Disruption in the Finance Industry – rapid technological innovation

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Article by Simon Bird

Technology and innovation moves rapidly in finance and I have seen it first hand during my circa 30 years in the industry. I came into the London Stock Market just at the time of Big Bang in 1986.

Within a year the jobbing books had been replaced by Colt and Topic screens and a few years later we were using Windows technology on our trading and sales desks. Roll on rapidly through the next 20 years from the usage of spread sheets, simple intra firm order routing all the way to algorithmic computer controlled and high frequency trading. It all seems a long way from those days of face-to-face trading on the London Stock Exchange and Traded Options Market floors.

Now we are well into the biggest leap in the advancement of the process by which stocks and shares are settled and transferred. This has remained relatively unchanged for decades but blockchain or distributed ledger technology is set to disrupt it beyond recognition. Traditional middle and back-office could disappear almost in their entirety.

Last month Nasdaq and Chain.com (a leading blockchain infrastructure provider) announced a pilot using blockchain to manage shares in private companies. Within the pilot, stockholders will have the ability to transfer securities seamlessly whilst maintaining a perfect record of those transfers. The process will be more secure, efficient, inexpensive, auditable and transparent than anything seen before.

Much of the finance industry has been built around providing the services of a middleman. A bank or a clearinghouse has traditionally been that trusted middleman, acting as the guarantor for the parties involved in the transaction, for a price of course. Now that may all change with technology likely to take over that role, significantly reducing the profitability for the industry.

The blockchain will be able to cut the settlement window from days to hours, meaning the vast number of people managing that settlement window will inevitably no longer be needed. The inherent risks associated with that window will also be reduced. Counterparty failure risk, exchange rate movement risk and credit risk, to name but a few, are all reduced significantly by the shrinking of the window. This means that many of the people and technologies managing those risks become redundant.

Inevitably what we now see is many of the incumbents getting in on the action, competing to maintain or grow their market share of a smaller pot of revenue. During the disruption process new start-ups with innovative ideas and significantly reduced cost bases compete, further reducing the available pot for the incumbents. On the face of it this looks likely, however there are two significant issues which these new entrants will need to content with which will inevitably raise the barrier of entry beyond many if not most.

The first is the loyalty and trust of the customer base. Although the credit crisis of the last 7 years has mortally wounded a few and maimed many there are still a significant number of relatively healthy financial institutions who still have a hold over their nervous client base. One should never underestimate the “stickiness” of those long-standing relationships, especially after the testing times in the previous decade.

Secondly, there is the ever growing influence of the global regulators. Obtaining licenses to run a business is not a simple and cheap task. Where customer money is concerned the regulators are becoming more and more strict as to the segregation of those funds and the amount of capital which is needed to be placed away from the firms’ working capital as protection. It is an expensive business for any venture capitalist or founding partner to start doing business in this environment.

In conclusion we will see major disruption from blockchain technology but in this author’s view it will be in the hands of the incumbents rather than new entrants.

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