Fintech Insights

Are Capital Markets Utilities a Free Fintech Lunch?

May 19, 2017

Free lunch, we’ve all had them – some good, some bad, sometimes with strings attached, sometimes without!

As the pace of innovation increases and the “next” Industrial Revolution awaits us, capital markets firms must explore which fintech to evaluate, invest in, ignore, or delegate to their service providers. Capital markets utilities may actually be one of the key enablers of fintech adoption, focus and prioritization the industry needs on the road to the fintech ecosystem of the future.

Capital markets utilities are a relatively new phenomenon; utility vendors take traditional outsourcing approaches, combine them with intellectual property and technology, and take responsibility for the operating model. In nearly all cases, utility providers are incumbent vendors with many years of experience, big balance sheets, and global teams, cultures and brands – a different flavor of fintech.

In the March 2017 McKinsey study Capital Markets Infrastructure: An Industry Reinventing Itself, this vendor shift to utility offerings was called out explicitly. Vendors are investing in and launching utilities across a wide range of verticals to support non-differentiating processes. The most successful vendors to date have been those with a strong underlying technology and market presence, minimizing the the cost for the market to transition to the utility service.

So where’s the free fintech lunch?

Since 2008, the business case for implementing fintech or any other operating model improvements at any individual firm has become more challenging, if not paralyzed, because of increasing regulatory compliance costs, increasing capital requirements and weak interest revenues.

Since investing in innovation is so challenging for individual firms, what if the investments in innovation could be made once across an entire industry vertical instead, distributing the cost across all who benefit?

By definition, capital markets utilities have one team, one operating model and one underlying technology platform. The most successful utilities also offer mutualized change management services around this standardized operating model – the ability to make regulatory and market changes once, across all clients.

The best utilities include this cost of ongoing mandatory change in their fees, eliminating an additional expense and project burden for utility clients and dramatically reducing the effort, cost and risk of change for the industry, as more clients join the utility.

Can this same industry-wide reduction in effort, cost and risk of mandatory change be expanded to dramatically reduce the effort, cost and risk of innovative new fintech too?

Are utilities the key to enable successful fintech adoption with less effort, cost and risk?

Some utilities shift responsibility for 80 percent or more of the operational and technology requirements from the client to the vendor. These utilities should also be responsible for driving innovation into this significant scope of service. If this cost of ongoing innovation is included in the utility fees, this might be one of the most compelling fintech free lunches the industry will ever see.

What makes this a free (or nearly free) lunch?

First, pick your fintech innovation – intelligent process automation (IPA), robotic process automation (RPA), other forms of artificial intelligence (AI) or even blockchain or distributed ledger technology (DLT). These are likely to impact most, if not all, of the capital markets, and a good place to start for this example.

Let’s use a simplified version of the exchange-traded and centrally-cleared derivatives ecosystem as an example where one or more of these technologies might be deployed in the future.

There are an estimated 100 clearing firms globally, each of which connects to one or more derivatives clearing houses and builds its own teams and processes around a handful of vendor technologies and/or proprietary technology. But what if those 100 clearing firms first move to a utility and the utility bears most, if not all, of the responsibility for implementing fintech innovations across its scope of services?

Instead of 100 fintech implementation projects for each of the 100 clearing firms, there would be one fintech implementation project run by the utility to transform the standard operating model and technology in the utility. Optimistically, this could result in an exponential reduction in project complexity, cost, effort and risk for the industry and each client, by a factor of 100.

This dramatic reduction in complexity, cost, effort and risk would accelerate fintech adoption and improve innovation time to market for clients and the industry as a whole.

Since project cost, effort and risk are some of the biggest barriers to the capital markets industry-wide adoption of fintech that ushers in the “next” Industrial Revolution, wouldn’t widespread adoption of utilities first give the industry the greatest chance of a successful transition to this future ecosystem?