The investment case for Embedded Finance

As digital finance matures, we're seeing new models emerge. Many challenger banks were built upon banking and cloud infrastructure provided by third parties. This first example of embedded finance may be the most salient but it offers just a small inkling of what's happening in Embedded Finance.

With EF, it's not just about financial services catching up with other sectors to become internet-enabled. The story now is about industries becoming finance-enabled. EF provides the infrastructure and connectivity to payment and banking services. This may serve to ease the friction in consumer payments like a passenger invisibly paying Uber for a ride upon completion. Or, embedded finance may pave the way for new value creation and new business models.

Anthemis partner David Galbraith spoke at Tearsheet's inaugural Embedded Conference last week on his firm's investment thesis in Embedded Finance. Along with his presentation, Anthemis published a white paper called Embedded Finance: The future of the economy [pdf].

2 ways to invest in embedded finance

Early stage investor Galbraith said that there are two ways to invest in embedded finance. The first is an infrastructure play: invest in the technology companies that provide financial services to non-financial services firms. These types of companies include banking as a service firms (eg. Green Dot (public) and Synapse (private)) as well as other 'as a service' firms like Finix (private).

The other way to invest in the EF trend is through non-financial firms that stand to create significant value by embedded financial services into their products and services. Galbraith cites specific industries with significant opportunity for embedded finance including health and wellness, media, mobility, energy, education, construction and real estate, urban planning, and trade and logistics.

Anthemis invests in both the infrastructure and distribution models, given the ambiguity of how the market will continue to mature.

Organizational advantages

To take advantage of a shifting paradigm toward embracing financial services, top companies should envision themselves 'at the heart of a network that governs flows of capital'. The Anthemis white paper encourages these companies to diversify their networks to create more resiliency and to more quickly react to change.

"In order to enable this transition, an organization must remain connected and attuned to the interests of the entire network, including incumbent financial services players, entrepreneurs, regulators, governments and academics," wrote the authors of the white paper.

Industries positioned to take advantage of embedded finance

Particular industries are poised to embrace embedded finance and provide potentially good investment opportunities for early stage investors.

• Health and wellness: While the healthcare sector in the US has traditionally been tied closely to financial services, there are structural flaws in the system. Better data and technology help people and the companies that insure them make better informed decisions.
• Media: With content creation democratized, the media industry continues to look for ways to decrease friction in payments. Advances in reducing transaction fees can improve the management, security, and monetization of digital assets.
• Education: New debt and equity offerings can help improve access to global education. To tap this market, people can look to direct capital to 'innovative education platforms themselves, to partnering with them on debt financing, to empowering the technology companies working with them—or with existing education providers—on solutions.'
• Mobility: As more electric vehicles hit the road, investment is needed to address this new model of movement and the energy distribution required to power it. Anthemis sees opportunities to invest in risk analysis technologies.

Embedded finance as the future of financial services

Galbraith emphasized the difference in the US and European markets versus their peers in Asia. Both geographies unbundled traditional banking services as startups were founded to provide narrow, monoline businesses that focused squarely on just one component of the banking product suite. But in Asia, leading financial firms like Ant Financial have begun rebundling all these services into a single platform. That's beginning to happen in the US, but to a lesser extent.

The future of financial services will be influenced by the emergence of embedded finance. Finance will come to resemble other industries of the internet era -- more interconnected and more customizable, powered by components that can be inserted into individual businesses in different sectors.

And this changes the way financial services make their way to the end user. "In a way, these new industries and firms are becoming the new drivers of distribution for financial services," said Galbraith.