Friday, January 15, 2016

The Fin-Tech Revolution

New fin-tech companies have sprouted by the hundreds and promote speed, cost efficiency, and information flow in financial services.

Financial technology is a bona fide industry sector in finance. Most people involved in banking and financial services refer to the sector as "fin-tech." (Some say, "FinTech.")

Fin-tech, however, encompasses much. It depends on who's describing the industry, talking about it or making observations.

We first heard widespread use of the term in the late 1990's, early 2000's, when securities and trading transactions drifted online, during an awakening when institutions realized that paper and telephone trading of securities or transferring of funds could be accomplished quite efficiently with computers communicating with each other.

Even back then, Bloomberg terminals were planted on most trading desks, and funds could be transferred electronically around the globe. But the industry was not yet sure how the Internet and other forms of technology could drastically improve the delivery of financial services.

Today, there is no boundary for what fin-tech refers to. In general, fin-tech describes a reorientation or new delivery of financial services, taking full advantage of technology and Internet connections. That can apply to any aspect of finance--from retail payments to the settlement of securities, from lending platforms to stock-trading matching engines, from corporate-finance modeling to corporate-finance advice, from wealth management to information gathering in capital markets.

That means just about anything beyond the conventional way of performing transactions and delivering services, as long as the new technology offers blinding speed, cost efficiency, and the neat assemblage of massive amounts of data.

A few years go, mention " fin-tech," and industry observers would think institutions trading securities online and institutions exploiting computer power to engage in algorithmic, high-frequency trading or organizations creating electronic markets to match buyers and sellers of securities, currencies, derivatives and commodities.

Today, fin-tech now means, also, payments, brokerage, and asset management for institutions and individuals.

The fin-tech phenomenon has resulted in the sprouting of hundreds of new companies, recent start-ups and young firms hustling to fill gaps in finance, occasionally threatening the domain of big banks.  They include companies with colorful names like PayPal, Square, Stripe, Wealthfront, Betterment, SoFi, CommonBond, ThinkNum, DataFox, and Axial.

(They include companies organized by Consortium alumni, like MyFinancialAnswers, founded by Virginia-Darden graduate Ben Pitts. There is even an boutique investment bank, FT Partners (as in "Financial Technology Partners"), based in San Francisco, solely focused on fin-tech deals.)

Many big banks, like JPMorgan Chase, Goldman Sachs and Citi, are aware they no longer compete just with each other and assorted funds, but also compete with well-funded enterprises with the best ideas about how to lend money, trade and settle securities, facilitate payments, and analyze markets--swiftly and cheaply and often without substantial capital deployment.

Over a decade and a half ago, JPMorgan established "LabMorgan" as an incubator for new ideas in fin-tech and helped birth new companies that went on to become leaders in selling services to quantify market and credit risks, trade credit derivatives and corporate bonds, and settle foreign currencies.

In the past year, JPMorgan's CEO Jamie Dimon mentioned in financial reports that his bank must now confront the competition of fin-tech start-ups that threaten to swipe swaths of market share in consumer banking, securities services or corporate finance.  In recent months, the bank established a working partnership with one outfit to facilitate to small business loans.

Fin-tech companies can be subdivided into the following categories:

Processing and information 

Robo-investing is now a popular sub-sector of fin-tech under the investments category. Bands of financial entrepreneurs have determined there are cheaper and scientific ways to help people invest, manage assets over a long term. They devised unbiased formulas to help investors to allocate funds among stocks, bonds and mutual funds. They argue that young investors will not pay exorbitant fees to financial advisers at large, reputable firms, when they can use surveys and algorithms to make the same selections at minimal costs (or at no cost, in some cases).

Examples of fin-tech firms include the following firms. Often, their employee rolls include computer specialists, data scientists, quantitative finance graduates, and finance portfolio theorists.

In robo-investing, ETF's tend to be the favorite investment, the better to minimize costs in all possible ways.  Investors sleep at night, aware that computer models update market statistics and assess performance and risk. They feed algorithms that redistribute funds among the classes of assets that include stocks, bonds, mutual funds, cash, commodities, and currencies. They allocate to minimize tax obligations, country risks or industry risks.

Wealthfront, a favorite among Silicon Valley professionals, claims to use behavior finance, machine learning and data science to strike the right allocation balance for investors.  It helps to have Burton Malkiel and Charles Ellis, legendary names in portfolio finance and investment banking, as advisers to give the firm credibility and to complement the core of Stanford MBA's on staff.  It helps, too, to have some of Silicon Valley's best known venture capitalists as backers.

The firm is now four years old and has amassed $2 billion in assets. Portfolios less than $10,000 pay no fees, an attractive lure for twenty-somethings, who are accustomed to DIY methodology and interfaces with computer screens.  The average client portfolio totals about $91,000.

On the East Coast, a competing firm is Betterment, based in Manhattan, a year older than Wealthfront and flocked with Columbia MBA's.  It, too, claims to offer algorithms that rebalance portfolios continually into about 12 asset classes (most of them ETF's), favoring "modern portfolio theory" (or more specifically a "Black-Litterman model," an updated version of finance that manages investment risks with a steady plan to diversify and rebalance).  It has accumulated $2.5 billion in assets.

The above firms, as investment-adviser companies, are not broker/dealers or stock-picking or stock-transacting firms.  Robinhood, a New York firm, falls in that category. It was founded by Stanford graduates who migrated to New York to work at big banks, but were outraged by high commissions on stock trades.  They devised a broker/dealer business model to use technology to reduce costs to virtually nothing and facilitate free trades. (Revenues will come from free use of customer balances and margin lending.)

They hope to upend the world of retail brokerage in the way the discount brokers (e.g., Charles Schwab) did a generation ago.  Operating in the fin-tech sector, the firm sells single stocks without hiring a house full of human brokers and consultants.  Andressen Horowitz, the venture capitalists, believes in the model enough to have invested with the firm.

At another end of the fin-tech spectrum exists Digital Asset Holdings (or "DA"), now run by former JPMorgan Chase executive Blythe Masters, best known for contributing to a core group there that created the credit-derivatives market.

While observing the explosion in popularity in the Bitcoin currency market the past two years, DA reasoned the technology and transaction logic behind Bitcoins could be useful in other markets.  DA's founders and computer programmers, with Masters now aboard , are researching ways to restructure the nuts, bolts, pipes and plumbing of traditional trading and settling of securities, currencies and derivatives by replicating the best of what happens in the Bitcoin marketplace.

DA claims when one bank agrees to sell a large corporate loan to another bank, it shouldn't take hours 2-3 weeks of negotiating documents and finalizing trade terms before the trade is settled. Technology should reduce such a trade to an immediate settlement after two parties consummate a transaction.

The Bitcoin market is decentralized, uses "distributed ledger technology," is an open data base, and boasts about being transparent, open-sourced, and, in some ways, democratic.  That market is not policed by government regulators, which presents issues for countless observers and potential participants. That market is also often volatile and unpredictable, although not necessarily because of its structure. (See CFN-Bitcoins.)

DA argues that, notwithstanding the volatility of the value of the Bitcoin market, the efficiencies of Bitcoin settlement can be transported into the trading, settling and risk management of corporate loans, foreign currencies, U.S. government repos, and derivatives.  While they present their case to institutions, they are in a fund-raising phase ($35-40 million), hoping to get investor and institutional support for a model that could diminish the roles of major organizations already involved in trading and securities clearance.

How about a fin-tech firm that takes advantage of social media?  Dataminr, a start-up formed by Yale graduates, does just that.  Aware that hedge funds, banks and traders are constantly hunting down information, news and data that will have impact on their portfolios or trading strategies, they determined it would be invaluable if all the updatesthat emanate from Twitter could be organized into "actionable signals."

Instead of traders sifting through mountains of Twitter feeds, Dataminr (for a fee) organizes Twitter feeds into useful streams related to mergers, acquisitions, energy, and specific companies.

If, therefore, bankers and traders have all this useful, organized information, expedited by Dataminr, what trading strategies should they adopt to take advantage of it?  Along comes another fin-tech outfit, SumZero, which was formed as an "investment community" of hedge-fund traders, asset managers, and private-equity investors to share ideas, research, concepts and thoughts about trading opportunities (for a fee, of course, and at different access levels).

It's ingrained in traders not to share investment strategies or trading positions they contemplate, but the site is popular and has attracted thousands of members, partly under the principle of reciprocity--that to find new strategies, you have to share your own.  A recent trading strategy on the site explained how traders can put on a Yahoo position (longs and shorts), tied to the likelihood the company will be split, the likelihood that it will have substantial tax liabilities related to its Alibaba investments, and the likelihood that it could be acquired.

The above companies are just a handful in scattered world of fin-tech, which now has tentacles in every sub-sector, every financial market.  The sample above hardly touched the bulge in fin-tech efforts in retail payments (mobile payments, online payments, etc.), consumer lending or small-business finance.

This snippet proves, nonetheless, how small technology-oriented enterprises are quietly and busily overhauling the industry in the way AirBnB and Uber are transplanting the travel and transportation industries.  Not only are these new companies changing the industry, mostly for the better, some are luring away the talent that otherwise might have opted for multi-decade careers at established firms.

And the big-name institutions know it.

Tracy Williams

See also:

CFN:  Bitcoins:  Embrace or Beware? 2014
CFN:  Financial Technology:  New Opportunities, 2014
CFN:  High-Frequency Trading:  What's Next?  2012
CFN:  Opportunities and Outlook, 2016

No comments:

Post a Comment