spending, lending and investing. Regtech is more important because it’s the law – meeting regulatory requirements, submitting compliance reports, getting ahead of criminal activity and achieving security standards.

Each financial sector is going through the classic stages of denial, anger, exploration and acceptance as technology changes the environment, rules and business models. It’s true in regulation too. While many regtechs look to replace the old guard entirely, others look to collaborate, augment and partner.

In the investment management world, we’ve passed the stage where fintech robo-advisors promise to replace human investment advisors entirely. The latest startups are looking to augment human advisors by building tools that allow them to be smarter, better, faster and stronger. We have been adding these new advancements to Osbon Capital on a regular basis. Dynamic on-demand reporting, better trading tools, new monitoring and alerts systems, APIs that improve data accuracy and portability by removing the need to cut and paste, fail safes, and improved security – we’ve invested in all of these areas over the past few years.

The Big Banks

In the competitive world of finance, the big banks offer stability. They already have the proper licenses, better access to capital and ready access to payment and processing networks. This gives the banks a significant advantage over newcomers. Nonetheless, fintech start ups offer better user experiences, better data and analysis tools, and are often more nimble with customer acquisition. Often times that’s simply not enough to draw in a significant piece of the market share. For many fintech startups, a reaction like “This is a lovely piece of software” is often the first and last interaction with its potential customer base. Adoption rates have been far below target in many cases.

But challenges remain for large institutions. Legacy systems are their concrete boots. The large banks invest billions into software development, yet the resulting improvement is often marginal at best. No one at these banks, not even their chief technology teams, can articulate all of the infrastructure gaps of their systems and it’s making regulators and operators nervous. This increases the likelihood that future bank CEOs are going to be technologists instead of traditional bankers. They will be experts at regtech.

Some problems

Regulators are worried about data sharing and the cloud. Who owns the data? How secure is that data? How might that big data be used for unethical purposes? Discrimination could occur via tagging medical records to credit files. In that case,  less information is better. Regtech will address these challenges first. Fintech can then deal with them.

Anti-money laundering (AML) is a particularly ugly spot in our financial system. It’s estimated that 98% of the $1.6 trillion in money laundering activity goes unreported even though the US spends $50B per year on AML activities alone. That means we’re spending $50B to catch $30B – a depressing return on investment. It’s largely a technology problem. Luckily, there are regtech firms aiming to tackle this issue, like Hummingbird Regtech. Full disclosure: I invested in Hummingbird in January of this year.

A peek at the future

It was mentioned at the conference that we’re likely to see full financial inclusion in our life time – meaning everyone on the planet will be connected to the global banking system. Already 700 million customers have come online in just the past few years and the majority of those customers are mobile only. Imagine the impact to global progress and GDP when you are better able to unlock the human capital that is sitting untapped and disconnected from the broader economy. The potential for progress and improvement is massive and truly astonishing.

I felt privileged to get a peek at the financial future this weekend. Regtech is a new field, a big field and change is coming quickly.

Max Osbon – mosbon@osboncapital.com