Could we be looking at a wave of M&A in the coming years?
There are many reasons to believe the answer to that question could be “yes.” Keeping up with a changing global financial landscape since the turn of the millennium has proved to be a challenge for many global financial institutions, many of whom still operate on cumbersome legacy technologies. At the same time, energetic, imaginative startups have re-written the global rules of communication and finance, with mobile and internet companies now offering a host of low-cost, convenient alternatives for payments, investing, and automated money management platforms.
The large incumbents in the finance industry certainly aren’t planning to leave the playing field and hand over the finance sector to the startup and internet world. Banks are some of the biggest consumers of technology – they spent $486 billion in 2015, 18% of worldwide IT spending. And some analysts predict that the global banking industry will grow to $163 trillion in assets by 2017, with a 5 year CAGR of 8%.
In addition, according to a white paper released in March by UK firm FirstCapital, 92% of bank executives understand that their systems and processes must be upgraded to comply with constant regulatory change. Leaner, meaner newcomers have challenged retail banks with enhanced user experiences, competitive rates and a consumer centric approach.
But, the same research estimated that new technologies and fintech startups stand to siphon $4.7 trillion in assets away from today’s largest finance companies. Venture capitalists are betting on a disruption of the finance industry, upping their investments in fintech companies over the past six years, from $366 million in the first quarter of 2010 to more than $4.845 billion in the third quarter of 2015.
All of which raises a host of questions. Can large banking and financial institutions adapt to the new millennium? Can an industry that has long been dominated by MBA professionals adapt to a world of roboadvisors, one where professional-quality technology is available to non-industry players, often in their teens or early 20s, with professional levels of competence, and a global exposure via social media?
And what about traditional banks, long accustomed to financing new cars, vacations or new businesses but who have suddenly been challenged by crowdsourcing and peer-to-peer lending platforms, or by non-bank money transfer platforms used by tens of millions of people in Africa that have no other access to banking and financial services.
In many ways, the answer is clear: The finance industry is adapting to a new reality, if reluctantly. For example, look at how the mutual fund industry is responding. Many asset managers and investors have switched their focus from expensive, actively managed mutual funds to cheaper exchange-traded (ETF) and index funds, to the tune of about $250 billion in 2015 alone. That’s a boon for investors, who enjoy lower fees. But for asset managers, the new reality is an ugly one that cuts directly into their revenue.
“ETFs have $2.1 trillion in assets, with an asset-weighted average fee of 0.27 percent, producing annual revenues of about $5.5 billion,” Bloomberg reported on April 7. Traditional index funds have 2.1 trillion in assets but have an asset-weighted fee of just 0.10 percent, producing $2.2 billion in annual revenue,” Bloomberg says. Those same assets would have generated over $30 billion in fees if they had been managed in actively-managed mutual funds — that’s $27 billion of revenue that’s just evaporated from the industry.
In addition, FirstCapital says that the largest US banks have made “strategic investments” in over 30 fintech companies. Some incumbents such as BBVA, HSBC and Sberbank CIB have launched dedicated fintech funds topping $100 million to be invested in early stage technology firms. Others, like BBVA, have acquired online challengers. Industry majors IBM, Microsoft, HP and Thomson Reuters have upped their games to service financial clients, investing heavily in enabling technologies, including fraud prevention and risk management software, infrastructure management for banks, data security and more.
To meet the challenge posed by disruptive startups and technologies, FirstCapital predicts a wave of mergers and acquisitions over the next three years as “financial incumbents [will] look to catch up with widespread innovation from new entrants… We expect a wave of M&A activity in the next 3 years as financial incumbents look to catch up with widespread innovation from new entrants, the internet majors scale up in financial services and the technology/software majors add new technology to deepen their offerings in this sector.”
In addition, the white paper expects “the internet majors scale up in financial services and the technology/software majors add new technology to deepen their offerings in this sector, particularly via the use of blockchain technology for payments, regulatory reporting and share trading.
Could be. Last August, asset manager BlackRock acquired automated investment advisor, FutureAdvisor, and is already rolling it out to financial advisors who work for the firm. Spanish bank, BBVA has purchased two challenger banks. It is certainly not inconceivable that major industry institutions could move to acquire upstarts into their basket of services in the coming years.
But that is far from certain. The incumbents’ sheer scale gives them the luxury of being patient and the ability to weather the challenges posed by newcomers calmly and carefully. At the institutional level, banks and lenders are already testing blockchain technology developed in-house and with he help of service providers. And Goldman Sachs still employs more engineers than Facebook. This could indicate that the traditional industry leaders are biding their time not until it is the right time to go on a buying spree, but rather until they have analyzed the industry, mapped out the future and they are ready to roll out their own, in-house technologies on their own terms.