Transformative forces impacting financial services

April 2016  |  COVER STORY  |  BANKING & FINANCE

Financier Worldwide Magazine

Without fear of contradiction, it’s fair to say that the financial services sector has a lot on its plate at present, with much to chew on in terms of the regulatory, technological, legislative and ethical pressures being exerted on the sector across the globe.

Solutions to such pressures are sought in many quarters, with the World Economic Forum’s (WEF) semi-regular parade of conferences and summits offering perhaps the most comprehensive opportunities to debate the myriad issues currently vexing financial services – or in WEF parlance, an “unparalleled platform for co-design, co-creation and collaboration”.

Exemplifying this search for global answers are events such as the annual WEF extravaganza held in Davos, Switzerland, which earlier this year played host to a 2500 people strong gathering of financial, economic and political leaders – not to mention a smattering of celebrities in the person of thespians Leonardo DiCaprio and Kevin Spacey and ‘rock legend’ Bono – over its four day duration.

And whilst it is true that many WEF events of this nature are not universally loved and often dismissed as merely oxygen consuming ‘talking shops’ for the global elite, this year’s Swiss summit, themed ‘Mastering the Fourth Industrial Revolution’, appeared to be something a little beyond the usual fare, examining as it did the regulatory and technological transformations (among other things) shaping the world today and how the financial services sector is planning to respond to them.

Unlike the accords reached at previous summits, such as the announcement at COP21 in Paris in late 2015 of the Financial Stability Board (FSB) Taskforce on Climate-related Disclosures, no cast iron global agreements were ratified in Switzerland.

However, important issues were brought to the fore, debates were conducted and a broad consensus achieved as to how to deal with some of the biggest problems of our century, including of course those currently bedevilling the financial services sector.

Key discussion and outcomes – this time around

What, then, were the key discussions that took place at the popular winter sports resort between global political and business elites earlier this year? Although talks were sans actual agreements, their potential impact on organisations operating in the financial services space can best be construed as considerable.

“We participated in a number of public and private gatherings of bankers, central bankers and policymakers where it was evident that financial technology was an overarching theme, and blockchain was a particular focus as an emerging technology that is shaking up the banking industry,” recounts Chris Larsen, CEO and co-founder of Ripple. “From speaking with other participants, it was evident that FinTech has never before been such a prevalent theme. “

In terms of blockchain, the transaction database shared by all nodes participating in a system based on the Bitcoin protocol, Mr Larsen believes that bankers around the world must determine a strategy for their businesses, and, furthermore, regulators must proactively determine a robust, secure and global regulatory framework to support emerging financial technologies such as distributed financial technology and the Internet of Things (IoT) connected commerce applications.

Recognising that global summits form part of a continuous process of responding to emerging issues, Dr Andrew S. Nevin, a partner and chief economist at PwC Nigeria and global leader of the Project Blue framework, is an advocate of the need to provide platforms to unite relevant stakeholders to further address existing debates on the future of the global financial system. “The WEF brings additional focus to the major transformative forces that financial players are currently dealing with, and provides a reminder on the previous consensus built, recommendations and actions needed to support global growth and financial stability,” he says.

On the topic of blockchain, which is seen by many as the next big thing in the financial services world, Dr Nevin considers it to be a technology that is almost certainly going to have a massive impact. “Blockchain means that a ledger is distributed and many parties can verify it; this will raise many fundamental questions, including what a bank looks like in the future,” he suggests. “The basis for banking has always been an institution managing a ledger and that the institution is trusted by parties on both sides. If that foundation is no longer necessary, what is a bank? And the potential applications of blockchain go well beyond banking.”

Additional discussions at the summit centred on cyber security and cyber crime, environmental and social impacts, understanding the changing risks facing financial services and the critical issue of rebuilding public trust in financial institutions and the services they provide. In terms of cyber security, Dr Nevin knows full well that financial services players have been focused on this aspect for at least the past five years, noting that today there is virtually no financial institution that does not spend a lot of time on this issue. “This is an arms race in the sense that financial services institutions need to constantly upgrade their cyber security capabilities to stay ahead of emerging threats,” he attests.

Impacts on operational strategies

The multitude of topics that were run up the flagpole during the summit talks, will, in all likelihood, lead to fresh operational strategies being identified and deployed by financial services players – a strategical realignment now seen as essential in the context of the present instability of the global economic environment.

“The existing financial services model as we know it is unsustainable,” opines Lawrence Wintermeyer, CEO of Innovate Finance. “Therefore, all major financial institutions have already begun working on building better products and services for consumers by working closely with FinTech players and establishing their own accelerator spaces to nurture and create the kinds of technologies their businesses need. They are definitely transforming the way they are thinking about the future of banking – but they realise they don’t have a choice.”

For Binoy Kampmark, a senior lecturer at RMIT University, financial services practitioners must accept the changing practices in banking and finance brought on by various innovations, including blockchains and virtual currencies which have provided a considerable challenge to traditional financial powers. “The conservative banking response has been to see them as temporary and essentially small – virtual currencies, for instance, coming in at a rough value of $7bn. Some of these issues were touched upon and it would be a mistake to ignore them,” advises Mr Kampmark.

Mechanisms for change vs. talking shops for the global elite

Although a depiction of summits being ‘talking shops for the super-elite’ may never find its way into the annals of derogatory statements, such a characterisation does carry with it a certain degree of resonance when it is used to describe discussions surrounding what it is that financial services organisations plan to do to rebuild trust in what they do and how they do it.

“Many people are cynical – and they aren’t completely wrong,” believes Lucy P. Marcus, founder and CEO of Marcus Venture Consulting. “Years ago, it was because the meetings were so openly secretive – much like the way people perceive board meetings. Nowadays, the WEF webcasts many of its sessions, and the cynicism comes from the sense that what is being discussed is not what business and government leaders need to think about.”

That said, according to Mr Kampmark, there is little doubt that an elite dimension to the summit experience does exist. Firstly, the cost for attending proceedings is hefty, with consumption extravagant. And secondly, membership in attendance – to panels and sessions – is hierarchical and roots out numerous groups or individuals who might have valid points to make on social, political and economic issues. Ultimately, this tends to encourage a group-think mentality where reform is difficult to formulate.

However, criticisms aside, there are those who view summits as incredible gatherings of bankers and policymakers who truly care about what the future of the financial world will look like. “The theme for the Davos summit earlier this year was the Fourth Industrial Revolution,” recalls Mr Larsen. “And discussions revolved around the idea that technology is rapidly evolving and being adopted more readily than ever before; governments, business leaders and consumers all need to be aware of the potential societal and economic impact of these new technologies.”

Addressing over-regulation

One of the major issues currently on the financial services agenda is that of regulation; specifically, the question as to whether or not the space is being subjected to over-regulation. Amid the hullabaloo of the Swiss summit, responses to the suggestion that over-regulation is putting global economic growth at risk, and just what the financial services sector should be doing to achieve a balanced regulatory framework, were certainly among the most vibrant areas of discussion.

“While regulations like Basel III and Dodd-Frank are definitely putting pressure on financial institutions to hold more liquidity and change their business practices, we believe that these regulations can also encourage financial institutions to work more closely with emerging technology companies to lower their back-end processes,” says Mr Larsen. “As financial institutions begin adopting new technologies, we believe the world will need a regulatory framework similar to that of the 1997 Bonn Declaration for e-commerce – one that is robust, secure and with built-in consumer protections. Regulators, technology companies and financial institutions must work together to pave the way for an internet of value – a world in which value moves as easily as information moves today. The world will also need a proactive regulatory framework for the IoT, in which smart devices will need better global payments interoperability than ever before.”

Addressing the WEF in Davos as part of a debate entitled the ‘Transformation of Finance’, Christine Lagarde, managing director of the International Monetary Fund (IMF), voiced her opinion that financial stability, even seven years after the collapse of Lehman Brothers, was not assured. She insisted that there were a number of areas where more regulation, not less, was required. She also warned that financial institutions and players must be mindful of continued efforts to harmonise and was supportive of the suggestion by fellow debater Don Schulman – president and CEO of PayPal and chairman of Symantec – of a sandbox to try out new ideas which could help deal with trust issues and limit the potential for damage to consumers.

Mr Schulman himself stated that financial services should not “look back at what happened, but what is likely to happen in the future”, adding that over-regulation need not be a worry and that the “regulatory environment needs to be globally applicable.”

Onwards and upwards

Without doubt, the past few months have seen the myriad issues facing the financial services sector uncomfortably laid out for all to see. Summit discussions have been numerous, leading to a consensus that technological innovations offer solutions to at least some of the financial services sector woes.

“We are going to see more financial institutions working with innovative pioneers to address the changes needed to create a future financial services sector that is more inclusive, stable and transparent,” predicts Mr Wintermeyer. “FinTech innovations are making impressive inroads in democratising finance. Entrepreneurs also have great ideas to help solve issues such as the financial exclusion of two billion people worldwide. What they need is a little help from those sitting at the top table – government and investors – and many of these people were at Davos.”

Recalling the sense of urgency at the Swiss summit surrounding policymakers, business leaders and technology companies as they came together to understand the societal and economic impact of adopting new technologies, Mr Larsen believes that the next 12 months will see more industry collaboration as key players work together to embrace technological change in financial services, resulting in lower processing costs as banks adopt new services and revenue streams.

Sounding a more pessimistic note however is PwC, which suggests that the financial system can only really move forward when individual financial institutions (and regulators) give some profound thought as to what their overriding purpose actually is. For in the absence of purpose, financial services players will continue to operate in ‘Never Again World’ (a term coined in the PwC report ‘The Day After Tomorrow’), where no regulation is too onerous if it, on the surface, reduces the risk of a financial crisis.

“Earning 20 percent Return on Equity (RoE) is not a purpose,” says a bullish Dr Nevin. “If at both the individual institution and the system level we agree on what the financial system is for and what it should be doing – allowing the management of risk, accumulating and allocating productive capital, permitting the time-shifting of savings and consumption – then it will be much easier to achieve a balanced regulatory framework that is fit-for-purpose.”

Conclusion

Once one accepts that global economic summits do not (and cannot) guarantee solutions and agreements but are essentially mechanisms for ventilating the major issues of the day, then their raison d’être is a lot easier to comprehend.

However, recent WEF summits have provided a sound platform for financial, economic and political leaders to share advice and guidance on how to respond to a global economic environment that is transforming financial services – be it regulatory discordance, the disruption caused by new technologies, the rebuilding of trust or the threat of cyber security – and the strategies that need to be implemented by financial players to reorientate their space.

As one anonymous summit attendee succinctly put it: “If financial services practitioners do not change their operational strategies to cope with an economy that continues to teeter close to the edge, then they won’t thrive in the 21st century.”

© Financier Worldwide

BY

Fraser Tennant