Making Wealth Management Available to Everyone (#38)

Structural Shifts with Sid SAHGAL, Qiaojia LI, Nikolai HACK, Michael O’SULLIVAN

This week’s podcast is the recording of an actual live event — a 4×4 Virtual Salon — we hosted in anticipation of the launch of our Digital Age Wealth Management Report (which is now out! 🎉). Our guests were Sid Sahgal (Product Manager at Hydrogen), Nikolai Hack (Head of Strategy & Partnerships at Nucoro), Qiaojia Li (CEO at Rosecut) and Michael O’Sullivan (author “The Levelling”, ex-CIO Credit Suisse). We discuss: changing consumer trends; changing technology; new business models and new fitness landscape for wealth managers. We hope you enjoy and, if you listen carefully, you will get access to some unfair advantage! 🤷

Full transcript
Making Wealth Management Available to Everyong

[00:00:02] Ben: Hi, everybody. Welcome to our latest 4X4 Virtual Salon in which we’re going to be discussing the democratization of wealth management. So just before we kick off, I just want to put another date in your diary because at this time next week, so at 12:00 CT, 11 UK time, wherever you are, on the 18th of February, we have another 4X4 Virtual Salon also on the topic of wealth management, and we’re going to be discussing new business models in wealth management, and for that we’re going to be joined by Tinkoff Bank, by Elinvar, by additiv, and so we hope you can join us for that as well — sorry, the one I forgot was Impaakt. So we’re also going to be joined by Impaakt, which is a platform for impact investing data. So, hopefully you can join us for that.

[00:00:57] Okay, for those of you that are new to this format, the 4X4 Virtual Salon is so called because we have four speakers who I’m going to introduce in a second. We cover four topics, which for this 4X4 will be Changing Customer Trends, Changing Technology, New Business Models, and The New Fitness Landscape for Wealth Managers. For each of those topics there is a poll. You can see on the portal there, there’s a poll which you can complete anytime and we will make reference to the poll results during the conversation. And then last, but not least, we’ll take one audience question per topic. So if you have a question, please post your question in the questions portal. Okay, right, so we’re gonna kick off. I’m going to introduce our four speakers.

[00:01:49] I don’t know if this is how it appears for other people, but I’m going to start with my top left, which is Nikolai Hack, who is Head of Strategy & Partnerships at Nucoro. Nucoro, which is based out of the UK, has followed the “make yourself the first customer” route to market. Nucoro launched an automated investment service called XO Investing in the UK and then it now offers the platform to others. Its platform is pretty broad and it allows financial institutions to build a range of FinTech, money management, propositions, everything from automated investments and stock trading to digital wealth management.

[00:02:27] Next, we have Mike O’Sullivan, who I think doesn’t need such a big introduction, because he’s a veteran of the 4X4 Virtual Salons, having appeared last year on the one we did on post-pandemic wealth management. But for those of you that don’t know Mike, he is a former CIO of Credit Suisse. He’s the author of the much recommended book, The Leveling, which is about the world after globalization; and if you’re interested, we also have a podcast episode with Mike on that topic. And then last, he’s also a serial entrepreneur and investor and a board member and advisor.

[00:03:03] Which brings us, I think nicely, to Qiaojia and Rosecut, because Mike is an advisor to Rosecut, and Rosecut is a London based automated investment manager, it’s two years old. It has a very interesting customer acquisition model because it has a freemium service where you can access some of the tools and simulations and content to help you manage your financial affairs. But if you want Rosecut to manage your investments, then there’s a 1% fee for doing so. The average AMU of a Rosecut user is £200,000, so this is not an ordinary automated investment service, this is very much a premium automated investment service.

[00:03:45] And then last but not least, we have Sid, who is Head of Product at Hydrogen. Hydrogen is a banking as a service platform, helping brands embed banking services into their proposition, including wealth management services. And to do that it works with a network of partners including Cross River Bank in the United States and Stripe. Okay, so, right, let’s begin.

[00:04:11] As I said before, the first topic is Changing Consumer Trends and Qiaojia, we’re going to kick off with you, if that’s alright.

[00:04:19] Qiaojia: Okay.

[00:04:20] Ben: I wanted to ask you, how big is the opportunity that gets opened up by using automated investment services to target affluent or mass affluent customers? By how much can we increase the size of the wealth management industry by using automated investment services?

[00:04:40] Qiaojia: Thanks, Ben, for the question and glad to be here. I think this is a very interesting question. Because from the tech perspective, they think everyone wants to invest and everyone deserves to invest, maybe with £1, with £10, and it is made possible in the past10 to 20 years by a lot of the first generation robo-advisors. But if you look down in terms of the slice of the market of various segments, there’s core like high networth, affluent and retail based on The Credit Suisse Global Wealth Report, actually, Mike was part of the key contributors to that. It’s in the UK, 1% of the population, the top of the pyramid, owns 3 trillion of assets and the next segment, 15% of the population, affluent, owns another 3 trillion of assets. And the remaining 85% of the population owns 1 trillion, one-third of either the high net worth or affluent. So, this is why Rosecut sees us as a meat market provider. We want to cater to the middle sort of 3 million. And the second point I would make is that wealth is fluid, right? It doesn’t always stay with the same demographics or same group of people. So, wealth transfer is a big topic these days and a lot of the older generation gives the wealth to the younger children who basically use an app for everything. If they don’t put the money into a Rosecut app, they will put it into a crypto app. So, you know, technology first is kind of how we see to capture these kinds of opportunities.

[00:06:29] Ben: And Sid, I want to come to you next. So digital channels, digital services are, if you like, democratizing access to wealth management and what would be the benefit of that? So, if more and more people can access wealth management, what will be, I suppose, the social benefits?

[00:06:52] Sid: There’s quite a bit of benefits and I think one aspect to consider is that, like Qiaojia referred to there’s different layers or different groups of investors, right? If you consider some of the affluent or mass affluent market I think it becomes easier for them to access like a sophisticated products which weren’t available easier, earlier. So, for example, you’re getting access to like uncorrelated assets, like art or like structured real estate deals or private equity deals or even like wine, and those are all uncorrelated assets which weren’t available to that segment earlier. You had to have a much higher base to start off with. So I think that’s like a pretty big benefit to that segment of the market. For the lower end of the market, for the retail market and investors who are just starting out, I think access to like a brokerage and simple investment tools has really made a huge difference, as we’ve seen with all the recent GameStop and all of the other trading things that are happening at the moment. I think like it’s a mixed blessing, a mixed bag, with how some of these platforms are set up. There are some, like, for example, like, which is a good one, which is focused on building engagement and literacy and community around it, whereas there are others which are built more on like gamifying it and at least in my opinion, they don’t always result in a positive benefit because it’s not really a game. So, I think all these tools are really helping bring wealth management to the fore in front of everyone, but I think we need to be a bit careful on what the propositions are and hope that they lead to positive outcomes for people.

[00:08:56] Ben: Fantastic. So, if I were to summarize what you said, it was slightly caveatic, but basically Qiaojia is telling us that there’s a very large addressable market of people who don’t have access to wealth management, and you’re saying that when they do, they’ll be able to get access to a wider range of asset classes, which will help them to diversify their risk or better manage their portfolios to their risk tolerance and then financial literacy should improve, so it seems like it’s pretty much a win-win situation. So, Nikolai, why is it still hard to convince consumers to sign up for wealth management services? Why is the cost of customer acquisition still so high, for example?

[00:09:36] Nikolai: Very good question. Thank you, Ben, for having me and thank you for being here, all of you. Yes, I think there is a bit of a misconception. I think, especially coming from inside the industry, I think we often think that we need to educate consumers more and explain things better, and explain things more, in more detail, but I’m not so sure that that’s actually what will help us here. If you look at some other examples from, like, I don’t know all the details of fractional reserve banking, but I will still get a mortgage to buy a house, right? Or, I’ll get a consumer loan to buy a car, which rests on that being a thing. Or, if you look at other pieces of technology, at our work we use G Suite and I don’t really know how Google does it, but I can edit a document at the same time as someone else is editing a document, but I’ll still use the product, right? Because it gives me a very material benefit. So, this product is not sold to me on the basis of its functionality, but on the basis of its outcomes for me. And I think we attempt to explain and educate people more, I think we’re actually putting off potential clients more than we are encouraging them. So, what really, I think helps, is if you have a focus on the outcomes instead of the product, I think especially within [inaudible 00:10:55] very guilty of explaining the concepts of investment management, the methodologies, the frameworks, the ins and outs of how it works, but for the average client most of the terminology doesn’t mean much, but they’re also not very interested in the details, they should be interested in the outcomes and what it does for them. They have objectives, goals, and plans for their life and the products we build should only be the underlying rails on which those goals and objectives are achieved. And that’s the winning proposition, I think. Also it means to break down the style of approach between saving, pensions, protection, investing, again, we look at those differently because they’re regulated differently, they have different revenue streams. Again, for the normal, average, especially mass market consumer, it’s quite irrelevant, because they only care about the outcome and they should care about the outcome, we should do the mental bridging in between to get them there.

[00:11:52] Ben: So, Mike, I’m going to come to you next. I want to ask you whether you agree with that statement. Is the way to encourage more people to take wealth management services, to portray their services more in an outcome-based way, rather than trying to explain to them how the mechanics of how the services work? And then the second thing I’d like to get your view on is the question we’ve asked in the poll, where people seem to be a bit split, between whether or not the pandemic has accelerated the democratization of wealth management. So, if you don’t mind commenting on both of those, Mike.

[00:12:33] Mike: I think these are fascinating areas, very apt in terms of everything that’s happening with Tesla, Bitcoin, GameStop, et cetera. So, let me try and react. And to go back to Nikolai, my experience is that that the process and the detail matter when the outcome is negative, right? I always try and design something for when things go wrong, because when you get a negative outcome, as many people who hold GameStop now in the last two weeks have, then you’ve got to go back and question your own decision making process, the marketing, the messaging from your broker, et cetera.

So I think detail and process are important in that regard. Broadly on the idea of the democratization of finance, I’ve got strong feelings in the context of what’s happening with Robin Hood, I would rather term it the democratization of risk, because that is what really is happening, because you have large established places like hedge funds or individual investors who are effectively selling risk to retail investors, effectively that’s what’s been happening with GameStop when we kind of analyze who has won and who has lost, and people are being exposed to lots of different types of risk they don’t know, they’ve never experienced before, illiquidity risk in the case of alternative investments, hurting correlation risk.

So, I rather see this as the democratization of risk. I also think we need to make a very sharp distinction between trading and the volatility of markets which is I think much more of an American than a European phenomenon. And then the idea of wealth management optimizing portfolios, which is obviously more a sane and balanced approach. And think anything that encourages people to have a balanced optimized approach to wealth is good and is useful, and that is in my view democratizing finance. So, I think, I think the idea of democratizing finance is also, someone mentioned financial literacy, and that’s a huge area, obviously being in the EU are beginning to get into this.

And for me, that’s the real barrier. Part of the time I’m involved with something called WEInvest, Women Empowered To Invest, whose aim is to get women to invest more and to invest better. In that project, one of the things we found is that men and women have these glass ceilings to finance and that the finance world talks to them in math and jargon, et cetera, about what should be products and events that are essential to their lives at retirement, but that’s communicated in a way that is obtuse and intimidating. So for me, the democratization of finance is really all about clarity and open and transparent communication.

[00:15:56] Ben: We’ve had a question from Jean Cristof, it’s about gaffers. So, Jean Cristof, I’m going to take it later on when we talk about new business models, if that’s alright, because I think can tie that into a question about aggregating services. So, I’m going to ask the question in this section, if that’s alright, and I would encourage other people to please post your questions, but I’m going to put this to you Sid, because I think Mike is raising a really interesting sort of distinction between the democratization of wealth management and democratization of risk. And my question to you is if we sort of disembody wealth management from the service providers, i.e. you know there’s this big trend towards embedding wealth services in other distribution channels, do you think that we therefore increase the risk of democratizing risk instead of democratizing wealth management?

[00:16:46] Sid: Yeah. I mean, I think there is a possibility, like, for example, if you offer through a brokerage to a provider who doesn’t have ownership of the risk in the book, then he is not going to be too worried about offloading it to as many people as possible, all he’s worried about is customer acquisition or making a cut on that. So I think where the risk sits is a very important sort of consideration, and so is the fiduciary responsibility, like exactly what are you giving to people, and takes the ownership, like when Mike mentioned, when things go wrong? So, I think just simply embedding some of the wealth management products without having a strong team to take on the fiduciary and risk and responsibility is actually going to be a bit harder and a bit more complicated than it seems.

[00:17:54] Ben: And so, in a model where you have banking as a service provider sitting between the regulated entity, the custodian and the customer, how does that play out in terms of risk management then? Who manages the risk?

[00:18:12] Sid: Usually it will be the banking institution, the institution that has the license that will always manage the risks. It’s on their books. They’re the ones who report to the regulators. So either the platforms or the software providers usually don’t have the risk on their books. And so that has been probably one of the reasons why sometimes embedding some of these wealth management services into other platforms takes way longer and way more complex than people think it is.

[00:18:46] Ben: Great, okay. I’m going to switch to the second topic and I’m going to come to you Nikolai again, we’re now going to talk about changing technologies. The question I wanted to ask you is which are the technologies that are most important in your view, in this democratization of wealth management? Do you think it’s analytics and the ability to use the trail of data that people leave as they interact with digital channels to be able to do that whole personalization at scale? So, what was once the preserved ultra high or the high net worth individual being, you know, democratized, so personalization being democratized.

[00:19:27] Nikolai: Yes, absolutely. I think, I mean, if we really talk about core technologies or deep tech, what is it then? I think obviously it’s cloud computing, it’s parallel processing, all the things on which most of the advances lie, and this is in general, of course, but yes, of course, and that brings with it the use of a lot bigger data sets and the extension of that is hyper-personalization definitely, and there especially, I think we can draw conclusions also from what’s happening in other industries, especially with e-commerce, media consumption, where hyper-personalization is the norm right now, where the offer you get is significantly different from what somebody else consumes, especially think about your Spotify recommendations with a curated playlist you get there. For example, you mentioned investing earlier that build in the UK and therefore example, based on an extremely high degree of automation, the platform builds a unique portfolio for every single client and then this portfolio is managed on an individual basis, on a daily basis, potentially; it doesn’t rebalance daily but it could. And that only works of course, because you have extremely capable server farms, in this case, it’s Amazon or Azure on which the proposition is hosted. And then at the moment of when you need to make the calculations to rebalance the portfolios, you just rent a thousand more workers that Amazon gives you at that very second, the couple of seconds it takes.

So based on that, personalization becomes a possibility at scale at very low unit economic cost, of course. I think something else that I’m quite excited about is the context generation through natural language processing and more important actually natural language generation. We work with a firm called Personetics and then there’s Cognitive Investment Technologies, a smaller UK player, they do very interesting stuff where, with the means of, of course sifting through again big data sets you give the client context to what’s happened in the market, how it has affected their portfolio, much like an advisor would, of course, but again, by bringing down the cost through skipping the human element, you are able to have a mass market proposition.

And I think the last one is classical automation and straight through processing along the entire chain, from onboarding investment proposals, reporting, et cetera, and especially their thing is also about the fluidity between the products, as I’ve mentioned before, saving, investing, pensions, et cetera, but also between the channels of self service and the advisor and that that becomes one experience. I think that’s also will be a key in propositions going forward.

[00:22:11] Ben: I’m going to come to you next, Qiaojia, I want to ask you, so Rosecut uses, still it’s human beings that manage the investments. But if we listen to Nikolai, if I interpret what Nikolai is saying, we can personalize portfolios and we can build a bespoke portfolio for everybody that matches their risks and so on, and in addition, it sounds like we’re getting closer and closer to doing the thing that’s much harder, which is, if you like the emotional aspect of wealth management, giving reassurance by using natural language processing and so on. Do you think there’s still going to be a role indefinitely for human beings in the provision and delivery of wealth management services, especially I suppose, for mass affluent and affluent customers?

[00:23:06] Qiaojia: Yeah that’s really a question that’s been debated within the digital community for the past 10 years or so. And I would say first of all, I want to make a distinction between personalized device and personalized portfolios. So I think for financial advice, it should always be personalized to your circumstances, your long-term life goals, your income level, even your wealth personality, am I a legacy kind of a person or to maximize my wealth and pass down to my children in the most tax efficient way, or I’m a freedom type of person who just wants to earn enough.

So in this case, we help you to define what is enough for your personal circumstances. I’m of the view that this is much more important than personalized portfolios. The traditional industry has come a long way from bespoke the portfolio and doing advisory services and frankly sometimes does not actually maximize efficiency or the return for the client. It’s like you are a chef and asking the customer to detect how you cook the meal, it does not always work very well. So, for us, we standardize portfolios with certain customization elements, but not necessarily bespoke or personalized that might really attract the affluent people.

So, this is why our discussion of offering has a standardized element, basically model portfolio, and then let you pick some interesting semantics, very much related to what Sid was saying, that the alternatives can play an interesting role here. So, going back to the personalized financial advice bids, if you think about the different types of client needs, as well as sort of the cost of human advisors, these are the two most important things driving the industry change.

So, people joke about going to see a wealth manager is like going to see your dentist every year. It’s the right thing to do, but it’s painful, and you really don’t see it, you know, private banks throwing, lunch and dinners and entertainment to make it slightly better, but still not everyone wants to sit down to go through a two hour integration of what are your assets, liabilities, and those kinds of topics. So, we actually found a lot of people enjoying a quiet time sitting at home, just going through that step by step at their own pace, rather than being interviewed by a wealth manager.

So, I think a digital service is a great place to capture those kinds of preferences who are sort of incremental wealth to the industry. And second is about the cost of advisors, you know, since RDR there is such a decreased in the qualified advice space and advisors that are retired, basically retired with some of the older kinds. So, if banks can’t make a living by providing bespoke advice to affluent people and then sort of dropping those clients then digital providers can’t either, and this has been evidenced by some of the first-generation robo-advisors having a hybrid model, hiring financial advisors to provide advice on an hourly basis.

So Rosecut’s view is that we, first of all, want to automate as much as possible, to build a beautiful user experience as close to social media experience, but you have the emotional elements, as well. Of course we still have a long way to go. And then use human as insurance. So anything that the automated platform doesn’t do we have the human advisor to pick up the slack and over time with the trend and the learning from those unanswered questions, you patch it up into the system and make it more and more sophisticated.

[00:27:18] Ben: Mike, I want to come to you next because, thank you very much, Qiaojia, because so far we’ve been sort of thinking about the wealth market and we’ve been splitting the demographic almost by how much money they have; are they affluent, mass affluent and so on, but it’s more complicated than that. Because as you said before, there are other demographics you can layer on top, such as women have different preferences, to men younger generations have different preferences to older generations.

And so I wanted to ask you a question that’s coming from the audience. If we assume that some of these robo-advisors, they have a high cost of customer acquisition today, for example, and they target say mass affluent or affluent, what is the possibility to grow with the demographics, whether they slice them in different ways? So they target younger generations who are mass affluent, who may over time accumulate more assets, how do you see the possibility for some of these new entrants to kind of move upstream into high net worth or ultra high net worth, that may be either by targeting a different demographic or growing with their existing demographic?

[00:28:35] Mike: Okay, so I think that there’s maybe two things here, one is the various changing demographics and then the other is the business model and how we capture that. And I think some online banks and online digital new entrants to the digital wealth management marketplace have made a mistake in paying far too much in terms of customer acquisition costs, and you see that in some of the results and some of the grounds they have, at a gross level they push the model of focusing more on the experience of what the theme is, which is sort of high net worth works because you don’t rely on playing odds on social media, there’s an element of kind of professional conduct as well.

So first of all, on the demographics I think in general, the wealth management industry is very poor at demographics and I kind of scold banking colleagues in old banks by saying you go to a supermarket or a shopping center, or go to High Street and look at how well luxury goods companies and retailers target different demographics, and banking doesn’t do that, it’s lazy not to try. And in the future, I think we will have more attention on younger niche over the topic of longevity would be a really big issue in wealth management, pensions, the accumulation of wealth, and then also women as a demographic is an area that banks in my view haven’t given any attention to at all in terms of services.

In terms of business models. I don’t think that digital banks who are currently focused on mass market community move up to the higher end for a whole load of reasons, one is you need to hire bankers with experience to have different products and a different product range and probably a different platform. And I think most of the people in the high net worth space and upwards, they want a focus on them, they want something that’s maybe less hands-on, they want something that’s sleek in terms of the service, but that’s less transactional. That’s a very, very different proposition if you’re a kind of more of a mass banking app. And I think the problem for those companies that they are increasingly going to be encroached upon by what individual banks are doing with their own digital projects.

[00:31:19] Ben: Just then one follow-up for you then, does that mean, do you think we’ll see turn? So, in other words, as customers get wealthier, they’ll switch from robo-advisors potentially to private banks when they demand a different type of service, in person, and so on?

[00:31:36] Mike: I think that will be the case, depending on the extent to which they get wealthy or not, and I think what also will happen is that some wealth managers will become better at IT, so better back office, Nick has talked about some of the solutions, better at reporting, really basic things that many wealth managers don’t do very well. And I actually think that the biggest revolution would be product and access to what I would call kind of the portfolio of the future, which would have more private assets, probably more crypto, and being a bit more international and these are the offering on new and old players. Not many of them have that.

[00:32:22] Ben: Fantastic. Sid, I want to come to you next, there’s a nice segue there because Mike is talking about some broader portfolios that extend beyond some of the traditional assets. And so the first part of the question I want to ask you, so we’ve had two really good questions here, that I want to put to you, the first one is around the role of tokenization in opening up some of those asset classes. I think you briefly touched on that before, but if you wouldn’t mind picking that up again, and then the second part is around gamification.

So, what is the role of gamification in terms of keeping people engaged with wealth management services? Because I always think about banking as having this engagement challenge, which is principally in the transaction-based service, therefore it doesn’t have high levels of engagement and therefore is open to being embedded in channels that have higher engagement. So the two-part question is tokenization and do you think gamification might provide enough engagement to keep people using wealth services for wealth managers?

[00:33:22] Sid: Good questions. I think that tokenization can definitely help, especially with alternative assets and like allocating ownership in a fair and equitable and a transparent way. So, when you’re talking about art, when you’re talking about wine, when you’re talking about obviously crypto is that very thing that originated from, I think tokenization can really help with access to some of these assets which were reserved for the ultra high net worth in the past, and I think that’ll definitely be a trend that takes hold. In terms of gamification, I think there’s definitely room for it.

For me, I think financial literacy is a really important aspect, and like academic research has shown, for example, that in Europe only about 30% of the population has even basic levels of financial literacy, and it’s about the same in the US, and these are affluent, OECD nations. Simple things like time value of money, about saving, about inflation, teaching people about having a savings account and having an emergency fund, just inculcating some of those habits, those basic financial literacy habits can make a huge difference in their financial outcomes.

And I think gamification for positive cases like that is really important. I think you have to be a bit careful where gamification doesn’t become about getting people to trade more, and I think that is that is something that I’m quite worried about, but in terms of increasing the literacy, getting people to save more, getting people invested more in equities, but more as a portfolio rather than like individual stocks, teaching people about those sort of a risk return trade-offs and better financial habits is where gamification can help.

[00:35:26] Ben: Fantastic. Okay, I’m going to switch now to new business models and I’m going to combine my questions, because we’ve had some good ones here also from the audience. So, I think what I’m going to do is I’m going to kick off with you, Mike, if that’s alright. I’m going to ask you, you might argue that wealth management potentially has lower engagement than some other services through which you could distribute financial services, but it has a high level of trust and you can use trust to aggregate other services, but we see very, very few examples of aggregation models in wealth management, by which we mean using the pull of an existing customer base to aggregate wealth and non-wealth services. So, why don’t we see more aggregation models from big private banks, for example? Why doesn’t UBS, for example, aggregate, other services?

[00:36:22] Mike: Yeah, I think it’s a good question. The answer for me lies largely in the area of organization culture. We’re beginning to get consolidation in wealth management in the UK, Western Europe, Switzerland, where we are today, and the logical question is why doesn’t Google buy UBS, or why doesn’t Amazon buy Credit Suisse? Because what we find is the brands, the top level expertise coming to clear out the tech problems. I’m not a tech person like Nick or Sid, I’m kind of a bystander, I see those things happening across the industry. There are big barriers in terms of banks doing tech, there are lots of interests on the part of people inside banks not having tech disrupt their own jobs. In Switzerland, we have an issue with data projects internally that are simply inefficient.

And then I also find that many tech people in FinTech have very logical solutions to what I think are banking problems, but actually what they don’t spend enough time thinking about is the idiosyncrasy of the banking problem and the fact that banking possibly is like to have humans rather than robots vested in their tech problems. And there are lots of reasons why the two don’t meet. I think that the most interesting space would be crypto because that would be, if I can call it tech banking or tech money designed by tech people. So, it’s entirely consistent within the ecosystem, and from Zurich and other parts of Switzerland, lots of people could get in to develop crypto operations, trading, digital assets, so that space is a very interesting kind of proving ground.

But, to come back to your question, there should be a logic in some of the bigger wealth and asset managers who trade quite cheap particularly compared to [inaudible 00:38:38] just being embasked by tech companies or tech entrepreneurs who can potentially cut the banking cost at least in half by introducing a much more rational tech focused approach. Finally, just to not go on too much, I think the disrupter to the industry will be consumer goods companies getting into finance, probably from the bottom up. They will have scale and they’ve already solved the customer acquisition problem. So the question of just starting with a range of sense of the products. So, that’s where the threats are going to come from.

[00:39:29] Ben: Okay, which is a super segue to use, Sid, because your business model is basically in facilitating that, facilitating non-banks to offer banking services or in this case wealth management services. Do you see that already happening? What is the level of demand for embedded wealth management services? And you kind of alluded to this earlier on in one of your answers, but it seems like it might be more difficult than people think. So, would you mind elaborating on that as well?

[00:40:01] Sid: Yeah, so, getting started with a wealth management product is hard. When I had a startup and we were setting up a brokerage, it took us almost two years to get a license, get all the legal agreements, get everything set up. I think having an embedded finance option, like some of the new platforms like ours, which are coming up make it a lot simpler. They abstract away some of the complexity, some of the compliance, some of the security. So I think that whole process can really be sped up. I think there are still roadblocks and those are related to who takes on the fiduciary responsibility, who has the licensing, and that is always going to be a bit of a problem in wealth management.

So, for example, with some of the embedded services that we’re offering, we finding that a lot of financial advisors are calling us about them. They already have the licensing, but they want to have a mass acquisition channel. And so for example, they want to offer like an aggregator or like a small calculator or risk analysis services on their website and that serves as an acquisition tool for them. So, I think in those sort of cases, having an embedded finance solution works well.

We’re also finding that platforms that are starting to take on more of the financial services burden off a particular segment, so for example, like freelancers, for example, there are people who are building like payments services for freelancers, because a lot of them don’t have even bank accounts. So, we’re setting up facilities to have bank accounts, but then why not add an extra feature where you can also allow them to save easily.

So, you know, having an embedded solution, which they can get up and running quickly is like a real value add to those types of companies, as well. So, we’re seeing a mix of both. We’re seeing both financial services providers who want to acquire people cheaply and non-FinTech companies as well, who want to start dipping their toes into offering some of these services to their customers.

[00:42:36] Ben: Thank you very much. Nikolai, coming to you next. I want you to, if you don’t mind, expand on this topic by talking about some of the interesting business models that you see, the kind of customers that are coming to Nucoro, and I want to just frame it slightly by talking about there’s many network type models that Sid touched on there, like can you take a pool of freelancers and help them to build a collective savings pool, for example. So I just wonder, are there other models like subscription services and things like that, that we start to see emerge in wealth management? So, can you just comment on what you’re seeing in new business model types?

[00:43:15] Nikolai: Yes, absolutely. I think it’s a very interesting question because it’s only remotely relative in tech than the business model which is a much more strategic topic and less tactical, and often overlooked. I think there’s a lot of potential for innovation, totally. I think a few models are interesting, and Rosecut is a great example, right? You have this premium entry level model where you can dip your toes in before it even draws you into the actual corporate position.

But generally the move from AUM based models or in performance based models I think which is flat subscription based fees, which is what consumers are by now very much used to, rather than a lot of the other services, digital and non-digital, starting again, as I mentioned before, Spotify subscriptions, Amazon Prime, everything else. I think another definitely related Sid to what you just said, I think the idea of building ecosystems and making connections with other services and selling across the services.

I think of the challenger banks, like Revolut does this natively within their app, they switch another tile and there is insurance, they switch another tile and there will be risk management. They build a lot of these things themselves, but not necessarily, that it needs to be necessary, right? You can still offer this functionality, but rely on someone else who actually will have the capabilities of technologically doing but also from a regulatory perspective, doing it, it will still be the service that you will be the gateway to that service. So building connections with other distributors in not only the direct approach, I think also plays into that.

And there’s also, there’s a bit of a fear and a concern around being commoditized in a way, however, and also coming to Michael’s point earlier, the biggest attack vector comes from the big tech players. And Google will not become a bank, but Google or Apple will be the biggest distribution partners you will have that you can possibly find if you are a bank.

So, overlooking that I think may be a lethal mistake, as well. And then I think it’s also got very strategic and business motivators, holding a flanker brand maybe, or a stock brand, and moving away from and giving up a bit of the brand equity you have potentially, because having an established brand is a great asset, but it can also be a liability if you want to reinvent your offering and reinvent also the target groups you have.

The biggest players doing it right with Marcus by Goldman Sachs or JP Morgan is rumored to launch something in the UK. It varies with a lot of brand equity but still, I think it plays for midsize market players and all of these, I’m aware all of these are harder steps and I think we often are a lot more comfortable to tinker with internal processes and tech and all this stuff that clients already touched, but I think it pays to be bold in applying some of these more strategic transformation points.

[00:46:32] Ben: So, I want to put the next question to you, Qiaojia, which comes from Ian Stewart and he asks which of the incumbent financial institutions are the most progressive and making the most progress in this area? So, kind of picking up on Nikolai’s point, who is taking the risks, so we’ve heard about Goldman Sachs launching Marcus, and now Marcus is also, the platform is also now offered to others. So, Goldman Sachs is potentially taking some risks and being quite progressive in this area. Who else do you think is leading amongst the incumbents?

[00:47:06] I probably wouldn’t say there is one single leader in the space, and we have seen sort of an influx of incumbents trying in this space in the past five years. I think UBS spent a huge amount of money launching UBS Smart Invest. Actually, the head of the program is one of those advisors, so we’ve learned a lot from their experience. Coutts have launched their mobile app with the basic functions a couple of years ago, and sort of piloted a program called Coutts Invest. At the beginning, it was only open to Coutts clients and then eventually was distributed under the RBS and that was invest with £500 to start with benchmarked against — not make that I suspect.

So, I think one of the key things is that people, the incumbents are worried about things like wealth transfer and how not to be left behind with digitization of the service, but they face two challenges. One is a legacy IT system. It takes forever to build something new and then bolt onto the old gigantic machine. So, in the case of UBS Smart, it took them 18 months to do that. And for Rosecut to have a fresh state of art tech stack, it took us six months. So, this is the level of challenge.

And second, in my view, it’s always easier to start evolution. You can be an independent, almost like a single cell creature, and then rapidly iterate your offering along the way, than starting a revolution within an organization, because you always are fighting against people who prefer the old ways of doing things. Another point is that a lot of the times incumbents treat the digitization as a back-office problem. So they see it as an IT project that a bunch of engineers there needs to go to work. At one of the major banks I worked, I really squeezed into the digital offering team out of my normal KPI and tried to contribute a front office perspective. They think it’s an architectural issue. It’s not only an architectural issue, it’s a user experience, client experience issue as well.

So, I think this is where we see happen again and again are the industries where independent, small, scruffy startups eventually over strong the established companies. And this is personally why I made the career switch and trying to figure out independently. But that said, I have not seen, I think Marcus is probably the best example of mostly investment bank trying to get into a more mass markets, and they have a good strategy plan of investing to not make during the saving product and now moving to investing.

[00:50:33] Ben: And what about somebody like Standard Johnson, because they seem to have a similar kind of playbook, with [inaudible 0:50:42] and I think they’ve got this new platform called Nexus, which is a bit like Marcus. I suppose this is open to anybody to answer, but it seems like, Nikolai was making this point, that if you’re a large bank launching a new kind of your own challenger brand is a way of, if you like, transferring some of the brand equity you have into a vehicle where to your point, Qiaojia, you don’t have the problem of Legacy IT and to your point, Mike, you don’t necessarily have the same cultural obstacles to introducing change, particularly around business models. So, is that the best way for an incumbent to face up to this digitalization threat?

[00:51:23] Nikolai: I think one key element there is also from a cultural perspective it’s the only way that innovation on a technological level can work, just because within the organization you have cultural bottlenecks, especially what Qiaojia said, you have a legacy system bottleneck that just prevents you from being able to do any meaningful change at a scale where it makes it a dent in what is the customer outcomes in the end.

I think there are good and bad ways to go about that. I have felt and we do a lot with the innovation labs or the digital arms that retail banks have set up, and that’s also to Qiaojia’s point, it’s also the way of looking at technology as something that happens outside the business, and then somehow goes back into the business and then change happens. But I think it’s great as a channel to introduce innovation, source ideas for innovation, but it’s not what drives true business model transformation. If you want to truly build a digital first proposition the business and the tech has to evolve and be built in synch, and that’s exactly what the challenger brands are doing, it’s what Rosecut are doing, it’s what all of us are doing, we are building a new startup but also a new technology spec.

So, by creating a subunit or an outside unit, I think it’s probably the only way to do meaningful change, it really then has a transformation curve that is not just like a band-aid to what is essentially a very heavy wound.

[00:53:02] Ben: You’re right, because Qiaojia made the point that a lot of banks kind of view digitalization as a back office function. And then on the other extreme, you’ve got a lot of banks that sort of see it as some sort of innovation function, a play thing for a group of people who aren’t really key decision makers in the organization to work with. And it needs to be in the very top of the corporate agenda. And so how do you do that? How do you make it top of the agenda? Do you hire people that aren’t bankers to join the board?

[00:53:31] Mike: Maybe I’ll chip in, the Rosecut experience opened my eyes to how the big banks were with tech and how good a small focused team can be. I’m now going through the same experience, we invest in startup, in terms of me learning what lots of different areas. So I think the decision would be made by the CEO of the large bank. So I think the kind of thing you want to do is to take some of your senior executives, make it clear to them that this is an essential part of their career, that they’re not just being part in operations.

You want to incentivize them. You arguably want this to be geographically remote from headquarters to give it sort of a mental break. I think we need to put tech and banking people together on party, maybe I think have a lot of interactions with customers or potential customers just to make absolutely clear what the problem you’re trying to solve is, and try and do it in that way. And maybe also look at the bankers, tech classes, entrepreneur class, and teach banking to the tech people, as well. So, it’s something I think, in which people have to be very, very invested, but it should pay dividends.

[00:55:5] Ben: And do you think banks can attract the right tech talent? Because if the competition for tech talent is global, because tech is part of everybody’s business, arguably the most important part of everybody’s business, can banks hire that tech talent or should they be using third party suppliers, like Hydrogen and Nucoro, more than they do today?

[00:55:26] Mike: Let me answer that. Tech talent is already very expensive in London and Zurich, tech talent is as expensive as banking talent. I kind of think what you want to hire, just my limited experience, hire project managers who have a taste of both and can actually advance the project, kind of skilled in both languages, but that’s not an expert opinion.

[00:56:01] Ben: Fantastic. And Sid, a question I want to ask you, I’m sorry to keep coming back to you on these questions of embedded banking, but I just think it’s fascinating as a new business model type. I’m just wondering, if banks or wealth managers in this case, don’t control the customer interface, i.e. that’s controlled by other brands, how do they continue to have a profitable business where they have some control over pricing, some ability to upsell and cross sell, or do they have to accept that they’re just balance sheet providers or custodians or whatever, or regulated services providers? What is the role of wealth managers embedded in the banking world? And then if they do have a profitable role, how do they bridge between being a back office supplier and having some engagement and continued role with the customer?

[00:56:59] Sid: Yeah, that’s a tough problem for them and that’s why some banks have not gone down that route of just providing the services, like in the US. You see most of the FinTechs are using only a couple of banks, like Evolve or like Greenberg.

[00:57:19] Ben: And Cross River.

[00:57:20] Sid: Yeah, Cross River. So there’s just like a handful of banks, but none of the big banks. But for these smaller banks, who have a much smaller customer base, for them it gives them access to huge amount of customers, which they would have never had access to previously. So for them it kind of made sense to build like a tech stack specifically for integration for the fintechs, where it’s like a scalable kind of solution for them. So, they’re still making money and they don’t have the customer acquisition costs. So, it can still work for them. I mean, it becomes obviously a bit harder to like cross sell anything, but I think just in terms of the scale that they can access, it’s huge, and it’s worked really well for people like Cross River, I mean their scale has just grown dramatically in a couple of years.

[00:58:19] Ben: Okay, so I actually looked because we’ve got a report coming out and I looked at some of these smaller banks in the US and some of these guys have got return on equity of 40% plus, because as you say, they don’t have to acquire the customer, they’re just providing regulated services, but it doesn’t seem to me that that would work very well for an incumbent with the kind of cost base the incumbent has.

So this is a question to anybody to answer, is an incumbent, therefore, with a large customer cost base, excluded from participating in embedded finance, or is there a way to kind of leverage the brand to make it such that if I’m using a third party service, I still would want the service from a given institution. In other words, is there a way to still differentiate when you don’t control the customer channel? And how is that possible? Is that a tech question?

[00:59:16] Sid: I think there just one aspect I’ll give, one example, which is like the Apple card offering, for example. Goldman Sachs was still involved in that, but they weren’t at the front of that brand offering. But what they were able to do is they were able to take on some of the risk assessment off their clients and that worked out poorly in some examples, but you know, people were able to see that they were able to get cards much easier. It also gave them access to a huge channel, as well.

So I think there are some possibilities of being embedded and still having the visibility and some control on the proposition that you’re offering. But it becomes challenging. I think now a couple of the banks are trying to offer banking to Google as well, and they there have been some deals that have happened over there. But they will just be in the background in that case, but it’s a huge customer acquisition channel for them.

[01:00:25] Ben: Does anybody else have a view on that? Because it seems to me that implicit in what you’re saying with Goldman Sachs Apple tie up is you have, if you like, two premium brands. Is it just about building brand? Do you think there’s a tech answer to it, I suppose is another way of putting it. If I can build sufficient, contextual information and I can serve up relevant offers and content and so on, even if it’s through somebody else’s channel, can I still carve out some differentiation that makes me more than just a commodity supplier of regulated services? And I’m curious to know if you think that’s a tech challenge, brand challenge, or whatever.

[01:01:01] Qiaojia: I’ll chip in a few of my observations. On the tech side, I think it’s really challenging because of the legacy system and the executive team may not have the courage to put in a couple billion and do a complete overhaul. But what other things they could have done is to really sort of reshape the sort of incentive system.

One thing that a power banking colleague put to me in terms of the private banking model, she described it as a hair salon model. You know, every advisor has their own desk and has their own support and look after their own group of clients. So it started with a bad habit of banks, I’m talking about specific power banks, poaching each other’s high producers and paying them a lot of money and hoping to attract the book. But overall it’s not a very structured effort of growing the organization together. So, this is one thing to think about, how to incentivize team effort, rather than rewarding lone wolves. This is something that we can think about.

And second is that when you face regulatory pressure and margin compression they you race up to the top of the pyramid and dumping your smaller clients to slow regulatory pressure, then rather than doing the reactive thing, it’s more important to be really clear who you are focusing on. It doesn’t mean if you are a big bank you should be just thinking, okay. I’m catering to everyone, have a tiered offering, like some of the British banks with retail, affluence, and then high net worth and ultra high. You really need to think about how you’re going to do that. Maybe outsource your lower tiered clients to some partners and then focus on the most important segments that you have the right skill and expertise for.

So, UBS went through the process of, well, let’s try to dab into affluent, no actually we should just focus on ultra high and a lot of banks feel like they focus on ultra high now, but there are only so many ultra highs in the world. Like you can even slice down the target market to entrepreneurs or certain industries or just really have a good view of what you can do, and a more organized effort and reinforce your brand in that. So, yeah, this is a non tech perspective.

[01:03:43] Ben: And the cultural questions again, so Mike, you seem to have strong opinions on culture. Is that possible, moving from the hair salon model, outsourcing customer management, all these things, again, to be quite alien, it seemed to me, when I speak to private banks, to be quite alien to their thinking, because they still think that they are in control of the customer and the fulfillment of those customer needs.

[01:04:14] Mike: That’s been enforced by the individual bankers. They will jealously guard their clients. I think, just to go back to your original question, which was I think if you have a high cost base, can you put in place some of these changes? My response to that would be ask why you have a high cost basis, is it a defunct business model, is it the wrong blend of bankers, that kind of thing. When you end up in that situation where you have a competitive margin, outsourcing tech might be a solution, but the real problem lies elsewhere, lies with core management, maybe institutional cultural issues that are very, very deep seated.

I think you’re going to see if you walk into a wealth manager in say Switzerland, they all look the same from the outside. People who meet you all look the same, to the extent that it’s become a bit of a party and that maybe tells you that means cultural elements are very, very strong and that trying to change them will meet a lot of resistance.

[01:05:33] Nikolai: Maybe to add something there, because also coming to your point, Ben, I do think certain elements or changes is met with a lot of skepticism. What I find interesting is that a lot of times it’s very difficult for them to articulate what is actually the value that clients see, a lot of them don’t really know actually. Is it because a rather trivial element like customer service team, for example, on the middle office side, for example, it might be that it’s very important for your clients. Maybe you don’t see it as important at all.

It may be other elements, maybe it is for the status symbol of what the brand represents, or it is the user experience with a personal relationship with your advisor. It might be a very wide range of things. A lot of times they don’t know. And I think that’s the starting point, first figure out what is it actually that your clients like and see as the value to add, then maybe actually only have a discussion around that, not doing all the things that you think are necessary to do.

[01:06:35] Ben: I think that brings us to I think probably the last question that I’ll ask, which comes again from the audience, it comes from Christopher, and it begs the question, what is the ultimate role of a wealth manager? What underlies his question, because he asks are technology solutions sufficiently so advanced that a wealth manager can outsource the entire thing to a technology ecosystem? And then what would be the USBs that remain? So, if I’m a wealth manager and I’m in charge of the brand, can I source everything else from an ecosystem of tech providers, from FinTech providers, et cetera.

[01:07:20] Mike: I think at the very high you can’t, and at the high end what some banks are beginning to do is to bring corporate finance bankers into relationships with families and family offices and that kind of stuff can’t really be commoditized, because I think at that level clients want security and they want the client to know them intimately, and you can’t do that remotely, you can’t do that with technology. That kind of advice networks are finding the business of clientele, that’s not something for which bankers offer a solution. I think also for senior bankers, they often play a partner role. So, at the very top end I don’t think that’s possible. I agree with Nick and Qiaojia.

[01:08:28] So, if I interpret that correctly, you’re saying that beyond the people that serve the ultra high net worth individuals, the family offices, whatever, everything else theoretically could be, because you’re saying ultimately it’s a question of scale and lowest unit cost, and access to networks.

[01:08:44] Mike: I think most of it could be, obviously as you go down the scale, I think you also want to think about content and education. Content is not something the banking industry does very well. Most banks keep an account with Twitter, no bank I know does research on TikTok, so I think there is actually a huge scope there, not to make things more efficient, but make things a bit more clear and more entertaining, as well.

[01:09:23] Ben: Okay, interesting you say entertaining. Absolutely the last question and then we’ll wrap this up. How do you make wealth management more entertaining? I’d like to get everybody’s views on that.

[01:09:39] Nikolai: Just one example I have, my girlfriend is learning German at the moment and she uses Duolingo to do this, it’s a very popular language app on the iPod. So, there is a daily lead, basically every evening before 12:00 she would go online and just rush in some sessions to improve her score for that day to end up, among the top 10 of her league.

I think there is a lot of literature around what are the best ways to learn a language, the most efficient ways to memorize vocabulary, a lot of theoretical approaches to that. The app sold it in a very different way, a very compelling way to get in maybe 10 more words or something. I think we don’t have to reinvent the wheel with wealth management, but to draw inspiration and insights from other sources, at least a starting point, because we’re a bit behind, others are ahead of us.

[01:10:57] Ben: How would you gamify wealth management without introducing democratization of risk, to Mike’s earlier point? It seems to me you can’t gamify a portfolio because then you’re changing risk, so is gamifying what aspect of wealth management, savings, because that seems external.

[01:11:20] Nikolai: You’re totally right, it must be different levers, not only the risk lever. But then you have, again, we see approaches like that already, like roundups, we see one sets a goal and we see visually how that goal materializes on a map and I think it’s more tangible. I think there are ways that are not risk taking.

[01:11:43] Ben: Maybe there’s an intergenerational play, parents or grandparents helping children, grandchildren to save, to invest sensibly and so on, which might help with the intergenerational, risk of attrition.

[01:12:01] Sid: I think a social aspect can be very huge, especially for the new generation, and I think we saw that with some of the Reddit boards and stuff, but that can be harnessed in a more positive sense where you have peers and maybe some interesting people who are talking about finance, talking about investments, and you’re kind of working with a group to kind of solve your financial problems. I think that is going to be some of the new kind of FinTech platforms that we’re going to see in the future. I’m already starting to see some of those they’re just starting to get funded now.

[01:12:42] Ben: Perfect, great. So, we’re almost out of time. So, I think all that remains is to thank the four of you very, very much for taking part in this discussion, to thank everybody who has listened to this either live or the recording, and then also just to remind you that if you enjoyed this, next week, we’re going to be double clicking on the new business model aspects of wealth management, and we’re going to be joined by Elinvar, Impaakt, Tinkoff and additiv to that discussion. So thank you everybody for participating and taking part in this, and see you at the next4X4 Virtual Salon. Thank you very much.

A Long View of Banking Industry Disruption (#36)

Structural Shifts with Marc RUBINSTEIN, former hedge fund partner and author of the Net Interest newsletter.

We sit down with Marc Rubinstein, a former analyst and hedge fund manager who currently authors Net Interest — a weekly insight and analysis newsletter on the world of finance. Each note of his newsletter explores a theme currently trending in the sector, whether it’s FinTech or economics, or investment cycles — and today, you are going to hear about a little bit of everything. Marc and Ben Robinson discuss the history of equity research and where it’s at now, whether current regulation is tilted too far against banks, the twofold challenge facing challenger banks, the past and future of embedded banking, the four key differences between investing in private companies versus public, the potential financial services game-changers that could happen this year that people are not talking enough about, and more. 

Full transcript
Structural Shifts with Marc Rubinstein

There’s a lot of overlap between what a very, very good equity analyst does and what an investigative reporter does.

[00:01:26.21] Ben Robinson: So, Marc, thank you so much for agreeing to come on the Structural Shifts podcast. We’re a really, really big fan of Net Interest and so, we feel very, very privileged to have you on the show. If you don’t mind, can we start by you just briefly introducing yourself and giving us a short summary of your career so far, just because I think that will be relevant. I think we can use parts of your career to frame some of this discussion.

Marc Rubinstein: Sure. Well, no, thanks, Ben. It’s great to be on. I’ve been in the realm of financial services for 25 years. I started as an equity research analyst, analyzing banks — I spent 12 years doing that — I spent 10 years investing in banks as a partner of a hedge fund exclusively focused on financial services, stocks globally, publicly-traded, long and short. And then since 2016, I’ve looked at financial services out of sheer interest. It’s something that it’s difficult to shake off. And so that’s basically it in a nutshell.

[00:02:22.07] Ben: Good. Okay, so we’re gonna pick up on different aspects of that. But I wanted to start with the equity research part because one of the newsletters I’ve most enjoyed — I mean, they’re all brilliant, but one of the ones I’ve most enjoyed just because it had personal resonance for me because I was once an equity researcher — was the one where you talked about the history of equity research. If you don’t mind, maybe you can just talk a bit about how sell-side equity research works, because it’s kind of a strange model where, you know, fund managers have access a lot of times to internal research, but yet they source it from a third party; that third party doesn’t charge directly for that research. So it’s kind of a strange model. So if you don’t mind just talking about sell-side equity research, and also how it’s changed, right? Because I think, you know, if I were to put it crudely, it’s gone from a really well-paid, really highly-solicited job to something which is not that anymore, right?

Marc: So, I started out as an equity research analyst in the mid-’90s. And I was not particularly familiar with it as a professional opportunity. It wasn’t something that I, at college, realized that it’s something that I wanted to do. I wanted to go into finance and I participated in a graduate training scheme at a bank — Barclays Bank — it was an investment banking subsidiary of Barclays at the time; and went through various placements across the bank, not dissimilar to the way graduate training programs work today. I do need to say though, any listeners that have watched the series industry, it was nothing like that. But I ended up in equity research and spent, as I said earlier, 12 years there. Now, the way equity research was conducted then was very, very different from the way it was conducted prior to that, and the way it’s conducted today. Equity research emerged in the 1960s, 1970s as an add-on to the core brokerage business that brokers offered their clients. At the time, commissions were very, very heavily regulated and the only way to compete was through ancillary services. And so, brokers offered equity research as one of those ancillary services. They gave it away for free. It was a marketing device in order to attract brokerage business. And that was the case when I entered as well. At around the time — so, we’re going into the ’90s, into the late ’90s and early 2000s — another side of the investment banking business was booming, and that was M&A — an equity underwriting. It’s very topical now to go back 20 years and look at the tech boom of ’99–2000s, given the conditions we’re currently seeing today. But the way it worked back then is that companies would want to IPO and they would choose their investment banks, not dissimilar today. And one of the features that they would look for in selecting their investment bank was the quality of the research that that investment bank produced. And so, rather than exclusively being an ancillary business to the trading business — which was the case, historically — increasingly research became an ancillary business to banking, as well. And as a result of that, equity research attracted a new revenue stream and was, therefore, able to grow. And in the late 1990s, this business of equity research grew, costs increased, a superstar culture emerged.

The markets are not efficient, and Signal and Zoom are great recent examples of that. And to the extent that they’re not efficient, research does have value and those inefficiencies typically emerge the lower down the market cap curve one goes.

Marc: The piece that you referenced, I talked in there about a telco analyst who worked at Smith Barney in New York, called Grubman, and he wrote on telco stocks like AT&T, and he was coerced by his boss, Sandy Weill, who was the Chief Executive at Citigroup, to rethink his view — it’s kind of a euphemism for upgraded to a buy — on one of the stocks under his coverage. The 2000s came along, Eliot Spitzer, who was the Attorney General in New York, took a view that actually there was a massive conflict of interest at play here and he tried to dismantle that construct within equity research. The problem is that the cost base was still there and the cost base didn’t have now a revenue stream to attach to. And so, you had like an orphan kind of wandering around looking for kind of a foster family; this cost base was looking for a new revenue stream. For a short period, it stumbled upon proprietary trading. So, the period between 2001 probably, 2006, 2007, investment banks built very large prop trading businesses, internally, and equity research was a feeder mechanism for some of the ideas that they would put on. And then, the financial crisis happened and that business disappeared as well. Ultimately, that was also dismantled by regulators through Volcker amendment to the Dodd-Frank Act of 2010.

Marc: So, throughout this entire history, you’ve had this kind of valuable resource — inherently, experts looking at companies and issuing investment recommendations through the process of research on those companies. Yet, in and of itself, it was a business that found it very difficult to reflect a model that was able to pay it sufficiently. Which brings us to today and you’ve had another bout of regulation — this was in Europe about three years ago — in 2017, you had MiFID II, which required an unbundling going all the way back to the ’60s, where this process started, where research was ancillary to trading, regulators in Europe came along and said, “Actually, there’s a conflict inherent in this as well.” Certainly in the degree to which it paid for by institutions, and yet again, the business has gone through a kind of an identity crisis. And that’s really where we are today.

[00:08:35.08] Ben: If you like, it’s been sort of hammered by three waves of regulation, right? So, first, Eliot Spitzer, then Volcker, now MiFID II. One of the things that’s changed is you said, I think in your newsletter, you talked about how much Grubman made, right? I think he made like $50 million or something in the space of a few years, which would be unheard of now. So, you know, payback has gone down. But the other thing that’s notable is the amount or the volume of equity research, which has dramatically changed. I mean, you talked about go-to Credit Suisse, an investor meeting, they were like, you know, hundreds of analysts there. I remember, you know, going to SAP investor meetings, there would be 100 plus analysts in the room. And so, clearly, we went from a situation where there was oversupply — do you think we’ve tipped to the opposite situation where there’s a lot of undersupply, particularly of smaller cap stocks?

Marc: For sure there is an idea that there’s an undersupply research out there, that a lot of it is being certainly a shakeout within the industry. Now, it was arguably overpaid, to begin with — and certainly Grubman, did he merit the millions of dollars that he accrued? Probably not, almost certainly not. Possibly not from a compensation perspective, but from a resource allocation perspective to the industry, we may have under shored on the other side. And it’s not dissimilar. Maybe the analogy here is the media, is the press and actually there’s a lot of overlap — and I draw this out in that piece — between what a very, very good equity analyst does and what an investigative reporter does. And there’s a public service here, there’s a public good here. You know, certainly what the research analysts were doing — so Wirecard, very well-known fraud. Interestingly, the credit, rightly so, for uncovering that fraud has gone to a journalist, Dan McCrum from the Financial Times. But there are other cases, and certainly, there were a couple of analysts. Some of them didn’t cover themselves in glory, but there were a couple of analysts who also got that right. And there’s kind of a public service to looking independently, without being influenced by the companies themselves and the management of those companies, nor by other constituencies, for putting out independent research on companies, for doing their job.

[00:10:49.16] Ben: It’s interesting that you call that public good, because it suffers from the same shortcomings of a public good, in the sense that it’s difficult to exclude access to that research once it’s in the public domain. And it doesn’t stop you from consuming. In many ways, it does have the properties of a public good, which means it suffers from the free-rider problem and in general, sort of under-provision.

Marc: Absolutely right. And in addition, it’s difficult before the fact to know if it’s any good or not. Clearly, the analyst report that said that Wirecard was a fraud, after the fact we know was very, very valuable research. The report, which would have arrived on the same day, on the client’s desk which said, you know, Wildcard is a great company and it’s got huge upside — again, after the fact we realized it’s got negative value. But at the time, the decision rests on the recipient to discern between those two. And that’s not easy. And it’s not easy as well, to know ultimately, where the value is, in this. There’s a lot of noise out there.

[00:11:53.12] Ben: I want to come back to Wirecard in the context of, you know, bank regulation, and whether it’s a level playing field. But just on this idea of, you know, perhaps under-provision of research. Do you think that creates arbitrage opportunities? So, for example, do you think it’s now easier to create alpha investing in small-cap stocks? Because there’s a high return on doing that research yourself, whereas before, that was not the case.

Marc: I think, yes. So actually, just recently, there’s two companies called Signal — Elon Musk tweeted quite recently that one should be buying Signal, he was a big proponent of Signal; readers picked up the wrong Signal. Actually, early on in the pandemic, the same thing happened with Zoom, there were two Zoom companies. The point here is, you know, the markets are not efficient, and Signal and Zoom are great recent examples of that. And to the extent that they’re not efficient, research does have value and those inefficiencies typically emerge the lower down the market cap curve one goes.

It’s incredibly difficult for any investor to change their mind.

[00:12:57.18] Ben: There’s a quite high proportion, certainly relative to, in the past, small caps that no longer have any sell-side equity coverage, right?

Marc: Yeah, that is right. And it’s not great, either. Now, the flip side is that some of it has shifted over to the buy-side themselves. That was a trend that was already in place from the institutional perspective. But what we’re now seeing because of the ability to share ideas more freely, through the internet and platforms like Twitter, and also dedicated platforms, like Sub-Zero, and the ability for individual investors or smaller, emerging institutional investors to get access to infrastructure — maybe they can’t afford Bloomberg at $24,000 a year, but they can afford other apps and other facilities — more research has been generated. And you know, actually, this brings us back to the model, it is quite interesting. So, the old research model was ‘we’ll give it away to everyone for free and we’ll attract some revenue dollars through trading commissions’. More recently, post-MiFID II, that translated into, ‘we will just service, say, the top 100 customers who are prepared to pay for it’. There’s a trade-off now between generating thousands of dollars from 100 customers or via the internet, particularly where the market might be individual investors who… And whether this is cyclical or secular or not, at this stage, I don’t know. But certainly, retail engagement in the market is increasing. They’re not going to pay thousands of dollars for institutional research but the quality of what’s available on the internet is very, very high, and maybe they’ll pay $20, $30 a month, and tens or hundreds of thousands of those… You know, there’s a good newsletter writer called — there’s a number of good newsletter writers out there, but a number of them, they offer, in my view, institutional-grade research, particularly in the technology space, and they charge $10, $20 a month for it. But they have hundreds of thousands. And I actually would be interested to see their p&l against a traditional equity sell-side research business, given lower costs and broader reach.

[00:15:21.13] Ben: I was actually gonna highlight this as a second arbitrage opportunity, which is one might be there’s more potential to make money from small caps than there was in the past, but the other one is, I think — you know, I don’t want to suggest that this is the model for Net Interest, but a bit where you can almost crowdsource almost as good or maybe even better, in some cases, research from the internet, which is, you know, the sort of the bottom up, you know, kind of organic production of research to fill the gap. Because, I agree, and you see the same thing also in investigative journalism and other content areas, which is, you know, your choices are either to pay a subscription for the FT or to subscribe to newsletters, right? Because these things are sort of mushrooming. And, you know, I mean, that’s another phenomenon in the way that you’re embodying, which is you publish your newsletter on Substack, and in some ways, you’re kind of contributing to this gap that’s been left as equity research has become or is provided to a lesser extent than it was in the past.

Marc: Yeah, I think that’s right. And, you know, it comes from just this, I don’t like the word ‘democratization’ that people use, but it certainly plays into our theme. You know, clearly, the advantage that… And I remember when I was an equity research analyst, it was at BZW, which you mentioned, which was a subsidiary of Barclays. And I was looking at Swedish banks in 1996. They kind of emerged from a crisis, they’ve been re-privatized, they’ve been re-IPOed, and there was kind of a recovery theme in a way. And I stumbled upon — it was kind of the early days of the internet, we had access to the internet, but what was on there was difficult to find. There was no search, it’s kind of the days before Google. And I kind of stumbled across a document written from the Central Bank of Sweden, the Rik Bank, which provided very interesting data on kind of banking volumes. It was faxed to me by somebody in Sweden. I literally, I was working at home, it was a Saturday, I was working at home. I couldn’t read it because it was Swedish. Google translate didn’t exist. I ran around to my local bookstore, bought a Swedish-English dictionary, translated this thing, put out a piece of research on this finding that actually loan growth in Sweden, based on this data was greater than anybody anticipated. And it was it. I stumbled across something purely informational. And clearly, the friction to getting that information now is just non-existent. Everybody has all of the information all of the time hence, there’s no arms race in place to get new sources of information. Kind of alternative, dangerous nets. But you know, that’s all done. What’s happening now is the same thing is happening to analysis. Now, people, again, through the ability to meet in the market square via whether it’s Twitter or any other kind of platform, there might be a great analyst who’s based in… I mean, I know there’s a great equity research analyst, who I read called Scuttleblurb, he is based in Portland, Oregon, far from Wall Street, and there are people just all over the world in India, in small towns in England, all over the world, all analyze it. So, they’ve got the base level of information and the degree of analysis they’re doing now is institutional grade, and it’s accessible.

[00:18:50.08] Ben: It was just before the financial crisis that you switched from being a sell-side analyst to working for a hedge fund, if I’m right. Presumably, that was a great time to have the ability to go short on banks. And I just wondered, you know, when you were living through it, how evident was it in advance of the crisis that it was coming. Could you presage that, you know, we were gonna have this big crash, or was it really as sort of sudden and unexpected to you as it was for the people that weren’t as closely following that?

Marc: It’s a really interesting question. It would be easy for me to say yes. I would say the way I would finesse it is yes, we saw elements of it. But it’s important to remember, somebody once said, ‘causes run in packs’. There’s never a single cause. I think it’s lazy analysis. And I see it and often politically motivated for people to say the financial crisis was caused by x — and x typically correlates with one’s political inclination. X could be, you know, greedy bankers, or x could be people borrowing too much or x could be sloppy regulation or x could be too much leverage at the banks or whatever it might be. There’s a whole range of reasons. And ultimately, it was the confluence of lots of those things that happened to create the crisis. Although we — me and my colleagues — identified some strands of it to have predicted the degree to which it all coalesced, you know, in kind of, you know, let’s say, October 2008, I think that was difficult to predict. But that’s never… There’s complex reflexivity to it. It happened, I remember watching, I vividly remember watching the debate in Washington around passing the torpid. It was controversial. And I remember specifically it went down. But because it went down, the market went down, and so, reflexivity because the market went down, then when it came back for another reading because the market had gone down, incentives have shifted. Predicting kind of reflexivity in advance is difficult. Having said that, the worst things we saw. So back in, you know, we were short. I mean, back in 2006, we were short some subprime companies. I went back through my — I’m not a Facebook user anymore but when I canceled Facebook, I downloaded all of my posts, and there was one post in July of 2007, where I cautioned about an impending financial crisis. We were short, Fannie and Freddie, and all the rest of it. Just an observation about investing broadly, and, going into more detail on the crisis, but investing broadly, it’s incredibly difficult for any investor to change their mind. And I think there were a number who were negative; a lot stayed negative beyond March 2009. But the fascinating thing to me is those that there were kind of negative, and then they switch positive. And just taking a step back away from financial services, but generally, investors’ ability — the very, very best investors, their ability to adapt to changing conditions like that, continually, it’s very, very difficult. And I think, you know, history is littered with investors who have got two or three calls right, but to be able to retain an element of persistence, through those changing dynamics, it’s very, very difficult.

[00:22:38.06] Ben: Yeah, I think it could be a rabbit hole but I would argue almost that potentially the greatest of all investors, Warren Buffett, has not been able to adapt this strategy to some extent to the digital age, because he’s still buying sort of, you know, asset-heavy companies with a lot of supply-side, economies of scale, and so on. So I think it even happens to the best when there’s a paradigm shift.

Some of the consternation of bankers right now is that tech companies are getting away with stuff that they just wouldn’t be able to get away with.

Marc: True. And to our conversation earlier about small cap, large cap, I mean, certainly, his performance hasn’t been as good in the recent past, compared to prior periods in his history. And he’s got longevity, very difficult to compare him to any other investor, because I’m not sure there’s any track record out there that’s as long as his. But he made the point recently — he actually made it ’99 — he made the point, there’s a great quote in ’99, where he was talking about if he had a million dollars to invest, you know, he’d crush the market because of his ability to access small cap, but it could be a reflection on your point as well.

[00:23:36.10] Ben: It might be both because you actually wrote another great newsletter about the curse of managing too much money — it becomes harder and harder to achieve a return on much bigger sums.

Marc: Yeah, exactly. That’s another curse — I call it the Zuckerman’s curse. Gregory Zuckerman, who’s a great writer, has written a number of books about — he’s written two, in particular — hedge fund managers. And they’ve been published. Clearly, he’s been attracted to them because of their profile, and their profile is a function of their performance. And therefore, there’s a direct line between them showing good performance and him writing a book. Actually, there’s more nuance to that. It’s not them having good performance, is them having good performance and being big enough for him to notice. One of my favorite investors out there is Hayden Capital. A guy called Fred Liu, based in New York, was up 222% last year, but he’s small, nobody knows of him. And the curse is that over a certain size it’s difficult to sustain that performance on an ongoing basis. Actually, it’s worse than that because typically, after a good year, the money then comes in. And investing isn’t mean reverting but certainly, there’s an element of… It’s only as difficult to sustain very, very good performance across multiple time periods.

[00:25:05.17] Ben: Do you know what Zuckerman’s next book is about? Just so we know in advance.

Marc: That’s a good one. I feel bad because I’ve read them all. I mean, they’re great books. It’s the writing on the wall.

[00:25:20.11] Ben: I’m gonna ask you, a bit like the financial crisis question I’m gonna ask another question, which is gonna be, I think, impossible for you to answer in retrospect, without any sort of cognitive biases, and so on. But you wrote another newsletter, which I really, really liked, which was called “The End of Banking”. How obvious was it now, in retrospect, that post-financial crisis, financial services was just not going to be the same again, right? Because their profitability is not the same. It doesn’t represent anywhere near the same size of, you know, as the composition of the index in which it sits. And so, it just seems like the financial crisis in a way was like, you know, the peak. And you know, maybe as you said, this may be cyclical, it may be that in the future, it becomes as big as it was and as profitable as it was. But certainly, it seems much more structural, for the reasons I think we can talk about now. But when did it become evident to you that the sector becomes structurally less sexy in a way?

Marc: I’ll be honest with you, it took me a long time. My mental model — I mentioned Swedish banks earlier — my mental model was that banks — and this has been true historically, and in my working memory through the Swedish banks, they went through a period of crisis, they’d be recapitalized, they’d come back to the market. Typically, they’d be a lot more conservative and so, underwriting would be tighter. They would then generate huge amounts of capital and then recover. There was a singularity inherent in the industry. They would crash, they’d be recapitalized and then recover. And that was my mental model. I remember at the time being told — we talked about the tech boom from 20 years ago, ’99–2000. We’ve talked about that already. I remember in 2010, 2011, a strategist who’d experienced the tech boom — I mean, I experienced a tech boom as well but I wasn’t directly involved in it — I remember a strategist at a bank saying to me, “The market has to cycle through a generation of investors to forget what happened, to forget the scars of the previous crisis for any kind of return to normality.” And I didn’t believe it. I said, No. You know, so I was sanguine about the extent to which the market recovered. I underestimated a number of things. I underestimated one, how low-interest rates would stay for how long. Two just the… You know, and I often think, actually, for the investment banks, worse than 2000 for them, and their long-term from a strategic perspective, worse than the experience they suffered in 2007–2008m how well they performed in 2009, hurt them longer term from a strategic perspective more, because the backlash was then huge. It was kind of the political disgust, they made so much money in 2009, and that increased the scope of regulation, which muted them for many, many years after that. So, I underestimated regulation, and then we can talk about disruption. It’s difficult. I’m not sure I underestimated that but that was clearly another factor.

[00:28:45.28] Ben: Maybe let’s unpack those things because I think interest rates, I think, you know, we won’t know for a long time if this is a structural or a cyclical factor. But it seems like the re-regulation of the banking is a much more structural thing. As is this one other thing which I don’t know if it’s permanent or not, but you talk about it as governments inserting themselves into the cap table of banks. This idea that they become almost like an arm of government in some ways, right? Because, you know, particularly during the COVID crisis, you know, that we used the direct funding and also, you know, they just don’t have the same control they used to have over capital allocation. So, again, I don’t know if that’s a structural or a temporary phenomenon, but certainly, one of the things that’s been so weighing on bank valuations. But the re-regulation part, I think is probably much more structural. And the question I wanted to ask you about that is, you know, I think we could probably talk about regulation in different buckets. So part was about making banks safer, part was about some introducing more transparency, but the part that I think is now looking a bit kind of controversial in a way is all the regulation is aimed at introducing more competition to banks. You know, so, a PSET, for example, almost seems like that was mistimed because I think what the regulators perhaps hadn’t appreciated because the lag, was that there’s just been so much new competition from non-banking players, right? So I wonder almost in hindsight whether regulators would still introduce some of the regulation they’ve done to introduce more competition into banking because it seems like almost now, not necessary. And potentially unfair. You know in your last newsletter, you talked about that letter from Ana Botín to the FT. And, you know, some of that I thought was quite justified, some of that criticism of recent regulation and the absence of a level playing field. So, it’s a long question, but do you think almost like some of the regulation are tilted or was too far against the banks?

Marc: Yeah, I think it is. I think it’s a truism that regulators typically fight the last battle. And not just regulators. I think it’s a response to, you know, I mentioned earlier, you know, my mental model for the period after the financial crisis was dictated by the last battle, which was the Swedish banking crisis of mid-1990s. So for regulators is the same. They are very, very focused on fighting that battle. And equally, I think it was a truism that whatever the cause of the next financial crisis, it was never going to be the same ingredients to the one in 2007, 2008 to 2009. By the same token, we’re not talking about a financial crisis, here. We’re talking about as you put it out, a playing field. But certainly, the combination of low-interest rates, and a playing field that’s not level was very, very negative for the banks. And there was a degree to which maybe regulators understood that, maybe they didn’t. If they understood it, certainly there was no political motivation to circumvent it, because there was this culture about wanting to punish the banks. But you’re right, you know, this point about they insert themselves, the role of any chief executive of any company, pretty much exclusively is capital allocation. And from an investor’s perspective looking at banks, if they don’t have the capability to manage their own capital allocation because regulators can come in… I listened to a debate recently, between some sell-side analysts, and market participants, and representatives from the Bank of England. And the view of the Bank of England — and I don’t think they’re unique here. I think it’s a view of many regulators that prevented their banks from paying out capital, in March of 2020 was only temporary. But you’ve spoken about scars and the degree to which scars can be left, and from now on, any investor that is investing in a bank understands that at any point, particularly given the capital framework that was put in place to protect banks from unknown. I mean, clearly, a pandemic was an unknown, but that’s what capital is there for. It is there to protect against the unknown. It is not there to protect unknowns, except for a pandemic, or unknowns except… All unknowns, whatever they might be. And so, even with that in place, for them to come in and say, “Actually, we’re going to take charge here of capital allocation” that sends out a very negative signal.

One could have made an argument 10 years ago that banks have got more data, more valuable data. I guess Amazon has got shopping data, Google has got search data, Facebook has got social data, and some overlap between them. Banks have got financial data, and what data is more valuable than financial data? And yet, they’ve been restricted, rightly, from their ability to monetize that.

[00:33:26.20] Ben: Plus, they’d already introduced regulations to ensure that there were more buffers, that you had to protect against losses earlier in the cycle. And so, to some extent, it was almost like a double hit on their ability to allocate capital, right?

Marc: Exactly. Exactly. So we’ll see the extent to which… There’s a view out there that we haven’t seen the worst, that maybe over 2021, when things begin to recover, small businesses will see unemployment. And there’s a view out there. The other thing is, again, a competitive point of reflexivity. Back in March, the regulators didn’t anticipate — to be somewhat fair to them — the degree to which monetary policy would come in, and fiscal policy would come in, but once they had come in, there was a degree of caution that was maybe unwarranted. And again, they might argue, who cares. We’re hurting some bank investors here, but who cares? But ultimately, from the perspective of a bank investor, there’s some long-term issues here. And actually the ultimate bank stop, and it worked in 2009 is that investors, the private sector bails out the banks, the private sector puts more money in because it knows that actually, at this point in time, we can draw a line and that future returns for that bank look positive. It would have been difficult actually, for that to have taken place in 2020, given what had gone on before it and given the things we’ve discussed about regulatory intervention. I think it would be very difficult. The banks have raised capital in the private markets, and that would have been very negative.

[00:35:19.18] Ben: Do you think maybe things might change from here? This is where I wanted to bring in Wirecard because the banks are so heavily regulated now and so closely scrutinized that a lot of the scandals and fraud and impropriety is happening outside of the banking sector in tech companies or shadow banking or areas of shadow banking. Do you think at some point that the regulator is now going to change the direction of, or at least move its focus to all of those companies that are doing banking, but aren’t banks?

Marc: Whether it’s going to happen or not, I don’t know. And actually shadow banking, I mean, I said earlier, I’m going to contradict myself now talking about fighting the last battle. But some of the ingredients of that last battle were in the non-banking sector, were in the shadow bank. Subprime companies weren’t regulated and in the US, different regulatory requirements for thrifts, such as Washington Mutual, who played a game of regulatory arbitrage, choosing to be regulated by one regulator rather than a broad financial services regulator. The investment banks weren’t regulated as banks. Lehman Brothers was regulated separately from… And as a result of the crisis, Goldman and Morgan Stanley became bank holding companies and became regulated as a bank. So shadow banks, this kind of regulatory arbitrage was going on anyway. But you’re right, is going on now. And these payments companies, to all intents and purposes, what a payments company does is not dissimilar to what a bank does. And we saw that with Wildcard, actually. And hence, you know, you mentioned Ana Botín’s FT piece. Some of the consternation of bankers right now is that tech companies are getting away with stuff that they just wouldn’t be able to get away with.

Nobody wants a mortgage, they want a home.

[00:37:23.05] Ben: in every sense, right? In the sense of the same scrutiny, but also, you know, they don’t even have the same level of capital, for example, to do the same business. It’s not just more scrutiny, it’s not just the supervisory level blame for this; it’s actually an operating level blame for this as well.

Marc: Yeah, that’s right. That’s right. That’s right. And the issue here is not about financial stability, per se. It’s about the specific issue that Santander has, and Unicredit has mentioned it, and Jamie Dimon at JP Morgan has hinted at it as well, which is about data. And one could have made an argument 10 years ago that banks have got more data, more valuable data. I guess Amazon has got shopping data, Google has got search data, Facebook has got social data, and some overlap between them. Banks have got financial data, and what data is more valuable than financial data? And yet, they’ve been restricted, rightly, from their ability to monetize that. And I think the issue now is we’re seeing this convergence of data and this degree of consternation about the degree to which the playing field is not leveled.

[00:38:43.00] Ben: And the PSDs bit as well. It’s not just that they have to share data if the customer says that’s okay, is that they’re sharing data with companies that already have, in some ways, an advantage because they’re already more embedded in our lives, right? So, you’ve made the point many times in your newsletters, if you control distribution in the digital age, you know, you’re in a much better position to create network effects and to reduce the cost of customer acquisition and so on, than if you’re a balance sheet provider. And so it’s almost like, it’s a double whammy of sort of thinking you need to introduce more competition and forcing banks to share a really valuable asset with those people that are already better positioned to capitalize on data and distribution anyway.

that combination of Goldman Sachs’ back office, banking as a service infrastructure, with Apple’s consumer-facing distribution and brand value, could be a bigger competitor to JP Morgan than Chime or any kind of startup, FinTech, challenger bank.

Marc: Yeah, that’s right. And banks, certainly some of the starter bank, some of the challenger banks are trying to exploit that idea about distribution. But they don’t have the distribution right now, and that’s obviously an issue for them.

[00:39:41.03] Ben: I’m really pleased you mentioned challenger banks because one of the things I wanted to ask you is, you know how people are talking about this COVID economy is k shaped, right? And the idea that everything digital is booming and everything analog is suffering or faring really badly. And to some extent, you’ve seen that in the world of financial services and FinTech. You know, you talked about Square — which we’ll come back to in a second — as a company that’s really shot up and really found more customers and been able to benefit from the crisis. But challenger banks notably haven’t. What do you put that down to?

Marc: Well, some of them have, actually. So you’re right. I did write. Some of them have. Chime in the US has done very well through this period. But others haven’t. I think the biggest challenge, singularly, that these challenger banks face is their ability to acquire customers cheaply — and the right customers. There’s some question mark as to the quality of those customers, let’s say. And actually, to be fair to the company, the company has provided disclosure in the past as to what the unit economics are, on a customer that pays its salary account into its Monzo account, as distinct from a regular customer that maybe saw their friend has got Monzo, downloaded the app, and maybe actually isn’t even an active user. I guess a problem — maybe is why it’s different from other digital industries — is that there’s a life cycle perspective, whereby the customer becomes more profitable when he’s a little bit older. And yet, digital adoption tends to take place when they’re younger. So the challenge for the challenger banks is twofold. One is, as I’ve mentioned, it’s the ability to acquire customers cheaply. But the second, linked to the ability to capture revenue from them, is can they turn a millennial into — can they extract profitability, which is equivalent to what a typical bank customer profitability might be? Or do they have to wait until that customer gets a bit older, and kind of hits that profitability level, which would be typical in a lifecycle process.

[00:42:11.04] Ben: Let’s talk about customer acquisition cost, because I agree with you, the unit economics are really hard to manage, if you’ve paid loads and loads of money to acquire the customer. It costs a lot to acquire the customer. And then, the lifetime value is somewhat held up — in my view, at least — which is, you know, the ability to sort of upsell and cross-sell customers is hard in banking because we don’t actually spend very much time on the banking apps. And so, we still have this thesis that it’s gonna become much easier to embed banking and other channels than it is to build a really, really profitable banking business going forward. Because, you know, if you consider social channels, for example, or e-commerce channels, we spend a lot of time on those channels. And if you can introduce banking at the point of sale, or if you can introduce banking in a social way, then, you know, first of all, we have a low or even negative cost of customer acquisition, but then you also have the ability to generate very high lifetime value, because you have the customer spending a lot of time on the app, and therefore, you have a lot of surface area in which you drop-sell and cross-sell. Where do you stand on that whole embedded banking discussion?

Marc: Yeah, I think that’s right. I think that is right. I think one of the reasons why payment has been the most successfully penetrated area within financial services by startups and digital propositions is exactly this point that the frequency of payments is infinitely higher than the frequency of mortgage application. So that is right. And I’ve thought about this in the context of insurance, as well as banking, but in both cases, nobody wants a mortgage — there’s no tangible benefit, there’s no tangible value in the mortgage itself. Nobody wants a mortgage, they want a home. And secondary to that is the financing of it. And equally, nobody wants a checking account. Ultimately it is a payments mechanism and they want some facility to serve multiple jobs. One is to preserve their payments. One is as a store of liquidity. One is maybe as a conduit into savings — longer-term savings. But the tangible value of the thing itself is low. And, as you say, therefore, the appeal of embedded finance is very, very high. Now there are issues around regulation, and from a business perspective, the ability to scale, but from a consumer perspective, it makes perfect sense.

[00:44:51.15] Ben: And do you think this is, therefore, the biggest threat to banks over the long term which is, you know, it becomes easier to embed finance in channels that have engagement, than trying to create engagement in banking channels, and therefore, as you’ve talked about this sort of split between what we might call distribution financial services and the, I guess we could call it the manufacturing financial services becomes even more pronounced, and therefore, you know, profits go one way and the other becomes more and more of a utility over time.

Marc: It depends. So, one of the features of banking is that each market is distinct. There’s a path dependence because we’re going back hundreds of hundreds of years, banking has evolved very, very differently across different markets. You know, a mortgage in Switzerland is very, very different from a mortgage in the UK, for example. So Russia is an interesting case study. Sberbank, the biggest bank in Russia, has brand value that banks across countries in Europe and in the US would envy. They have phenomenal brand value. Sberbank itself has launched a marketplace where… Everything we were discussing earlier, it knows it’s got the data and it’s got the brand value. So it’s got the data and the brand value. So, it’s offering a marketplace to its customers via its app. So that’s one approach. Everything we’re nervous about big tech companies in the US and countries in Western Europe, everything we’re nervous about them achieving, Sberbank itself might be achieving that and is in competition to the tech companies in Russia because it’s forging its own path there. So that’s one market. It’s a bit different. But you’d be right elsewhere. You know, I often think about that. I’ve written this in one of the newsletters that Goldman Sachs plus Apple is probably the biggest competitor — that combination of Goldman Sachs’ back office, banking as a service infrastructure, with Apple’s consumer-facing distribution and brand value, that combination of both of those could be a bigger competitor to JPMorgan than Chime or any kind of startup, FinTech, challenger bank.

[00:47:18.01] Ben: Listening to you, it seems there’s a tendency to conflate retail banking with banking in general, because, you know, trust is so important. And as you say, once we move into wealth management, then you just don’t see the same level of tech or FinTech disruption. Once you move into wholesale banking, you know, you don’t see the same level of tech and FinTech disruption. So I wonder, you know, are we guilty sometimes for talking about retail banking, as if it’s whole banking? And then the second point would be because you’re such a student of financial services, I wonder, do we also fall into the trap of thinking that these things which look so disruptive, have actually played out many times before in different guises? Because I was reading your newsletter about Visa before and it’s almost in a way that, was Visa not embedded banking in a way? So I wonder, are we also guilty of thinking these are bigger trends than they really are and they happen quite regularly over the course of history, in cycles?

Marc: Yeah, it’s such a good point. I think 100% I agree with that. And there’s nothing new under the sun. A lot of what we’re seeing now we’ve seen before in various guises. So you’re right, I did a deep dive on Visa, recently. It’s a fascinating story. The founder of Visa, Dee Hock was so far ahead of his time in thinking about payments and the way in which payments simply reflect — just to give some context, we’re talking about the 1960s, where, you know, computers were the size of buildings, and he was thinking about payments. And most of the payments at the time were done on paper that was shuttled between banks. And he foresaw this system whereby payments were — he didn’t use the phrase ones and zeros, but he talked about alphanumeric data — simply alphanumeric data. He has written about all of this. So, Dee Hock, the founder of Visa, is 92 years old today. He founded Visa in the late ’60s, let’s call it 1970. He was CEO until 1984. And he wrote a book in ’99 that was re-issued in 2005. And he questions the need for banks. He says, “If it’s just alphanumeric data, why do we need banks, and the payments?” And he, at the time, knew nothing about crypto, knew nothing about digital currencies. But presently, he talks about a global currency, he talks about payments just taking place directly between consumer and merchant, much of the functionality that Bitcoin potentially offers — or crypto more broadly potentially offers today. And he was talking about this in the ’60s and ‘70s.

Marc: Just to come back to your question, similarly, equally, he allowed JCPenney, which went bankrupt last year, it kind of came out, it went through a bankruptcy process in 2020, has come through with that now. But back in 1979, it was one of the three biggest retail merchants in the United States. It was so big, he said, “Well, let’s introduce embedded finance, let’s bring it straight into the Visa ecosystem”. But even before that, interestingly, it was companies like JCPenney, that actually invented the credit card in the way now that… So now we think about kind of Shopify, and everything that Shopify is doing with Stripe to embed finance at the point of sale in merchants. This was a big merchant’s… I guess, what’s changed is that you don’t have to be big anymore, that because of these providers, because the cost of everything has gone down — the cost of storage, the cost of underwriting, the cost of everything has gone down — it’s become more accessible for smaller companies to offer these things that the big companies have been offering since the 1950s and 1960s. So yes, there’s nothing new under the sun. The same with challenger banks. AG was a challenger bank that merged in the UK with a not dissimilar model to the model of many challenger banks today, 20 plus years ago, 25 years ago. A lot of these models have appeared before and one of the things that I try and do in that interest is look back through history — as you said — as a student of financial services, to learn from them and apply them to the situations we find ourselves in today.

[00:51:54.04] Ben: Having said that, there is nothing new under the sun, I just want to get you on digital currencies, because actually, it does seem like something which is more transformational. If you don’t mind, can you briefly just describe what digital currency is because, you know, one of the things that, you know, when we talk about digital currencies, people get, I suppose, a bit confused about is, you know, if I were to pay you some money now, and I would just transfer it to you, that’s in a way digital money. So what’s the difference between just an electronic transfer of Sterling versus digital Sterling?

Marc: There’s three types of digital money broadly. One is crypto. So, basically, it’s got its own infrastructure and its own coin. So, like Bitcoin. Two is we can talk about stable coins, which have their own infrastructure. So Facebook looks like it will launch any week now, actually, its own stable coin. It’s got its own infrastructure, but it’s stable in the sense that it’s not its own coin, it’s a US dollar or some other currency. And then the third type is a Central Bank Digital Currency, which is, the central bank maintains the infrastructure. It is also an existing currency — call it the US dollar. So these are the three types. And the difference is… So, if we’re talking about your question referred to Central Bank Digital Currency, the difference is, you know, if I give you a 20£ note, it will have a serial number on it. So, when I’m talking about a digital currency when I’m paying you online, it won’t have that serial number on it. So basically, I’m digitizing that 20£ note. I’m digitizing that 20£ note such that if I was to pay you 20£, it would have a serial number attached to it, such that the regulators, the central banks could then audit the trail of that currency the way they do with cash right now through a digital system.

[00:53:56.06] Ben: But isn’t that the most important point for Central Bank Digital Currencies, which is about that ledger? And therefore, it really goes into the question the extent to which you need banks to intermediate. Because if you can have your wallet directly with the central bank, if the central bank can disperse money to you directly, does it to some extent take away that role of banks as creating money supply? Because I suppose, to the earlier question about, you know, if we are going to see an increased split between the distribution of manufacturing financial services, and the central banks kind of rising up to take a bigger share of the manufacturing — or I don’t want to call it manufacturing, but if the balance sheet aspect of financial service because more will just sit directly on their ledger. Does that again squeeze the traditional banking sector?

Dee Hock, the founder of Visa wrote a book in ’99 where he questions the need for banks. He says, “If it’s just alphanumeric data, why do we need banks, and the payments?” And he, at the time, knew nothing about crypto, knew nothing about digital currencies. But presently, he talks about a global currency, he talks about payments just taking place directly between consumer and merchant, much of the functionality that Bitcoin potentially offers — or crypto more broadly potentially offers today. And he was talking about this in the ’60s and ‘70s.

Marc: Yeah, absolutely. And one of the reasons why the central banks are being so cautious in rolling out Central Bank Digital Currencies — everybody’s looking at China — China is trialing Central Bank Digital Currencies right now. They’ve suggested that those trials will continue up until Beijing Winter Olympics in 2022. So, we’re not going to see anything launched until at least then. And that’s in China. And similarly, Europe and various other central banks have said that they’re still studying it. And one of the things they’re studying is exactly that, is that what would differentiate between retail central bank digital currency, and wholesale. And one extreme would be retail, which is the picture you paint, which is that you and I have an account with a central bank, the same way that UBS has an account with the central bank, or Barclays has an account with a central bank. We have an account with a central bank and are therefore able to conduct ourselves without the need for banks.

[00:55:48.18] Ben: Because I can just send you money through my wallet to your wallet, right?

Marc: Exactly. And it’s insured. The way bank deposits are currently insured. All they do at wholesale, and actually, they maintain the role of banks. And again, it goes back to this idea of path dependence. It is quite interesting. Dee Hock, when he thinks about Visa, he’s got this framework for looking at the world. He says, you know, “To understand anything, you have to think about the way it was, you have to think about the way it is, you have to think about the way it might be. And you have to think about the way it ought to be.” And when he was thinking about Visa back in the early ’70s, and say today, actually, he’s made this very clear in his book, that Visa had been created through his kind of organizational principles. It’s not a panacea, and he lists in his book, and I quote him in my recent piece, some of the issues, some of the drawbacks some of the flaws in the Visa model. And to come back to what we were talking about, the point applies here as well, is that there’s a path dependency that, you know, maybe on a blank sheet of paper, we can devise this phenomenal new financial system. And they did that in China. You know, China didn’t have credit cards, they went straight from cash. So they didn’t need credit cards. They went straight from cash to a digital wallet, and you cut out the middleman. That’s very, very difficult when you’ve got vested interests that are cultural, political, data, that when people are used to a certain way of doing things as they are in Europe, in the US, you might be right, from a blank sheet of paper, if we could devise a financial system, we do it like this. But that’s not, to use Dee Hock’s framing, that may be the way it ought to be but we can’t neglect the way it has been and the way it is. And therefore, it probably won’t pan out like that.

[00:57:49.16] Ben: I was going to ask you this question at the end, but I feel I need to sort of preempt it now. Which is, you talked about Libra. And I just wonder, you know, if you look ahead at 2021, what’s the most potentially game-changing thing that’s going to happen in financial services that people aren’t talking enough about? It feels like that might be Libra, because, in a way, they’re going to roughshod over all those vested interests and introduce something that’s going to potentially have the adoption of every Facebook user, which is I don’t know how many billion people and it’s kind of outside a single country jurisdiction and it just seems massive. I’m wondering, you know, are you going to write a newsletter on Libra? Because it just seems such a big phenomenon?

Marc: Yes, I agree. I think it will be a big story for 2021. Riding roughshod. Interestingly, they already watered it down. So initially, they put together a consortium, which included financial service companies, there was a backlash from regulators. And so, they watered it down and the result today is something a little bit different. But I agree with you 100%. I think it’s gonna be a big story of 2021.

[00:58:54.13] Ben: But it’s still a currency that might be used to intermediate peer to peer and other transactions. You know, and even all the vendors that sell through Facebook, right? Within the Facebook network, you might have a currency that sits independently of any fair company, or is that not?

Marc: So again, I mean, anything I would say, the regulators do still have the capability to insert themselves. And we saw that too in Brazil, WhatsApp, which is part of Facebook launched a payments mechanism. And they spent a lot of time preparing it, launched it, presumably at launch they’d had the approval of the central bank because they’d spent a lot of time preparing it, but nevertheless, the central bank once it saw it, changed their minds and shut it down. So, regulators still do have this power, which is, I guess, classic disruption. Bitcoin has been operating at the margin and interestingly it never really became a payment coin. So, Coinbase, which is going to IPO this year, started out as a payments system for Bitcoin. And there’s a book that was released in December, called Kings of Crypto, about the story of Coinbase. And in it, they talk about hiring somebody in order to acquire merchants that will accept Bitcoin. And they did a great job, he got all these merchants, he got multiple billion-dollar revenue companies, lots of merchants, all lined up to accept Bitcoin. But consumers didn’t want to spend their Bitcoin. And so, they pivoted to a broker and Bitcoin became less of a payment mechanism, and more of an asset class, more of a commodity. But clearly, that can change. But as I said, it’s tangential, classic disruption. So they operate margin, and it can become mainstream.

[01:00:58.23] Ben: Yeah, if I understand what you’re saying, Libra, first of all, you know, whatever way in which it’s envisaged that it will be used might change because the use case is different from the one that was a bit like Bitcoin. I want to move on to a different topic now, which is private versus public investing. Because, you know, to get to the latter part of your career, I think one of the things that you’re doing now is you’re doing some angel and private investing. I just wonder if you have any interesting observations about the difference between investing in public markets versus investing in private companies? And I suppose we’ll come back to it as well. But you know, I think it’s relevant because companies seem to be staying private for so much longer than in the past. And it’s almost like being an expert in private investing is a more important skill set than it was historically, we could potentially argue. So I wonder if you’ve got observations around that.

Marc: Yeah. So, interestingly, three months ago, I might have agreed with your point about companies staying private for longer. I think what we’ve seen recently through the rise and the emergence of SPACs…

Ben: You’ve preempted that because I was gonna ask if the SPAC is the vehicle to get companies from private into public markets faster?

Marc: Yeah. I think yes, they are.

Ben: Let’s break this down into three sections, if you don’t mind. So, first of all, maybe everything we’ve got on the data shows it’s changed yet, but why weren’t companies staying private for longer? Because it must have been because it was difficult to realize the value in public markets. And how do SPACs do that? Why would a SPAC or a company taken to market through a SPAC, have a higher valuation than a company that would have gone through an IPO process?

Marc: Yeah. In the short term, maybe that’s an inefficiency in the market. Long term, it’s not clear that the mechanism through which one comes to market has a bearing on one’s long-term valuation. But having said that, there are some structural differences in the process. The key one here being that when, through the IPO process, management is not allowed through SEC guidelines to provide any projections on the future. And coming back to what we were talking about earlier, in terms of equity research, one of the roles, one of the jobs that equity research analysts used to fulfill was to provide equity research at the time of the IPO. Now, it wasn’t always independent, which is one of the issues why it was shut down. But there was a service provided nevertheless. Now, that’s not allowed. So now, what will happen is the company will provide its own filing and the institutional investor will have to peruse that filing, do their own due diligence, do their own work in order to take a view, but they’re given no steer as to what the projections are.

[01:04:08.23] Ben: Do you mind, just because I’m not sure everybody knows what a SPAC is. I mean, I love the phrase that you put in your newsletter, you said, “The SPAC is a bit like the wardrobe, is the portal to Narnia, complete with unicorns on the other side.” So what did you mean by that? If you don’t mind just spending a minute on what it is because it’s such a new phenomenon. Maybe many people don’t know what it is.

Marc: Sure, that’s fine. So a SPAC is a Special Purpose Acquisition Company. And what it is, it’s a pool of money that is raised by a sponsor. Typically, a well-known sponsor will raise several hundred million dollars in cash. And the purpose of the cash and the role of the company that the cash sits in is to do an acquisition with a private company, to find a private company — hence the analogy of Narnia. So public investors clearly are restricted to investing only in public companies. But if they were to buy a share in a SPAC, it’s just a pool of cash. If they were to kind of hand some cash to the sponsor, the sponsor will then go through the wardrobe, into the land of the private companies and find a private company to merge with, bring it back out. And then, all of a sudden, you now, through the merger process, have got a share in a private company.

[01:05:31.21] Ben: That is a great analogy, by the way. That’s superb to describe what a SPAC is.

Marc: And just to finish off what I was talking about earlier, the difference is — and it’s slightly arcane, it’s kind of regulatory — but the merger process enables the company to provide projections. So the guy on our side of the wardrobe, when the sponsor comes back out with his private company, can say, “Well actually, in 2022, ’23, ’24, these are our projections. What do you think?” And at that stage, he can either kind of roll with it, or he can sell because maybe it wasn’t what he wanted as a public market investor, so he can sell but he’s kind of got that right.

[01:06:14.17] Ben: So you think this sort of recent last 20-year phenomenon, with more companies staying private, is maybe addressing this fact? Because it does two things, essentially, if I understand rightly. Firstly, it reduces a lot of the friction and the cost of going public because I can’t remember how much an IPO costs, but it’s a lot, right? You pay your fees, I think it’s like four or 5% that you pay to the investment bank?

Marc: It could be even higher, actually. Yeah.

[01:06:35.04] Ben: So yeah. So there isn’t that big cost, there isn’t the sort of, you know, I don’t know how many months it takes to IPO. But it reduces the friction, the cost, the time to go public plus also through being able to share projections with the market. Arguably, and I think this is the bit you’re talking about, there isn’t the data, but arguably, it enables you to achieve a higher valuation. Because I guess there are two reasons why people stay public for longer, right? One, they didn’t feel they could achieve the valuation that they deemed appropriate in the public market, or they were just put off by the time and the cost and the friction.

Marc: Yeah, that’s right. And also the third reason is the private market was rich with capital. So, why would they…

Ben: But that bit hasn’t changed, has it?

Marc: That hasn’t changed. But you’re seeing even in the public… You know, interestingly, recently… So Lemonade is a FinTech, it’s an insurance company that was founded on a kind of a digital platform. And it was SoftBank. So the SoftBank vision fund is one of the biggest venture capital backers out there, it was an investor in Lemonade. It went public in July of 2020. Actually, recently, already in 2021, it’s raised fresh capital in the public markets, at a valuation much, much higher than when it went public in the summer. Typically, normally — and that’s an unusual occurrence — in the public markets, normally, that would take place in the private markets to be a funding round, even six months after the last one. It’s more unusual in the public market. There was kind of a convergence between… I mean, maybe it’s cyclical just because of where valuations are. But it feels as it was kind of convergence between some of the behaviors that were typically the case in private markets and in public markets.

[01:08:23.10] Ben: I suppose you could argue companies like Tesla wouldn’t achieve a richer evaluation on the private market than they could in the public market. But do you think also, there’s some of the stuff that couldn’t IPO because it didn’t come under the same level of scrutiny would do so through a SPAC?

Marc: Yeah, I think that’s right. I mean, some pushback about SPAC is people have talked about as being a SPAC bubble. And, you know, inevitably, there’ll be a lot of poor companies that are coming through that wardrobe, sneaking through that when the, you know, as Buffett says, when the tide goes out. Yeah, we’ll say who’s swimming naked.

[01:08:59.29] Ben: I think probably we’ve run out of time to talk about Robinhood, and that whole phenomenon of the gamification of the stock market investing. But I just wonder if you had any other observations just from your practice as a public and a private investor. You know, the kinds of things you look for in companies that you didn’t historically, or whether it’s very similar.

Marc: It’s really very different. It’s very, very different investing in private companies, from investing in public companies. For one, probably four key differences. One is the level of transparency, which is much higher on the private side than on the public side. Two is — and this is an interesting point — two is volatility. So, a lot of people inherently don’t like volatility. And I think one of the attractions of private market investing is that they only get revalued when there’s a funding round. And so, kind of right now it’s not an issue, because, in the markets, we’re only seeing upward volatility with everything getting up. But I think there was a kind of a degree of, think back to March, April of 2020, when there was a lot of not such good volatility in the markets. I think there was a degree of comfort around private holdings, which, you know, whether it is Robinhood app, or whatever broker one is using, one’s not seeing kind of the daily volatility of valuations in private holdings than they are in public. That’s a big behavioral difference. The third difference is the structure. It’s very, very important as a private investor to be comfortable with the structure of the holding. You know, when you buy a share in Apple, it’s a share in Apple. It’s pari-passu with all the other shares in Apple. That’s not necessarily the case with private companies. Well, they are different classes of shares so it’s something that as an ex-public investor gone private, I suddenly have to learn about. And the final point is just that you’re in the room. I mean, I can write a newsletter about Jamie Dimon at JP Morgan, he may or may not read it, he may or may not do anything about it…

Ben: I think he subscribes to that, doesn’t he?

Marc: Probably he won’t do either. But it’s just a great experience being involved in a private company.

[01:11:31.05] Ben: Yeah, I think is that last point, which is, you know, you have the ability to make your own weather in a way, right? Because I always thought, for me, that’s the key advantage of angel investing, which is, you don’t just sort of invest the money and hope for the best. You can actually get involved and materially affect the return on that investment that you make.

Marc: Yeah, exactly. Exactly. Exactly.

[01:11:51.10] Ben: One question I wanted to ask you, which is the big downside, obviously, of private investing, is liquidity. And it just amazes me that we haven’t seen more people enter the space for the secondary market for private investing. Why do you think that is?

Marc: There are some crowdfunding platforms in the UK — it was one crowdfunding platform in particular in the UK — was Seedrs, which offers secondary trading of its companies that is crowd equity, crowdfunded for. But probably is difficult, actually, because of the fact that, coming back to the point about structure, different classes of shares. You know, I did another newsletter on fixed income markets — electronic trading and fixed income markets — which is much less developed than electronic trading in equity markets. The reason being is there are multiple fixed income instruments out there. Whereas there’s only one equity for most companies, there’s only one equity. And it’s the same here with private, there’s two different classes of shares with too many different terms. But there’s no standardization.

[01:12:53.08] Ben: So, I have two quick follow-on questions for you. One is, what’s getting you really excited beyond Libra looking into 2021?

Marc: I think what’s happening in embedded finance is fascinating. I think what’s happening broadly, just the acceleration we saw in 2020 around digital, I think what’s happening broadly, through payments mechanisms, and beyond payments, not payment as the hub. It used to be that the checking account was the anchor product for most banks, or potentially, the mortgage actually, increasingly is becoming payments. And that I think has all sorts of implications, whether it’s around crypto or Libra, or embedded finance. It’s basically the common theme across all of those things.

[01:13:40.06] Ben: And then the last question I wanted to ask you, which I think is gonna be difficult, you may have to come back to us, which is, what’s the best book that’s ever been written about the financial services sector?

Marc: Liar’s Poker.

Ben: Yeah, that would have been my pick. Yeah. Okay, good. So if anybody hasn’t read Liar’s Poker, you really, really should. Great. Marc, thank you so much for coming on the podcast. It was a great discussion, and I really appreciate you taking the time and keep up the good work with Net Interest which is awesome. And if you didn’t subscribe to Net Interest, you really should. One fantastic deep dive into an aspect of financial services every Friday. So subscribe. Marc, if people want to subscribe, where do they find it?

Marc: Yeah. So is the page.

Ben: Thanks so much again.

Marc: Thanks, Ben. Great to be on. Thank you.

Sequencing the World’s Regulatory Information (#35)

Structural Shifts with Manos SCHIZAS, Lead in Regulation and RegTech at Cambridge Center for Alternative Finance

Our guest is Manos Schizas — Lead in Regulation and RegTech at Cambridge Center for Alternative Finance at the University of Cambridge. We discuss how regulatory change is accelerating so fast that people alone can’t deal with it and how does the technological solution addressing the problem looks like. Can technology solve this problem at scale? How much innovation are we seeing thanks to machine learning? And we also discuss about the Regulatory Genome Project, a recently launched long-term project that aims to sequence the world’s (financial) regulation, allowing developers and firms to build own applications on top of the platform. Before joining the Cambridge Center for Alternative Finance, Manos also served as a regulator with the UK’s FCA.


It costs something in the order of 4% of turnover for a major financial institution to comply with regulation.

Ben: Manos, thank you very much for coming on the Structural Shifts podcast.

Manos: Thanks for having me on the show, Ben.

[00:01:22.05] Ben: Maybe let’s start by you talking about your background because I think it’s useful for our listeners to know that you’ve seen this interplay of finance, tech, and regulation from many different angles. So, if you don’t mind, Manos, just tell us kind of, you know, how you started off in this world?

Manos: Sure. So, I first got involved with writing and reading about regulation back in 2008. At the time I was a very, very junior lobbyist at an association for accountants — the ACCA. And because I had their access to finance brief, inevitably, around that time, I had to feed into the discussion around Basel III, and the implications for financing of small businesses. But before long, I was talking and writing primarily about FinTech and regulation. At some point, I made the jump over to, I guess what I thought at the time was about the dark side. So, I joined the FCA — the UK regulator — I spent some time there leading their work, at the working level, on things like crowdfunding or their approach to small businesses, surprisingly, political and fraught topics. And then, I moved on to a London-based RegTech startup, where I was their Head of Regulatory Content Operations and also had the product brief for a short period of time. And then, of course, the rest is history. I joined the Cambridge Center for Alternative Finance, where I lead their thought leadership practices, as well as their applied research program on RegTech and machine-readable regulation.

The pace of change and the volume of data has really long outstripped the ability of firms to just throw humans at the problem — human brains and human bodies.

[00:02:53.10] Ben: We’re going to come back to the Regulatory Genome — the project that you’re working on — but before we get there, I think we should zoom out and talk a bit about the whole terrain of regulatory compliance and why it faces so many challenges? So maybe let’s start from the point of view of a regulated financial institution. Why is it so time-consuming and expensive for banks and other financial institutions to comply with regulations?

Manos: Well, alright, let’s start from the top line if you will. It costs something in the order of 4% of turnover for a major financial institution to comply with regulation. Again, that’s turnover. That’s not, you know, breaking margins, that’s not profit. It’s colossal amounts of money on a global scale. And why does it cost so much? Well, I guess, there hasn’t been a time in very recent memory when financial services weren’t heavily regulated. But since the financial crisis, in particular, there’s been an explosion in regulation, that has seen the amount of regulatory notifications rise, I think about seven or eightfold between 2008 and 2018. So, I guess the key point is, the cost is driven primarily by how demanding the regulatory framework is and the pace of change. Now, it’s not the same for every part of the regulated sector. So, a tier-one bank will probably recognize the pace of change as I describe it, whereas let’s say, you know, a smaller asset manager might not, but by and large, there’s been an explosion in regulatory requirements. At the same time, there’s also been an explosion in the sheer amount of data that firms hold, not just the ones that they have to hold for regulatory purposes, but the ones they hold for commercial purposes. You know, only recently — I think it was HSBC — one of the major banks was creating a data lake that was in size exactly the same size as the entire internet had been four years earlier. It gives you a sense of perspective of what we’re talking about. The pace of change and the volume of data has really long outstripped the ability of firms to just throw humans at the problem — human brains and human bodies.

Manos: There’s also other elements related to the way you manage institutions like that. So, you know, many of these major firms are matrix organizations where it’s actually, in the time of change, quite easy to lose visibility as a senior manager of why you’re complying the way you’re complying, what exactly the outcomes you’re achieving are, and so on and so forth. And at the same time, regulators are hardening their stance on the personal responsibility of senior managers. You know, you’ve got senior managers regimes in the UK, in Singapore, in Australia, in Hong Kong, and in an increasing number of jurisdictions. So you’re in this kind of the opposite of a sweet spot, if you will, or the sweet spot for vendors, where the key decision-makers are facing increasing scrutiny on a personal level, and at the same time, are losing visibility. So if you’re a vendor, this is a good time to come in and try to sell them technology.

[00:06:12.08] Ben: What about if we look at it from the point of view of regulators because it sounds a bit like, you know, listening to you, the regulators are really driving the agenda here — which I guess is true to an extent — but the regulator doesn’t control the pace of technology change, which is driving innovation; and the regulator also only can really affect its jurisdiction. And I think one of the things that’s become more apparent over recent years is there’s a lot of competition between jurisdictions to attract new financial institutions and also new FinTech companies. And so, does the regulator also see the need to do things differently in this space?

Manos: Sure, I guess there’s two types of regulations depending on where they come from. So, there are rules that are fundamentally quite harmonized across the globe. AML, for example, prudential requirements — at least in banking and insurance. And for those, the rules come down from Mount Olympus, from the G20. They cascade through the standard-setting bodies and then finally into national regulators. Now, if you are a regulator working in that kind of subject matter area, then your key concern is, am I fundamentally compliant with international standards? And have I found the most efficient way to comply with them? AML is the usual example here because if you’re not compliant, that’s a big problem. The whole country can get graylisted or blacklisted, and you just don’t want to be there as a regulator. But you know, even when the stakes aren’t that high, regulators want to know that they are compliant with international standards. Then there are other areas of regulation which are closer to the matter of technological change that you mentioned earlier, where good practices are bubbling up from the bottom up. So areas like, I don’t know, cybersecurity, data protection — you know, there is no single unifying force or no single cascade of standards from the top. But everyone wants to know how they compare to the jurisdictions that they see as competitors. So, if you’re in Malaysia, you’re the Securities Commission, you will look at what MAS is doing in Singapore. If you are in the UK, you’ll be looking at what the Europeans are doing post-Brexit. Pre-Brexit, obviously, you just have to comply. So this process of regulatory benchmarking is actually one of the factors driving regulatory change internationally. When at the CCF, we surveyed regulators from 111 jurisdictions around the world. They told us that nearly every exercise of review of regulation in relation to FinTech had involved some benchmarking exercise. And, in more than half of these circumstances, it was the benchmarking exercise that had prompted regulators to change how they do things.

if anything, regulators are under more pressure. So when we say something like, you know, the pace of regulatory change has increased sevenfold since the financial crisis — well, you know, firms’ compliance budgets have not increased sevenfold. But regulators’ budgets have not increased at all, not in real terms anyway.

[00:09:11.06] Ben: What about COVID? Has that had much of an impact on the pace of regulatory change?

Manos: Well, that’s what our research tells us. So, we have just come out of a significant project to basically carry out a rapid impact assessment of COVID on the FinTech and RegTech industries, as well as the regulators responsible for them. And obviously, what you hear from regulators is that COVID fundamentally changed the way they approach some areas of their work — not just their rulemaking, but also their hands-on supervision. But I guess what regulators tend to see here is some megatrends that have accelerated — so trends towards you know, more or less material financial services, more online banking, more app-based financial services and so on and so forth, but also greater demand on their resources, so that they can do more with fewer touchpoints with industry. And then, of course, COVID also came with some of its own, if you will, pathologies. So, regulators told us, for instance, that they were much more aware and worried about fraud in a COVID environment where a lot of things have had to be put on the cloud or have had to be done remotely at relatively short notice, or where firms have had to deal with stuff that previously were very closely held in-house on a remote basis. So, of course, the focus of regulators has had to change.

[00:10:48.17] Ben: So, Manos, if we were to try to summarize what you’ve told me, you’re saying that the pace of regulatory change is accelerating to the point where financial institutions can no longer just throw, you know, human resources at this problem because it’s an exponentially changing situation so it requires a technology solution to it. But would you also argue that the regulators need to be putting more technology at play here? Because presumably, they also want to know how regulations are changing and being implemented, and they want to make use of the data to make sure that they’ll keep up with the potential rates of innovation, put that to good use in terms of financial inclusion and everything else. So would you say that the need for new technology applies to both the regulated and the regulators?

Manos: Yeah. I mean, if anything, regulators are under more pressure. So when we say something like, you know, the pace of regulatory change has increased sevenfold since the financial crisis — well, you know, firms’ compliance budgets have not increased sevenfold. But regulators’ budgets have not increased at all, not in real terms anyway. And so, regulators find themselves in these very interesting challenges wherever there’s this use of data involved. Like, to give you a simple example, the first touchpoint with technology around regulation and compliance for most regulators is reporting. And if you talk to an emerging market regulator — not the poorest countries in the world, necessarily; just, you know, significant emerging markets — they will say, “You know, firms report data to us and by the time we’ve validated the data and made sure it’s not garbage, it’s three months old.” Now, let’s go back to that COVID discussion we just had. If you had three-month-old data on the robustness, the financial stability of firms, as a regulator, it would be useless. It’s a snapshot from a completely different world. So you can see how COVID can really create an issue for regulators there and waken some of them to the challenges. But even if you think of more normal times, you know, the FinTech revolution has created a very big fringe of very small, very marginal firms that fly sometimes under the radar of regulators, and sometimes just above. And so, for instance, when the FCA took over payments, for instance, the population of firms that they were supposed to supervise more than doubled overnight. Now, their resources did not increase at all. So, what exactly do you do when faced with a situation like that? You have to find some way of prioritizing your human resources. And the only way, really, to get to a point where you can do that is to invest in technology that allows you to prioritize better by getting insights more cheaply, more efficiently, where the risks are proportionately smaller.

in the AML space, every year there’s a new estimate of what percentage of the illegal flows of funds are actually intercepted by AML controls. And it’s usually always in the low single digits. So, you know, you have to keep wondering, like, is this really the best we can do?

[00:13:49.05] Ben: That’s happening, is that not? So, we are getting thousands of new entrants into this space, new technology companies, new RegTech companies are entering this space to solve these challenges that regulated companies have, and regulators have. I was reading before this podcast that I think collectively, over $10 billion of new venture capital has gone into this space in the last 10 years. So, are we solving this problem at scale?

Manos: Well, it’s interesting. I mean, obviously, throwing more firms at the problem doesn’t necessarily solve anything. It is a good indicator of how valuable the prize is, I guess, for whoever wins the race. Just to be clear, just the number of RegTechs really depends on how you define this sector. So, you know, you will hear estimates from 800 all the way to the 2000 number that you quoted, but the amount raised is almost always estimated the same way because most of the fundraising is concentrated in a handful of large firms. So, this is one of the first things I think we need to keep in mind in the context of this discussion. You will hear about RegTech growing very fast as a sector, and all of the success stories, but the typical firm in the RegTech sector — we did our own research on this — has raised somewhere in the order of $1.5 million. Now, it sounds like a lot of money if you give it to me to buy a car or a house even. But how much runway does it buy a technology company? Like, less than a year. And to put it into further context, how long does it take from the moment, let’s say someone at the bank shakes your hand and says — well, they can’t shake your hand anymore, but you know, looks you in the eye virtually, and says “I love your product, we will definitely buy it” and the moment when you first see any money from them? Usually about 18 months. So, you have to put these two numbers together, like, how much runway do they have versus how long it takes for them to actually convert prospects to paying customers. So, most of this sector isn’t particularly successful financially. And so, the sector is kind of ripe for consolidation. Quite a few of these people are competing in very, very crowded segments. Also, of course, in our own research, what we’ve seen is that there was a golden era of new market entry between let’s say, 2013 and 2017. And the pace of market entry has slowed since then, quite significantly. So, this sector is now growing more from the center than from the margins — so, big firms getting bigger, as opposed to new firms joining.

I’m skeptical about the pace at which we can move towards machine-readable and machine-executable regulation, where we treat regulation as code.

Manos: Now, to your question, though, the actual question was, you know, are they solving this problem? I think the first thing to bear in mind is that the sector has been around for like 20, 30 years, depending on how you define it. So, you know, you had regulatory intelligence applications 20 years ago, you had BPM and GIC applications 20 years ago; they’ve evolved since then, yes, but the fundamental kind of offerings were already being imagined at the time. What firms are now much better able to do, I would say, is, first of all, they can scale a lot faster and deal with smaller institutions because their services can be delivered through the cloud and by APIs. It’s much easier for them to work together, so, hooking up different applications via APIs is now much more realistic than it used to be. And so, what that means is that ideally — and we’ll have to come back to this point — you know, no one firm has to build everything, end to end your entire kind of compliance factory. So, that obviously helps. But there are areas where RegTech has yet to make a significant impact. If you try to map where most of the effort has gone — AML, reporting, risk particularly on the prudential side — between those three areas you’ve probably captured 80–90% of the activity that we’ve seen; probably a lot more if you count it by funds raised. And then there are other areas, notably on conduct, for instance, that are kind of less tangible and quantitative areas of compliance, where, you know, you don’t see the same level of success. And, of course, even where the RegTech sector is making inroads — good on them — you still have to ask yourself, how much success do we have to show for it? So, in the AML space, every year there’s a new estimate of what percentage of the illegal flows of funds are actually intercepted by AML controls. And it’s usually always in the low single digits. So, you know, you have to keep wondering, like, is this really the best we can do?

[00:19:02.21] Ben: And listening to you, it sounds a bit like, you know, even though lots of money has gone into this space, and accepting that, you know, most of it has flown to a few big firms, rather than the long tail of smaller suppliers, it sounds like there’s still a lot of duplication of activities in this space, and also potentially, like, there’s not complete coverage of the regulatory space, i.e. people keep shooting, I guess, for the areas with the largest addressable market. So, would you say that they’re two of the challenges that still persist, that the RegTech community is still duplicating a lot of its own efforts, as well as, you know, perhaps don’t have complete coverage yet of all the areas of regulatory compliance?

Manos: Absolutely. And I’m not sure that any one firm has a particularly good overview of its entire competitive environment, just because so many people are trying this and many of them are still under the radar unless they’ve done two or three funding rounds and you start seeing kind of headlines about them. But I think it’s also important to say that compliance, in general, involves a colossal duplication of effort. If you think about it, the regulations are the regulations. They are what they are. But there’s thousands of financial services firms, each developing their own mapping of rules, you know, against their own internal systems. And you think, “Well, how much of that is duplicating effort? And is there really a business reason to duplicate this for each firm to do it on its own?” Because compliance in itself does not confer a competitive advantage. Being able to manage risk better does. Being able to understand customers better does, of course, so there are some things that firms will always want to keep close to their chest. But compliance in itself does not. So the duplication is quite substantial and not very rational.

[00:20:54.08] Ben: In terms of technology change, you mentioned cloud, you mentioned APIs? What about AI? Because it seems to me that one big area of potential improvement here is to train models… You know, you can imagine this particularly in the case of financial crime, for example, where, you know, many actors contribute information about financial crime and one provider can train the best models and can give the best predictive analysis about where financial crime might arrive, or stop financial growth based on patterns seen in the past. So, are we seeing much innovation and headway being made thanks to AI in this space?

Manos: We are. And I guess we’d better because the amount of processing power we can leverage these days is colossal. So, you know, in the first AI spring, in the ’50s and ’60s — I’m not reminiscing, I wasn’t there — back then it would take about seven minutes for a computer to parse one sentence or one paragraph worth of text. And now we can do, like, billions of them in the same amount of time. You know, obviously, that helps. Having said this, applications of AI mostly end up with a trade-off. So, think of it a little bit like an industrial process, where, because at the end of the day, most of the applications of AI that you’ll see in compliance come down to statistical models. You’ve got error rates, you’ve got false positives, you’ve got false negatives. And the whole kind of quality assurance process is around saying, “Well, how many false positives and false negatives can we tolerate?” And particularly, like, “How many false negatives can we tolerate?” Because that’s where you get fined or put in jail. And so, usually, what happens is firms, certainly in compliance, are very, very reluctant to accept that there will be a consistent level of errors in a compliance process, particularly around things like AML. And so, you know, many will seek a level of certainty that is just not possible. Some of them will tolerate redundancies and duplication, just to make sure that they are covered. And particularly in the larger firms, often you will have a duplication internally. If you’re a tier-one bank, there is actually a decent chance that you’ve licensed software that duplicates things you’ve built in-house, that you have licensed software from two different people that overlap. So, the strategy around incorporating AI in this area is still not fully fleshed out.

to get from the messy regulatory language to something that humans can work with, you have to have some kind of mental map of what regulations are out there, a kind of taxonomy of regulatory obligations and concepts. That’s one side. And you have to have a corresponding mental map of what the firm looks like — what matters to the firm. So a firm doesn’t see itself as a collection of compliance obligations. It sees itself as a collection of products and functions and locations, and yes, even processes and controls and policies, and so on, and so forth. So, you have to have both of those maps, and then get them to talk to each other — so create linkages between the two sides of the equation.

[00:23:41.02] Ben: What about this whole area of machine-executable regulation? So, you know, certainly, I’ve been reading about a lot of companies that are working on, you know, basically turning regulation into code, which can then be executed by the machine. And this seems, you know, at least prima facie, like, this is the most elegant solution to this problem, right? Because if regulators can put out very precise regulations, and they can be turned into code, not only can that code then be executed immediately, but it will be executed exactly as the regulator intended to be executed. So that seems like the holy grail here, would you agree? And do you believe that this is realistic and that we’re making progress in this direction?

Manos: I mean, it is the holy grail. And it’s interesting because it’s one area where software developers and lawyers kind of lead in the middle. Both sides think like machines. They want very precise and consistently worded inputs and outputs. But in reality, most regulation doesn’t work that way. So, the hype around machine-readable, machine-executable regulation is what it is because some of the earliest use cases for RegTech and SubTech are around reporting. And reporting use cases involve heavily standardized data — I say heavily standardized, but if you see them upfront in their raw form, they’re not always that good but they involve much more standardized and much more quantitative data, more structured data as well than most other RegTech use cases. So, if you’re only really interested in reporting and adjacent use cases, actually machine-readable and machine-executable regulation will happen. You know, it’s already happening in some domains, and it will happen in most others. Enormous amounts of money, enormous amounts of attention, and standard setting effort has gone into those. But then there is a lot of regulation where this level of standardization, of quantification and of structure just doesn’t exist, partly because that’s not how it’s been designed and it’s very expensive to redesign it from scratch, but partly because regulators want it that way, or legislators want it that way.

Manos: So, to give you an example that’s close to my experience: let’s say consumer credit regulations in the UK do not include any indication of what criteria somebody should meet in order to get a loan. Not because they couldn’t come up with, you know, a good sense of what credit worthiness looks like, but because legislators and regulators want firms to have the flexibility to come up with their own answer to the question. In other cases, the point isn’t flexibility, but responsibility. So, very often, what the regulator wants is for the onus to be firmly on the firm to find a way to reassure the regulator that the outcomes are as the regulator expects. And so, you can imagine a situation at the limit of this road towards machine-readable, machine-executable regulation where the regulator just releases their code and they say, “Okay, plug this in, connect it to your data lakes, and out will come compliant outcomes.” If something goes wrong, who’s to blame? The only person left to blame now is the regulator. That’s not a very comfortable place to be, certainly not if you’re an independent regulator. Like, if you become a sandwich between industry and government, that’s the sort of thing that would end up with the regulator being crushed. So, there will be a natural resistance in some areas of regulation against this level of mechanization. But even in reporting where this is supposed to work well, you know, if you hear the noises coming out of some of the kind of leading regulators in the world — not least the FCA here in the UK — what you will hear is that there’s enormous amounts of data standardization that needs to be done before the promise of even that use case — which is the most promising RegTech use case of all — can be fulfilled. So I’m skeptical about the pace at which we can move towards machine-readable and machine-executable regulation, where we treat regulation as code.

Treating regulation-as-content where we say the regulatory language is what it is and the job of RegTech isn’t really to turn it into push-button executable code, but rather to turn it into workflows and business rules.

Manos: Now the opposite, which does work, but is more human in the way that it does work, is treating regulation as content where we say the regulatory language is what it is and the job of RegTech isn’t really to turn it into push-button executable code, but rather to turn it into workflows and business rules. And so, the idea is that to get from the messy regulatory language to something that humans can work with, you have to have some kind of mental map of what regulations are out there, a kind of taxonomy of regulatory obligations and concepts. That’s one side. And you have to have a corresponding mental map of what the firm looks like — what matters to the firm. So a firm doesn’t see itself as a collection of compliance obligations. It sees itself as a collection of products and functions and locations, and yes, even processes and controls and policies, and so on, and so forth. So, you have to have both of those maps, and then get them to talk to each other — so create linkages between the two sides of the equation. If you’ve done that, then effectively you can get either one application or multiple applications talking to each other by APIs to do this interesting kind of relay of regulatory content. So regulatory content comes in, it gets labeled according to where it has to go, what it’s related to, and then it’s passed on to the appropriate application, to the appropriate subject matter owner with an instruction that implies what kind of workflow is expected afterward. So, that’s messier, it’s more human, but for the same reasons, it’s bulletproof. Eventually, someone will make sure that the system works. Whereas end-to-end machine-readable and machine-executable regulation will usually break down.

[00:30:19.28] Ben: You know, if we think about the idea of machine-executable regulation as being… You know, if we were to be on the Gartner Hype Cycle, it would probably say machine-executable regulation in brackets for reporting, right? And then it would be somewhere quite early in the hype cycle, because, you know, this is probably being hyped, and we’re going to go to the trough of disillusionment. Where are we with the alternative approach, which is, you know, using, I guess, AI and classifiers, and so on, to be able to classify regulatory text at scale, and to serve it up, as you said, into workflows. So this seems like the more promising approach and where are we in the hype cycle with that kind of bridge?

Manos: Just before we move on from machine-executable regulation, I think the key moments in the hype cycle for that, you know, probably, the key moments would have been the FCA and bank of England’s digital regulatory reporting pilot. So that was definitely a hype point in the hype cycle. And if you’ve read all of their lessons-learned reports, you actually feel yourself sliding down the hype cycle. It’s hard to read those and think, “Oh, this was this was a slam dunk.” But then you look at things like, you know, ISDA’s Common Domain Model that basically gives you a way of making both machine-readable and machine-executable a lot of the contract terms around derivatives. And you think, “Well, that’s quiet there. But actually, that seems to be working reasonably well.” And the whole kind of cause of machine-readable and executable regulation has been given a new lease of life with the Saudi-led G20 sandbox, which really is focused on these types of applications. So, you know, I think we’ve still got some time of hype left in the machine-executable side of things.

Manos: But as you said, I think there’s a lot more to be said for regulation as content and the other side or the less ambitious kind of side of RegTech. And there, I guess, the level of maturity is very good. So, when we looked at the market last — you can probably name something in the order of 25 to 30 platforms or tools that are in the regulatory intelligence space, that are really making significant headway in organizing regulation, according to their themes and topics and using things like natural language processing and machine learning to automate that so that they can read rule books at scale. Now, where you want to go eventually is that there’s one kind of virtual front end to every rule book in the world. We’re not there yet. But equally, I think, as long as you’re thinking of private standards only, we’re not that far either. I mean, there’s very significant work done and you can already name three or four firms that are way out ahead of anyone else — I won’t name them here. Now, what you don’t have, though, is some way of reconciling all these proprietary standards into one language of regulation. And that’s quite hard for someone on the purchasing side because what it means is, if you’ve done a lot of work to onboard one of these suppliers and mapped all of your internal systems and controls and processes to their dictionaries and their map of compliance, what then happens if you want to change the supplier? You know, or what has to happen if you want to onboard some other compliance application that needs to talk to that first one, but just doesn’t know the language? That’s the bit that we don’t yet have a very good answer for and there’s no clear kind of commercial incentive for firms to create that.

[00:34:18.08] Ben: Which is the segway into the Regulatory Genome Project, because that is at least partly a public good, right? And it’s aimed at solving exactly this problem of creating common standards and interoperability, right? At the level below commercial applications.

Manos: That’s correct. So let’s start with a little bit of background on the Regulatory Genome Project. So, at the CCF, we were approached in 2017 by what is now Flourish Ventures and was then part of the Omidyar Network with a very specific use case. So these guys were impact investors, they invested in FinTechs mostly in emerging and frontier markets, that were kind of mission-driven to improve financial inclusion. And what they said was, “Look, our portfolio is doing quite well. But one of the things that usually get in the way of growth and manifests itself in the kind of growth plateau at a time that is not really helpful for our firms is that if you want to grow beyond a certain point, then you have to expand at least on a regional basis.” So let’s say you start off in Kenya and you want to cover all of East Africa. Very reasonable. So, when the firms reach that stage in their development, it’s actually quite hard for them to grow because different markets, even within the same region, even if there’s a certain level of integration, have different rules. And so, a lot of time and money, and lawyers fees have to go into making sure that you get market entry just right from a compliance basis. And there’s no obligation for regulators to be consistent with each other or to make life easy for you.

Manos: So, they came to us with that question, saying, “You know, you have access to resources at the university, you know, cutting-edge research on NLP, you know, machine learning engineers — isn’t there something that you could build, that would pass regulation across jurisdictions and make it comparable?” And we thought at the time, well, look, this is a nice applied research program. Of course, we would be interested in looking into this. But what we found as we went along and created a pilot application and tested it, and saw they worked reasonably well, we thought, well, we’ve only covered one domain in this area. We came up with an AML model. We’ve only covered one domain and anyone we tried to take this to as a potential user would say, “Well, what about this other area of application?” So they might say, “Okay, AML good. What about cyber? Or payments, great. But what about insurance?” And it seemed to us that we were going down this rabbit hole of mapping out all the regulations in the world in order to create this one product.

Manos: Obviously, there was also a kind of existential question — you know, the university isn’t really a RegTech vendor, we didn’t want to be permanently in the business of building applications. And it’s a busy space out there, right? Other people have done this longer, and they know this better. So, we thought, what is it that we feel is really needed? Is there a public good that our research can produce? Now, that is consistent with the mission of the university. And so, we thought of an analogy to, I guess, the life sciences. And, at the time, because we were dealing with people who had been involved in the Human Genome Project, it kind of triggered this thinking of, is what we’re trying to build really kind of parallel to the Human Genome Project? And is this pilot application we built, something analogous to an application like 23andMe? And then, from that kind of thinking became the genesis of what we now call the Regulatory Genome Project.

even if you’ve already gone quite a way and had a lot of success in implementing RegTech within the organization, the appeal of interoperable applications and open standards, I think, should be quite significant.

Manos: So, we basically thought we need to find a way to fund and resource and guide a long-term project that maps all regulation. And then, to make sure that it’s available to people truly as a public good, we have to not only make the marked-up rules, I should say — the classified rules — as open data or as near as open as we can make it, but also, we need to find a way to release some of the pent-up innovation out there, by allowing developers and firms to work on this map of regulation, this global map of regulation, and build their own applications. And that way, we don’t have to be, you know, the guys who build everything. We can tap into the creativity and technical skills out there.

Manos: I think what’s really important also, just to bear in mind is the skill sets on the two ends of this journey are just very different. So, building a map of regulation requires a certain amount of technical expertise in the areas of regulation, it requires very strong ties with regulators — which the university has. Whereas, building applications on what we call ‘the right-hand side’ of this journey requires very different skills and a deeper understanding of how the institutions work internally as organizations. So, what does it mean to keep the machine kind of running? And so, to expect somebody to cover all of that is actually quite hard. That means that most people who have innovative ideas in RegTech, either coming from one end or the other end, can’t really deliver the whole thing. So, I guess this is a long way of saying that the key principles behind the Genome Project are, first of all, regulations should be available in machine-readable form as a public good. This is stuff that firms are required to know, by law. They’re made with public money. There is no reason for it to not be open data in a machine-readable format. That’s principle number one. Principle number two is, all of this information must be available to developers in such a way that people can build applications around it. And finally — and this is a key point — both the representation of regulation and the resulting application need to be interoperable. You need to have one common language of regulation. It’s true, different jurisdictions regulate in different ways so, you’ll never get to the point where you say, “Well, this requirement in Brazil is exactly equivalent to that requirement in Mongolia.” But what you do have in the middle is a kind of regulatory Rosetta Stone that can map regulations from any given country against a common framework. Think about, I don’t know, the Dewey Decimal System, right? If you go into a library and you’re a librarian from anywhere in the world, of course, the books are going to be different, but you know that nonfiction is going to be there and you know that life sciences are going to be there. So, that’s the level of interoperability we want to get to.

[00:41:27.18] Ben: And how do you get there? How do you sequence the genome of regulatory information?

Manos: So, let’s get as practical as we can. So, it starts with a paper exercise — I mean Excel exercise — whereby you create almost a hierarchical list of regulatory concepts and obligations. You usually do it by domain. So, you might say, “Here’s my taxonomy of AML concepts and obligations, here’s my taxonomy of cybersecurity, and so on and so forth.” And you know, some of these taxonomies are what you might call horizontal — they cut across the entire financial services industry, so the two examples I gave just now — some of these are vertical. So you might have payments, for instance, insurance, crowdfunding, which was one of the areas of the Center’s particular attention and expertise. And what you do is you create these hierarchical lists of obligations. So for instance, you might say, I don’t know, let’s say you’re dealing with investments, right? You might have client categorization and within that, the definition of an accredited or professional counterparty. You know, perhaps not the best example, but the point is that you always move from a higher level, more general obligations or families of obligations, to more specific ones. Now, at the end of each of these branches, if you will, you will have an end node. You will have the most detailed level of classification of regulations that the genome can manage.

Manos: Now, in theory, there is no limit. You can keep making them more specific, and more specific, and more specific. But remember, the genome as a public good is about making regulations comparable across jurisdictions. So there is a natural stopping rule. You want to stop at the point where the regulatory requirements at the end node are still comparable internationally. So, for instance, client categorization, yes, that’s comparable. You know, the distinction between professional slash accredited investors and more ordinary retail investors, yes, that’s comparable. But if you go all the way to saying, you know, ‘treatment of local authorities for the purposes of client categorization’, you are getting now so fine to the weeds that you’re going to draw blanks for most jurisdictions. And then for everyone who’s subject to MiFID, you will just have this note that says, actually, in most cases, these people are retail clients. So you can guess what the stopping rule is. You go as many levels down as you can until you reach a point where international comparability is compromised. So, that’s how you build that.

Manos: Up to this point, you’re still kind of in the paper world. You can still be doing that in Excel. But then, once you’re happy with the structure you have created, then you can start using machine learning. And machine learning relies basically on collecting large amounts of data from a diverse sample and teaching the machine that a specific example corresponds to a specific node. So, for instance, let’s say you have rules around credit worthiness assessments of consumer borrowers in different jurisdictions. You basically say to the machine, “This is a credit worthiness assessment-related obligation. This is as well. This is as well. This isn’t.” You repeat that over and over and over again until you can train basically a statistical model — which lives as code and we call ‘a classifier’ — so that model can now take in unfamiliar text, and take a stab at what category it fits into. So the next time around you feed regulatory text that you’ve never seen before to the same classifier, and it can say what the probability is that it is about credit worthiness, and you set yourself a cutoff and you say, “Well, if it’s above, let’s say, 70%, 80%, we’ll mark that as a one.” And so, what that does is, if you try to imagine now the machine-readable version of the same regulatory document, that paragraph or that piece of text now carries a tag, an electronic tag that says, “This corresponds to this type of obligation.” And any other application that knows the universe of tags that you’re working with — your taxonomy — can now read this and say, “Oh, okay. I know that this paragraph now is about this.” And that’s how you might be able, for instance, to run queries via an API; you might say, “Can you bring me all the text that’s tagged as credit worthiness assessment?”

[00:46:13.17] Ben: How difficult is the tech there? It sounds almost like, you know, provided you train the classifiers with enough data, then the results will get better and better and better. So, would you say it’s more of a challenge to get the data than it is to get the tech, or am I oversimplifying?

Manos: It’s a good question. I mean, I don’t want to downplay how difficult it is to get the tech. Like, the colleagues who we have working on this are obviously at the top of their game. Having said that, the technology comes with its own significant challenges. What do I mean by that? You know, there isn’t an enormous amount of regulatory tax out there. Now, this may sound really funny bearing in mind what I said earlier.

Ben: Yeah, the sevenfold increase you mentioned earlier. Yeah.

Manos: That’s true. But, you know, from a machine learning point of view, if you look at what kind of corpora people are working with to train machine learning models, they will usually use, you know, all of Twitter for the last three years, or, you know, the entire text of Wikipedia, or the entire internet if it comes to that. So, you know, in comparison to things like that, the amount of regulatory text out there is not enormous. And so, a lot of the challenge is around making sure you have enough samples to actually build good models. The other thing I guess, which people need to appreciate is that the returns to just having more samples start to diminish reasonably early. So, you know, the models don’t get exponentially better as you double or triple the amount of data you have access to.

Manos: Where this becomes really challenging, is, first of all, when you look at really new or niche areas. So, let’s say tomorrow, you know, one of our regulators came up with a very, very specific type of obligation in relation to making, let’s say, AI auditable. So it says, “If you implement any AI applications as a firm, you have to make sure that they are auditable by a regulator — whatever that means. You know, in the early days, only one regulator will have any references to that. So your sample is going to be tiny, right? That is a problem because it means your model runs the risk of having blind spots and you have to find ways of bootstrapping the small sample that you do have, in order to make sure that the classifiers work. I’m not saying that’s not possible, and obviously, my colleagues are working on things like that, but it is challenging. And it’s also challenging when you look at non-English techs because if you create a classifier for AML obligations written in English, that’s going to be completely useless if you’re reading documents in Spanish. But the problem is, if you want to replicate that process in Spanish, your corpus of documents now becomes a lot smaller. And Spanish is, you know, a major global language. Try doing that in Japanese, try doing that in less widely-used languages, that are not the language of business for many people. That is another major issue in that area. But I guess the final issue will always be with these things — and I’ve already mentioned it once already — is that, at the end of the day, there will be errors. And there’s a question of, you know, how much liability should the parties accept for these errors, and who does it sit with?

[00:49:45.07] Ben: If we move beyond the tech and the data — although I think this is a bit related to the data — to this idea of the chicken and egg problem because it’s not difficult to foresee a time when the genome exists and therefore if you’re a RegTech provider, you would build any new RegTech application on the genome because you then don’t need to do all of the mapping of taxonomies yourself. You can just query the public good, right? But between now and then, you’ve basically got to convince software providers to build on the genome, you’ve got to convince regulators to work with you, you’ve got to convince commercial users to use it. So, how do you go about building that ecosystem around the genome to make it successful in the first place? Or, in other words, how do you solve that chicken and egg problem?

Manos: So it’s a fair question. I mean, there is a place you can start, obviously, and it depends on where your relative strengths are. So if you look at other initiatives that have tried to kind of force some level of convergence within industry, they would usually have some strength in one area or the other. Now, if you’re talking about the university’s areas of expertise, obviously, because of our work in capacity building with financial regulators, that for us is the obvious place to start. So we’ve got very strong links to financial regulators around the world and we also know that they have a very strong use case around regulatory benchmarking. So, remember what we said earlier in this podcast that regulators are always checking their homework against the guy who sits next to them. And so, these benchmarking exercises are big painstaking things — expensive, very slow. I remember one regulator saying, “You know, if I had a tool that could do this, I would have nine months of my life back on just the last project.” Which was quite intense but I sympathize with that.

Manos: So the first people to reach out to are regulators. But regulators being involved gives confidence to financial services firms. And not just confidence in the quality of the taxonomies and the classifiers because frankly, regulators will never pull out a big rubber stamp and saying, “I approve of this.” But what a firm can see is that if this is good enough for the regulator to use for their own use cases, then, you know, maybe this is good enough for us as well. I think — you know, as far as industry is concerned — this standard-setting process is also an opportunity to influence in the direction of the common good, in the sense that, of course, you know, no regulator is going to go to a consortium of firms and say, how should I write my AML rules? But giving them the tools to compare against their peers, will usually give you, as a result, better regulation, because people will now have an evidence base on which to say, what is common practice? What is good practice? How do different things correlate with market outcomes or consumer outcomes? So, from an industry perspective, even though you can’t just lobby these people in a crude way, they have been given tools whereby, internally, they can come up with better outcomes for things that you care about. So that’s another reason why industry really, you know, ought to care about creating something like this.

Manos: And then, once you’ve got a few major banks, a few major fund managers, a few major insurers on board, as well as a developer platform through which you can access these assets, then, as a developer, it becomes quite reassuring to know that you can build on this standard because you’ve got the sense that whatever else happens, there are some people who are already on board, and will use applications or will build applications against that standard. So, your investment, your one-off investment in mapping all of your internal systems to this common denominator set will not be wasted. And, as a developer, that can be quite attractive, because the alternative is that every time you onboard a new major client, you have to do all sorts of ad-hoc fixes, so that your systems talk to theirs, which is, you know, expensive work that you’re not always going to get paid for because the client, as far as they’re concerned, it pays for the actual result not for the path you have to walk in order to make sure you can service them.

[00:54:16.15] Ben: So you’ve just launched the Genome Project, and you just started to try to recruit new members, new consortium members — the private sector, the regulated users of the genome. First of all, how is that going? And secondly, if I were a large financial institution, and I had, you know, significant resources to invest in RegTech, and as you say, already had many, many existing RegTech applications and suppliers, what would be the case you would make to join the consortium?

Manos: It is true. We have been in conversation with a number of major financial institutions starting with some of the larger ones, as you might imagine, for obvious reasons, which are now starting to yield results in the form of potential collaborations. Now, that activity is not going to end anytime soon, because, at the end of the day, you want as much of the industry onboard the consortium as possible. But once the first step of recruiting firms is significantly under way, then the work begins to build out the rest of the genome, and also to recruit developers and make sure that you raise awareness of the benefits of your platform and to build the kind of tools that will help developers build applications against the genome. So, there’s a significant kind of technology roadmap, there’s a significant business development roadmap, as well as, of course, the semantic roadmap whereby we’re actually creating the genome itself. So this is just the beginning. But we’re already seeing some of the first successes. Similarly, on the regulatory engagement side. So, you know, we’ve had our first few workshops with individuals from the regulatory community who are willing to dedicate their time to review and make suggestions to improve the various taxonomies. And so, you know, I’m quite confident that if we’re speaking again this time, next year, a significant percentage of financial regulation will have been mapped — and come 2022 we’ll be in a position where people can actually start building applications.

[00:56:31.28] Ben: If I’m a bank and I want to make this case internally — because I presume there’s a price point to join the consortium — how would you convince me, practically, that it makes sense?

Manos: Yeah. I guess it’s always a very different conversation when you’re dealing with a major financial institution that actually has done a fair amount of work in the RegTech space — and pretty much all of them do. If you speak to tier one bank, they have been bombarded with proposals from RegTechs, and even from potential consortiums as well. And so, I guess the way people will usually respond this — you know, why do I really need this sort of thing? I’ve already got fairly mature solutions in-house that I’m reasonably happy with. So where is the real kind of long-term strategic value?” And I guess there’s three layers to this. The first one has to do with how procurement works effectively. It’s great that you’ve got the supplier that you’re happy with. That’s amazing. However, what it also does is it locks you in because you’ve invested a significant amount adjusting your internal systems to fit with theirs, and particularly adjusting at the semantic level — so, making sure that all of your other applications speak the same language as the vendor and can map to the same taxonomies. Now, that’s usually a significant sunk cost. And so, a firm that wants to move away from a supplier relationship doesn’t actually have a lot of good options, because they’ll have to take on the cost of doing this all over again if they onboard somebody new. And it’s very unlikely that they’ll be able to get a startup, for instance, to do that work because the startup just doesn’t have the cash and the runway with which to do it. So you end up in a situation where you’ve got a significant supplier lock-in. And it shouldn’t really be the way that a major financial institution runs compliance technology. So, that’s one part of the answer.

Manos: The other part of the answer is that usually, even when you do have really good applications, they tend to be limited in scope. So they will either be limited to a few domains that they were originally built on. So let’s say, you know, anywhere in Europe or anywhere in firms that deal with Europe in any way, people will have built ad-hoc systems to deal with MiFID compliance, for instance. You can’t then repurpose that to deal with some new type of securities law that comes in 10 years down the line. If you’re lucky, maybe you have architected that way but most people will not have. So the benefit is that dealing with a kind of de facto standard, like the genome, as and when it becomes available, builds some longevity into the applications that you do build. And obviously, it’s not just scalability across domains. It’s also, are you able to serve jurisdictions that are not in the magic circle of jurisdictions that suppliers usually target? So if you think about what most applications can deal with, they can deal with EU, UK, US and Canada, Australia, Hong Kong, Singapore — that’s your magic circle. Beyond that, you know, here be dragons in many cases. So being able to have that same level of scalability and functionality beyond those core jurisdictions is a huge benefit.

Manos: And then finally — and I think this is the more where interoperability really comes into its own — is when you deal with suppliers or partners to whom you have the cascade regulatory obligations, or with which you are tied together in a compliance pipeline. So I’m thinking of things like, for instance, product governance, where the producer of a financial product and the distributor of a financial product are tied together in a set of obligations around, for instance, identifying what the target market of a product is, identifying any applicable risks, understanding what kind of uses the clients are supposed to have for these products, reporting on whether it is sold and distributed in the way that was envisaged. Now, all of that requires that information flows between two very different firms — you know, the distributor might be a huge bank or it might be an IFA; the producer will usually be a very substantial financial institution — but they can be very different is what I’m saying. Similar things happen, for instance, when you cascade obligations in the area of cybersecurity or cyber resilience, where the two organizations — the supplier, the vendor, and the buyer — are actually very different organizations. So, if you need their systems to talk to each other, you need some common denominator to map them against each other. Otherwise, you risk, again, that kind of lock-in that we talked about earlier with regards to suppliers. So, I think the bottom line here is even if you’ve already gone quite a way and had a lot of success in implementing RegTech within the organization, the appeal of interoperable applications and open standards, I think, should be quite significant.

[01:02:03.05] Ben: Let’s assume that you build this, it gets wide usage, you overcome the chicken and egg problem, then we can imagine the network effects — the flywheel of network effects — will really start to kick in. And you know, then you’ll be able to level the playing field between regulators, regulators will get better feedback to make better regulations, there’ll be fewer barriers to entry for new vector companies. And so, you’ll see this unleashing of new RegTech innovation. Firms will be able to comply with regulation more cost-effectively, more quickly. Would you describe that as the end state, the kind of collective good that will be created, or is there anything I’ve missed?

Manos: So, no, I think you’re mostly there. I mean, what I would expect to see if this whole thing works properly, is that in the end, there is a marketplace where firms can engage developers to work on the genome — you know, they don’t need to involve any of us in any way. But also, regulators can start writing regulation that is as machine-readable as possible. So, for instance, right now, there are standards like a common torso for writing machine-readable documents at the document level. You know, you can do a lot better than that if you have a common standard for what is in an AML document or what might be in a cybersecurity document. At some point, once you’ve reached critical mass, you’ll start to penetrate a lot more deeply into how regulators do their work, and also a lot more deeply into how people build applications. And that, to me, is what success will really look like — that people start considering your standards at the outset of building their tools and applications.

Ben: Manos, thank you so much for coming on the show. It’s been great!

Manos: Thanks for having me! A real pleasure!

Hard Truths about Digital Banking (#32)

Structural Shifts with Leda GLYPTIS, Chief Client Officer at 10x Technologies

We’re discussing with Leda Glyptis, a self-described recovering banker and lapsed academic, who’s worked in technology implementations for the last 20 years. Leda is one of the leading voices in banking and FinTech today, she has served as Chief Innovation Officer at QNB group, she was Director of EMEA Innovation at BNY Mellon, and most recently she was Chief of Staff at 11:FS. In this episode, Leda and Ben discuss what a Chief Innovation Officer actually does, whether innovation can come out of innovation departments, what most companies miss when they talk about culture, why emotions are holding back traditional and challenger banks from making money, why selling banking services like supermarket offers doesn’t work and what banks should be doing instead. For more information on Leda, look up the hashtag #LedaWrites on Twitter. She publishes an article every Thursday.

Leda recommends


  1. One book: “To end all wars: A Story of Loyalty and Rebellion, 1914–1918” by Adam Rothschild
  2. One influencer: if you don’t follow Bradley Leimer already, I don’t know what you’ve been doing and you don’t know what you’ve been missing
  3. Best recent article: ‘Can empathy be the cure’, by Theodora Lau
  4. Favourite brand: Converse All Star
  5. Productivity hack: I have ‘writing spaces’ — windows of time in spaces away from my desk where I write with no interruptions, no internet access and usually with a specific time box imposed by a friend arriving to join me in a café or park at a given time or by virtue of doing it on a flight or train ride.

One should only build the technology that is tied to their differentiator and partner or buy the rest

[00:01:28.12] Ben: Thank you so much for coming on the Structural Shifts podcast! I wanted to start off by asking you how one goes from studying social and political science to becoming a banker?

Leda: First of all, thank you very much for having me. The answer to that is ‘by accident’. I have always found it extremely impressive and confusing when I hear people talk about their careers and say, “You know, when I was 17, I decided I want to do this, then I had a plan, and I did it.” I don’t know who these people are. This was not me. Mine was entirely accidental. As I was finishing my Ph.D. with a series of deaths in the family which knocked me for six, I found myself sort of delayed and frustrated, ended up getting a job in, actually, private security of all things, and was my first taste of corporate life and working with technology investments — because the company was investing in non-weapons defense technologies at the time. And I found myself quite far away from academia, in a place that was interesting but didn’t make that much sense. And I chatted with a friend one day saying, “There are parts of my job I really like, parts of my job I don’t like, but I really don’t know what to do now, where to go next.” My friend said, “Well, we’ve built some software. We want to sell it into banks, but we don’t like people and things. You like people and things. Why don’t you join us?” It was an absolute audacity of your mid-20s. I thought, how hard can this be? And it turns out, it was quite hard, but it was also quite incredibly interesting. And I fell sideways into banking IT, and I haven’t looked back since, to be honest.

[00:03:02.08] Ben: I wanted to ask you: so, your last job in banking was at QNB and you were Chief Innovation Officer. What does a Chief Innovation Officer do? So, for example, is that a role that holds a budget, or is it one where you sort of seek to influence the rest of the organization and guide them towards some sort of digital future?

Leda: It absolutely varies. In some organizations, the Chief Innovation Officer is part of a marketing effort and they’re there to drive organizational learning in and organizational positioning out. In those cases, the job doesn’t have much of a budget, and it tends to be all about teaching the organization what they should know and helping the organization tell a story to the market about how they’re thinking about the future. Then, there’s another type of Chief Innovation Officer that it’s all about the third frontier of technology — so, the stuff that is really out there, that is not going to be useful or usable for the next 10 years but the bank should be thinking about them. They’re doing a lot of experiments, and they tend to have budgets for POCs, but not much beyond that. And then, there is the Chief Innovation Officer that is essentially the new technology IT person. So, I would say that my role at BNY Mellon was a combination of the first and second. So, while I was at BNY, my role was a lot about bringing learning into the organization and helping the organization position itself in a changing market, and running experiments with technologies that, at the time, were very new for us. My role at QNB was very different. It was, what are the things that we should be doing and we should be seen to be doing for the type of corporate citizenship we want to have in our chosen markets, both in Near East Africa but also in the sort of Far East subcontinent and beyond — Southeast Asia, where competition and technical literacy was extremely high. So, the Chief Innovation role for QNB was, “Come in and help us do the things we need to do fast, but also help us move the needle a little bit on the ways of working internally.” And I say ‘move the needle a little bit’ because a lot of Chief Innovation Officers are all about the internal workshops. This was, I would say, more indexed into doing things that were business focused and external-facing without changing the infrastructure of the bank. So, it was things that could either plug into that infrastructure or stay on the glass, and less about changing the ways of working. So, to answer your question, it could be anything, and my two innovation roles have actually been very different — but very useful in the sequence that they were in because a lot of the experiments we had done at BNY Mellon were the learning I needed in order to go straight into implementation at QNB.

[00:05:56.05] Ben: Do you think it’s a more important role than it was in the past?

I don’t think there has been a clear sense of where profitability will lie in the future.

Leda: Perversely, I would say no. Actually, somebody called me recently and said, “Would you take another innovation role?” I was like, “Nope.” I think it was an extremely important role early on because it both signaled internally and externally, that the organization is engaging with some hard topics. And also, it showed an acknowledgment that the way we work, the way we learn, isn’t right for the way that the market is moving, and therefore we need to change. Fast forward almost 15 years later, there are very, very few organizations that have moved the needle meaningfully in terms of either way of working or transformative technology use. Some have, but they’re few and far between. And even those that have, haven’t done it through their innovation departments. So, I would say that the function it represented as a department is more vital than ever — the new ways of working, the different deployment schedules, leveraging technology differently, all of that is more important than ever — but I would say that the structure doesn’t work anymore. What the innovation departments taught us is that we can’t do it through innovation departments. It has to be right at the heart of the business.

[00:07:10.10] Ben: And do you think that’s why those banks have found it so hard to introduce significant change? Because there hasn’t been this sort of CXO buy-in, other broader buy-in of management. And therefore, do you think it’s as much cultural as it is technological change that’s needed?

Leda: Yes and no. So, I think there is a cultural change that is bigger than the technical change — I think you’re right — but I think it’s much more systemic than saying people are resisting. I don’t think people are resisting. I think the structures we have created are not conducive to the type of decision making we need. Everything from the fact that you may be running an agile project in your part of the bank, but the testing schedules for the wider bank are waterfall and therefore you need to book in your testing before you’ve started building. It’s mad, right? It makes no sense. But it is how it is. Similarly, the risk matrices you apply, the way you measure success on a quarterly basis, the way that shareholders measure success, all of those things we bundle under culture change, but it’s actually much bigger than culture. It’s about how we build up the business, how the business reports success to the owners of the business, and how the business makes sure mistakes are not made. So, it is facile to say culture and dismiss all of those things as an attitude problem. It isn’t. I would say that the biggest challenge — when we started this journey, part of the question was, “Well, are these technologies real? Are they useful?” And we spent a lot of time in labs, testing and finding that the technologies are both real and useful. They’re robust, they’re scalable, they reduce the total cost of ownership, they do all the good stuff. But they also fundamentally transform the business model, both in terms of how they enable you to operate in a way that you’re not prepared to operate in — the speed of decision making that these technologies enable you to do, you don’t have the governance for. So there’s a big change piece that is around governance and approvals that is human, yes, but not just cultural; it’s organizational. The second piece is that cheaper infrastructure and faster infrastructure kind of requires a different business model because you can’t go charging the same for a very different service. Your customers are wise to the fact that you do different things and potentially less from a human perspective. So, I would say that the challenge hasn’t been technical for a while. It’s governance and monetization.

Maybe what we’re seeing is a transition to a world where retail banking is a public service utility. And I’m not saying it necessarily needs to be run by the government but it is approached by a utility, and therefore the profit structures become very different. And that’s something that your challenger banks don’t necessarily address

[00:09:46.03] Ben: On that topic of business models, banks, in general, know where they’re headed in that direction — you know, what the business model opportunities are — and if they know where they are, which one would suit them best?

Leda: I don’t think they do. I don’t think they do. And it’s not an easy thing. I don’t think there has been a clear sense of where profitability will lie in the future. I was recording a podcast with John Egan from BNP Paribas, recently, and he led with the statement, “Banks don’t know how to make money in the new situation. Therefore, what are the options?” And it’s very refreshing to hear someone say that from within a bank, although admittedly, he doesn’t sit on the traditional side of the bank. I think there are a couple of pieces there. One is the appetite of the market is shifting. Certain products that we were comfortable seeing being profitable, aren’t profitable anymore. Retail banking isn’t profitable. Mortgages, credit cards, institutional banking, transaction banking, investment banking, that’s all still profitable, but the regulatory pressure to change pricing and the way that money is made is definitely making it less profitable than it once was. It’ll be interesting to see how far the regulator will push certain things. I’m seeing banks change their infrastructure and invest in technology, not because they want to be seen as innovative, but because they want to lower their total cost of ownership. They’ve reached a point where growing their top line is much harder than it used to be, then, actually reducing your operating costs is the only way to increase profitability. So, we’re definitely seeing that shift. But I would say that monetization is a challenge for the challengers — funnily enough — not just the traditional banks, because the challengers, they are extremely well-capitalized, burning through cash, building up something that is very, very beautiful from a UX perspective, that is, challenging banks, the assumptions we had on how hard or easy it should be to do certain things, they have definitely reduced what has now come to be considered predatory pricing and all of that. But at its bare bones, their business model is not too different. I was at a panel a few months ago, and Nick Ogden turned to Anne Boden and said, “What challenger? Your business model is exactly the same as everyone else’s!” And Anne made some very interesting points around pricing and focus on the consumer. And she’s right in all of those points, but actually, at the level that Nick was raising the challenge, he is right. If you look at the challenger banking model, their proposition was, “We can make money the same way, but by being cheaper to run, we can also be cheaper to use. So we will pass that benefit to our customers.” The reality is, retail banking is not profitable, not in the same way it used to be. And the traditional banks are making money because they have universal banking. And the challengers are looking at their business model going, “Oops, that doesn’t make money.” You know, there are the Revolut’s of the world that do make money through crypto trading. There are other ways, but the traditional retail banking, as we knew it, is only profitable for the big banks, after the third or fourth product per customer, which is not a scale that your challengers have. And I went on for an hour here to answer a very straightforward question. I don’t think they know how to make money. And I don’t think it’s an incumbent problem. I think it’s a systemic problem. It’s banking, as we know it.

[00:13:26.04] Ben: If retail banking becomes some sort of a lost leader almost, to around which you have to bolt on more profitable businesses, what does a more radical business model look like? One that accepts the premise that, you know, retail banking is not inherently very profitable.

Leda: I would start with the proposition that maybe it doesn’t need to be. Maybe what we’re seeing is a transition to a world where retail banking is a public service utility. And I’m not saying it necessarily needs to be run by the government but it is approached by a utility, and therefore the profit structures become very different. And that’s something that your challenger banks don’t necessarily address because, in order to have a credit card and an affordable mortgage and an affordable consumer loan, you tend to have a balanced book, underwriting, repacks, and investment vehicles that move that debt around and leverage it in instruments that are highly complicated and have nothing to do with retail banking. And that is how you make mortgages more affordable. That’s how, allegedly and theoretically, you make credit cards more affordable. Now, I think there are two questions inherent in the question you just asked. One is, can you create retail banking that is systemically independent from institutional transaction investment corporate banking? And I would say not with the current pricing models that we’re used to because things slosh about and move around. And the second is, can you create a business model that says, “It won’t be particularly profitable, we will do it at cost and we will perceive it as a utility.” It is possible. The technology we have to do it would allow for the running cost and maintenance cost to be lower. But I would say that the cost of lending will probably go up, or you will have to pay for a current account, which in some societies already happens, and people wouldn’t even blink. But in places like Britain, people were like, “Whoa, what’s that all about?”

even if it makes perfect sense to focus on the thing you’re best at or the thing customer comes to you for and leave other things to others who are better at them, there is an emotional blocker there

[00:15:30.03] Ben: Do you think we’re seeing the first indications that that’s actually happening? In the sense that the manufacturing balance sheet part of the banking is becoming more and more heavily regulated and I guess less and less profitable? And then secondly, because we’re already starting to see big bank mergers, which would suggest that we’re moving into a phase now where institutions are trying to just maximize economies of scale, which is what’s at play here. Would you say we’re already heading in that direction or we’ll take a more direct intervention from governments or regulators to make it happen?

The challenger banks measure their success in terms of accounts or in terms of being primary accounts, but the number of people who close their high-street bank account is minimal. The whole notion of being multi-banked is a given now.

Leda: It’s too early to tell, actually, is what I would think. We’ve definitely seen, as you rightly point out, some mergers and consolidations. But in the world of banking, those mergers and consolidations — or de-mergers — are part of how business is done. We have not seen big banks exit retail banking, which I bet is tempting. But actually, bankers, not to bash them as cynical, but I have never met a bank CEO who didn’t feel a sense of duty towards the community they serve. And even though no bank CEO’s retail arm is where the money is made, they all feel extremely strongly about retaining that. And I can’t stress that enough, there is no bank out there that I can think of — actually no, I lie; there are a couple in very particular circumstances — but for the vast majority of banks, their retail division either breaks even or loses some money. But no one ever considers killing it, because they do feel a sense of duty and responsibility to their communities. And they don’t need the regulator to tell them that. They actually do that themselves. So, to answer your question in the negative, the obvious thing would be to kill your retail banking and focus on the profitable stuff, but people don’t. And I don’t think the regulator would permit it, even if people were inclined to go that way. I think there will be a couple of things: there will be consolidation, as you say, because there’s definitely profitability in scale. I think we will see an acceptance that certain products will become less profitable, and that will become the new normal. And I hope — but I have seen very little indication of that — I hope that people will start making the hard decisions to invest in the infrastructure of the core entity, not the greenfield captives, not the small experiments, but really create an overhaul of the infrastructure of the bank, that will mean that the cost of ownership and the cost of doing business will go down. And therefore, yes, you know, the return on equity will be terrible for a few years. But once they’ve paid off the cost of build, then actually, they will have a much lighter infrastructure. So the fact that certain things are not as profitable won’t matter as much, because they’ll be much cheaper to run.

[00:18:26.28] Ben: I want to come back to that point about how banks should transform technology. And so, I’m going to come back to that, but just in the meantime, I wanted to ask you: so, if retail banking doesn’t necessarily get split off from other types of banking, do you think you’ll have different players doing the manufacturing from those that do the distribution? Because, as you say, the manufacturing part is capital intensive, it’s not very profitable, but the distribution part seems to be where you could achieve network effects and where you could achieve much higher margins and potentially very low cost of customer acquisition and so on.

No one will ever enjoy buying banking services. One of the things that the banks have to accept is that you can make it as snazzy and fun and cute as you like, it’s not going to change the way people feel about it.

Leda: Well, you speak sense, and that should be the direction of travel, right? Whether it will happen or not, will depend on a lot of things. Regulation is one — we don’t have a clear direction of travel from the regulators, but there is an increasing push for separation clarity and demarcation lines between different pieces of the life cycle that the regulator is pushing towards. So, that may be a factor. But what is holding banks back from doing this is emotional, it’s not practical. I mean, over the years — I worked in a transaction bank and custody bank and I kept saying to them, “Plumbing is amazing! Why do you care about the sexy stuff?” Like, plumbing is where you can make money, you’re needed, but it is unsexy and people emotionally want to do the more exciting stuff, the client-facing stuff. So, even if it makes perfect sense to focus on the thing you’re best at or the thing customer comes to you for and leave other things to others who are better at them, there is an emotional blocker there. So, you see, for instance, quite a lot of the traditional high-street banks who don’t actually drive profitability through their retail businesses, should say, “I’ll tell you what: open banking has landed, I’m not very good at this digital journey stuff. But people still want to have their money in a place that feels secure, so why don’t you, Mister Startup, create all your propositions on top of my platform and account, your customers’ money will be in an HSBC account, but they won’t even see HSBC, they will see PensionBee and Revolut. Neither of them is doing that, and there are many reasons for it. For the challengers, it’s both the independence that you get from having your own license, but also the feeling of being a grown-up and sitting at the grown-ups table, and not just being a little app that sits on top of another system. The traditional banks are convinced from the old way of running relationships, that owning the customer is important, right? If you sit inside a traditional bank, there are usually fights between departments about who owns the customer. The notion that you need the customer touchpoints, you need to own the customer, that’s where profitability comes from, is actually complicated, convoluted, and in some cases, entirely misled.

Leda: The point is that you have the challengers spending a lot of time and money creating infrastructure that, to your point, should be created by someone else and it should be sold as a utility to all banks. The traditional banks are spending a lot of time trying to create propositions and user journeys that they’re not very good at. Meanwhile, they don’t make any money from them and they could just sit back, take the deposits, let other people be creative. They were symbiotic relationships that could have been explored and haven’t. And I think we’ve reached the point now, where none of what exists makes sense at scale. All of the various banking players will need to think about scalable and robust infrastructure. And, as part of that same discussion, they will need to think, “What am I for? And do I need to build all the bits that I will use to be that?” And my personal view is one should only build the technology that is tied to their differentiator and partner or buy the rest because it means that you carry less legacy, you carry less need for dependence on know-how, and if technology moves on and your provider doesn’t, then great, you change providers.

[00:22:37.11] Ben: So if we think about, I don’t know, eCommerce, right? You’ve got Amazon as an aggregator, and Shopify as a platform, right? How do you think it plays on banking? Do you think banks can be aggregators? Or do you think they’re destined to be platforms?

the data that you need for timely, intelligent, embedded financial services is there, but nobody is doing it yet

Leda: That’s a very good question, and I think it depends on two things. One is the economics of it. So, the way that financial relationships are monetized right now makes it very hard to go down, actually, either of those paths, because the way you make money is hard to unbundle. It’s not a case of, “Okay, now you will be doing 30% of that process, so you get 30% of the revenue.” It’s sadly not how it works. The second challenge is, which bank has the technology to actually even start thinking about that? The people who are quietly, but interestingly, doing quite a lot of that work is Standard Chartered. They are looking at the types of work they have historically done and creating partnerships to allow them to retain their usefulness. So, it’s less about, are you an aggregator or are you a platform? And more about, in what you currently do, where do you retain brand relevance? And where are you still actually a meaningful part of the puzzle? And who can you partner with upstream and downstream to make that piece where you’re still good, bigger? And the only bank I’ve seen do that to any meaningful scale, actually, so far is Standard Chartered.

[00:24:08.19] Ben: The big advantage that the incumbents have, as you say, is every challenger is spending hundreds of millions of dollars on trying to acquire customers that the incumbents already have.

Leda: That the incumbents already have and don’t lose, right? Because it’s actually a false statistic we see. Because you are absolutely right. The challengers measure their success in terms of accounts or in terms of being primary accounts, but the number of people who close their high-street bank account is minimal. The whole notion of being multi-banked is a given now. I don’t know a single person who has one bank account.

[00:24:43.27] Ben: Yeah. So, you’re almost saying that that’s not a meaningful statistic anymore, right?

Leda: No. So, I’ve done a very informal survey of a few friends of mine who took the leap, so to speak, and started paying their salary into a challenger. And so, rather than having your traditional bank for your salary to be paid into when you’re spending money, playing money in your challengers, they actually started paying their salary into their Starling, their Monzo, their N26. But you ask the next question, if the vast majority of them sweep what they don’t expect to use immediately. So, actually, the deposits, which is where the money is made from a banking perspective, still go to the traditional institutions, either because they offer better interest rates, or because they offer higher protection, better security. The motivations are multifaceted, but if you say that the main thing that a banking player will monetize is deposits, then even the people who pay their salary into the challengers — and I would say that that number is nowhere near as high as the total number of customers, obviously — even these guys don’t leave their deposits in the challenger in any meaningful sense.

we will see much more embedded finance, much more embedded payments, actually much more complicated financial transactions being embedded in the commercial activity, but it won’t be driven by finance. It will be driven by the consumer need and the consumer opportunity.

[00:25:57.29] Ben: And do you think that’s like some sort of proxy for trust? And do you think trust is the key attribute to be able to do aggregation? I.e. I’m going to introduce you to other products and services you might find useful and value-added, because you’ve given me your trust?

Leda: Trust is absolutely vital. However, I think the main thing is that people don’t want to think about any of these things unless they absolutely have to. So, the proactive up-and-cross sell the banks are trying to do is noise. Nobody says, “Do you know what I’m gonna do today? I’m gonna pick a car loan. This is my plan for the afternoon.” People will say, “I have to renew my mortgage and I hate it, and I’ve been putting it off.” No one will ever enjoy buying banking services. One of the things that the banks have to accept is that you can make it as snazzy and fun and cute as you like, it’s not going to change the way people feel about it. The second thing is, people want these things to be available when you need them. So, I keep getting mortgage offers from my bank — my high-street bank — even though my mortgage is paid for out of that bank; but I get first-time buyer offers on a weekly basis. So, the data that you need for timely, intelligent, embedded financial services is there, but nobody is doing it yet. And I mean, from the standard banks. And I would say that the challenges are not doing as much of it as they could.

Leda: There was a proposal I saw recently that N26, was going to be doing this. I don’t know whether it actually went live or it got delayed because of COVID. But essentially, it was, if all your movements take place within your N26 account, N26 says to you, “Hey, leader, you pay this much for rent, you qualify for this kind of mortgage, and you can afford an apartment in the neighborhoods you do most of your spending in. So, in the neighborhoods where you spend your life, you can afford to buy.” Those data points are actually available, either publicly or through your own protected account. Now, that is a useful service, right? That is intelligent, embedded finance. But I don’t think that my mortgage provider saying “Do you want a credit card? You can afford one.” Or, my high-street bank saying, “Would you like to buy a house? We can help you.” is in any way helpful. Trust or no trust — because, of course, I would trust them to execute — but it’s not like the supermarket where you will buy your favorite shampoo because it’s an offer even though you don’t need it. And yet, the way financial products are promoted is exactly like your supermarket offers. People will see it and buy it. No, it doesn’t work that way. So, intelligent embedded finance is technically possible. It’s absolutely possible from a data perspective. When it becomes the way we offer services, then the people who do it best will be the people who read the situations best, not the people who have the best pricing.

digitization is not about allowing the banks to dominate this conversation. It’s about allowing them to stay compliant and relevant with the way people live

[00:29:01.18] Ben: So you’ve mentioned the term ‘embedded finance’, which is something that’s become, I think, really quite fashionable, over the course of 2020. Do you not think that it will be embedded into products and services that aren’t financial at all in nature, i.e. those that have the highest engagement? Because that always seemed, to me, the problem, as you said, which is, I only go into my banking app when I need to do banking, whereas, you know, I’m in WhatsApp all day. So, isn’t it easier to try to engage me with financial products and services through apps and services that I’m regularly using, and in which I have the pool of engagement?

Leda: I would expect so, but I think that the starting point would be interesting. So, for instance, the Uber example is a very interesting one, right? By taking away the process of payment, they’ve given you back, what? Two minutes of your life? And yet, it felt like a revelation the first time it happened. Uber didn’t create embedded payments to help MasterCard make money. They did it to create a proposition that would make them more attractive to the user. So, I think we will start seeing embedded finance for that purpose. And it will put everything on its head. I was speaking to someone who works for Experian, and they were saying, “Creating a good credit footprint has become second nature. We all know you need to brush your teeth and have a good credit score.” But the reality is that assumes you need to enter the credit system. That’s an assumption that we have made without even thinking about it. But is that the right thing? Is that something we should be encouraging new generations to do? So, for me, the interesting thing is, we will see much more embedded finance, much more embedded payment, actually much more complicated financial transactions being embedded in the commercial activity, but it won’t be driven by finance. It will be driven by the consumer need and the consumer opportunity.

[00:30:56.12] Ben: If I were to summarize, you’re saying that it will be more intelligent, more useful, and it will be pull not push, right?

Leda: Yeah.

[00:31:03.25] Ben: Changing the topic slightly, do you think that open banking is the catalyst to move us to this world of pull not push, and intelligent and useful embedded banking services?

the consumer will not choose the bank that has the best user journey; they will choose the bank that gets out of their way the most

Leda: I was asked a similar question not too long ago, and we had been talking about dance earlier and something entirely unrelated. And I used the analogy in a way that was relevant in the moment, but I think it still works. And what I said is, gravity is essential for dancing. But nobody thought, “Gravity is great. How could I use it? Let me invent dancing.” And the thing that has been frustrating for most big organizations that open banking came, and the banks kept looking at it until the eyes bled, and couldn’t figure out how to make it work for them, how to make money through it. And I heard equally a lot of startups looking at it and going, “There’s an opportunity in there but I don’t know how to monetize it.” And I think that if you stop staring at it, and you start going down the path of solving real problems, then open banking will be an enabler, a facilitator, and an accelerant to things that you can do to solve real problems. A little bit like you couldn’t dance without gravity, but the two are not… You know, nobody came up with dancing or slides by thinking I need to use gravity for something.

the boat that said ‘digitization is your key to future profitability’ has sailed. The boat now says ‘digitization is a key to survival and compliance’

[00:32:20.16] Ben: It seems to me that the whole digitization of the industry banking, is the new driving force to embedded finance, all these other downstream applications that will be super useful and value-added. But it doesn’t seem like open banking itself is actually that relative to everything else that important. Or do you disagree? Do you see it as being really quite significant in pushing us towards this?

Leda: I think open banking is going to be significant in enabling solutions that wouldn’t have been possible before. But it’s for the consumer, and for the creativity that the industry will see. It’s not for the incumbents. I think that, as I said earlier, embedded finance, and those truly empowering capabilities won’t come from the banks. They might be powered by the banks, but they won’t come from the banks. So, the revolution and the truly transformative pieces won’t be because the banks finally found a way of doing this. It will be because somebody thought of something that is now possible because of open banking. So, digitization is not about allowing the banks to dominate this conversation. It’s about allowing them to stay compliant and relevant with the way people live. So, for instance, at my high-street bank, you can’t set up an international payment on the app. You can only do it online. Now, if you’re not a banker, you either don’t question that, or you assume it’s for security purposes. If you are a banker, you know that’s because their systems don’t talk to each other and the online bank is on an entirely different infrastructure than the mobile bank. The reality is that a time will come — and that time is not far away from us — that the challengers and some of the incumbents will solve some of these problems. So, the consumer will not choose the bank that has the best user journey; they will choose the bank that gets out of their way the most. And by getting out of their way equally means not bombarding them with products they don’t want, but also enabling them to do things on-the-go. I remember a few years ago, I was here, in Athens, visiting my parents, and I needed — it was a routine KYC check for my mortgage. I couldn’t do it remotely. I had to go in-person into the branch that has changed in the intervening time. So, there are things that are hygiene factors these days, both because the customers expect them and because the regulator expects them, but I think that the boat that said ‘digitization is your key to future profitability’ has sailed. The boat now says ‘digitization is a key to survival and compliance’.

[00:35:06.26] Ben: I suppose asking the question a different way, do you think that… So, open banking kind of creates an obligation to share customer data. Customers, as we observe in other realms, they’re happy to share their data where they perceive there’s a utility for doing so. So, do you not think that this will happen anyway, as the right use cases emerge?

Leda: I don’t think that use cases will come from the banks. Now, I think open banking is not an obligation to share data, it’s an obligation to share infrastructure that enables the sharing of data, should the customer consents to it. And the onus was on that consent mechanism, because banks would allow you to screen scrape in the past, which is extremely insecure, but cheaper to do. I think creating that infrastructure for consent and control has been what? Has been a sort of a point of contention, because it was expensive, and the banks couldn’t figure out how to make money with it. But I firmly believe that the creative solutions that leverage open banking are not going to come by people who look at open banking and think how can I make this — make money? They will come from people who are solving problems and go, “Oh, look! With open banking, it’s much safer and easier to do that.”

[00:36:18.12] Ben: What effect you see COVID-19 having on banks, on B2B FinTech companies, and then on the B2C challengers?

Leda: I think it very much remains to be seen. I’m extremely skeptical of all the triumph of, ‘this has sealed our digital efforts and accelerated and…’ I don’t see that. What I see is, banks that knew they had challenges and problems in their infrastructure faced those problems by throwing more people at the problem, the people working extremely hard to create bridging solutions, and delivering for the clients and the bank being extremely proud of their people — as they should be. And then, the conversation of whether they should actually challenge change, restructure being not even started. So, I would say that the banks have done well in the midst of COVID because of sheer hard work, creativity, and determination on their human sides. But not because their systems were up to scratch. And I’m not seeing anyone saying “Okay, our systems were not exactly up to scratch, and I should do something about that.”

you can’t change systems without changing the supporting economics and surrounding governance. Which means that if you’re doing the slow refurb process, you’re going to have a schizophrenic organization for quite a long time

[00:37:30.03] Ben: What about, do you think, they’re investing more in B2B FinTech solutions to help them to digitize faster or to, at least, service customers digitally faster than they were?

Leda: There is some loan disbursement work that has gone ahead. But honestly, what happened when COVID hit is that people went into panic mode because they needed to deploy quick solutions for particularly loan holidays for both businesses and individuals. The systems were not set up to do that. And the reality was that if you have a COBOL-based system to change an interest rate is two months’ worth of development work. The reality is they threw the people at it, they made the change, but the system is still COBOL-based.

[00:38:13.24] Ben: And then, what about the B2C FinTech companies? Because there was a piece that was written by McKinsey, I think it was called, “Rerouting Profitability” or something, and they made the point that all of these challenges in the unit economics of some of these businesses have been laid there, and now they’re struggling to raise new funding, and the FinTech sector is an existential crisis. How do you react to that kind of comment?

Leda: I’ve heard about the existential crisis before. I saw that report. And they were saying the FinTech sector is an existential crisis, then the FinTechs responded all over Twitter and LinkedIn, “You’re the one, an existential crisis”. And the reality is, no one is an existential crisis. This is a long game. It’s a long game. And in the last 15 years, everything is moving in the direction we said it would, but because it’s not moving as fast or as radically and because the startups that were around at the beginning are mostly not still around, therefore, the winners and the losers are not as black and white, people are feeling a little bit more relaxed than they should. But we said 10–15 years ago, the economics of banking are changing, the significance of technology is changing, the world will be more connected, service orchestration will be the name of the game, unit economics will change. All of that is happening. It’s just happening slowly, as you should expect, and therefore, I don’t understand people who are trying to find comfort in these radical revelatory moments of, “We fixed it” or “This was wrong” or “This is right, and that is wrong”. It doesn’t go that way. There is a direction of travel and we’ve been very much moving in that direction for 15 years. Certain events accelerate certain parts of the journey — regulatory moves, certain mergers, the rise of the Chinese giants, COVID. But it’s not a pivotal moment after which everything is different.

[00:40:10.02] Ben: What about payments? Do you think the impacts on payments from open banking has been more transformational?

Leda: I mean, my answer when it comes to open banking is, it is what it is, right? There’s no change. Payments are in an area that has had a lot of focus and has had a lot of innovation over the last 10 years. It hasn’t been transformative, because the monetization relationships are similar. But we’ve seen incredible speed in payments, particularly cross-border. So, payments, I would say, is a place where we’ve had so much innovation and creativity, that unless the rest of the banking infrastructure starts catching up in terms of the build of the systems that can support, there’s only so much more that we can see in payments, because there’s a little bit of saturation.

[00:41:00.10] Ben: I want to go back to something you said earlier on. If we think about this, there’s typically been a few approaches to technology transformation. One is the Big Bang approach, which I think is becoming increasingly less viable or palatable. And then you’ve got this progressive…

Leda: People lose their jobs when they do that, right?

Ben: Yeah. I mean, I just think it’s just, the time to value is too long, the risk to value is too high. And so, we’ve seen people moving to more progressive renovation type renewal strategies, and then also, as you said — I think you used the term ‘greenfield captives’ — but this idea of building a new digital bank, and then trying to migrate customers and books of business to that new bank. So, first of all, I’m sort of inferring you’re a bit of a skeptic when it comes to this build and migrate strategy. So is progressive renovation the right approach to technology transformation, or do you see another option?

Leda: There are many options, right? One is Big Bang, the other is refurbish as you go, and the third is build and migrate. We have not seen the migrate part happen yet. Some of the greenfield builds have failed to provide the skills. So, First Direct is a good example, right? Everyone who uses First Direct loves it. Why am I still on the old HSBC systems? I don’t know. But they haven’t migrated. Now, I would suggest that it’s too late now because even though First Direct customers are very happy, the technology is almost 20 years old now. But even with a successful challenger, no migration took place. Then, you have situations like RBS’s Bo where, for whatever reason, they pulled the plug on the effort. Now, a lot has been said, and a lot of criticism has been piled on top of RBS for killing Bo. I actually think that I don’t know enough about the ins and outs of it, but I think if you think something isn’t working, having the courage to say, “Pivot, move” is actually brilliant, is what we should be doing as well. That’s what we said our innovation departments were for. And the fact that quite a lot of the technology is being redeployed elsewhere shows that the experiment was not a failure. But the whole idea of build something at arm’s length and migrate didn’t work there.

Leda: There’s currently Mox in Southeast Asia, which looks to be an immense success — they’re onboarding a new customer every minute. Will Standard Chartered migrate customers on to there? No idea — remains to be seen. So, the build and migrate thing is brilliant as an idea and lower risk. It’s just that the migrate thing never seems to happen. The Big Bang approach doesn’t work, and we’ve seen a lot of very good CTOs stop being very good CTOs — in fact stopping CTOs at all. It’s the fastest way to end your career, right? So what are you left with? You’re left with slow refurbishment. And the thing about slow refurbishment is that it has two massive challenges. One is, it’s a long game, and people lose momentum and focus. It’s a long game. Like, if you start doing that, it’s going to take 10–15 years. And in year three people start going, “Are we still doing this?” And the answer is “Yep. And we’ll be doing it for quite a lot longer.” So people start losing focus, it stops feeling like a top priority, it feels like an endless log in a bottomless pit. The second challenge is that you can’t change — and we touched on it earlier — you can’t change systems without changing the supporting economics and surrounding governance. Which means that if you’re doing the slow refurb process, you’re going to have a schizophrenic organization for quite a long time, where part of your organization will have a different governance model and a different pricing model and that creates immense tensions, both in terms of the operating model viability, but also in terms of humans. Imagine a team that sits in the same office opposite to each other, half of them have transitioned to a new system with new governance with real-time approvals from risk and compliance and a different pricing model. And the guy sitting opposite you has to go to the risk committee. And if they miss their slot, they have to wait for three months. But that’s the reality: if you’re doing a slow migration, you have to change the system, the pricing, and the governance for each part of the bank, and then move on to the next one. And it’s not just the cost of running two parallel infrastructures until you can migrate and switch off. It’s the fact that you’re gonna have to be running two different organizations, from a governance and pricing, etc. perspective.

[00:45:26.24] Ben: One idea that I hear more often is, you know, as you said, I don’t believe there is a silver bullet — but this idea that maybe you can put some sort of orchestration platform in between channels and record-keeping, which enables you to deliver better customer experiences, and sort of buys you time to replace those record-keeping systems, which is where the real complexity and the real legacy lies. So, how do you react to that idea of introducing a new orchestration layer?

Leda: Bring it! Great! But you still need to fix the human governance, which seems to fall off everyone to lift.

[00:46:10.21] Ben: And do you think it’s issues of governance that are ultimately the reason why these greenfield captives don’t become the bank at large?

Leda: That’s a very, very good question, and ‘I am not sure’ is the answer. I would suspect the answer will be different in every captive. And it would depend a lot on whether the captive is expected to run on the existing bank infrastructure — in which case, it’s not just the governance, it’s also the infrastructure — or whether you have your own board and you’re essentially not just a separate entity name, but you’re genuinely a separate entity, in which case your decisions can be different. I think it varies. It could be lack of conviction, it could be the fact that nobody has successfully done it yet. It could be a case of, when is it big enough? Or when do you know? So, Mox is very young, so it’s easy to pick them as an example — Mox is succeeding by every metric right now, but it’s extremely early. Assuming that the plan is if Mox succeeds — and I hope they will, and I think they will — if the plan is, well, we expect that some of the traditional bank customers will choose to go to Mox, great! But if the plan is, we will migrate the customers when Mox has achieved size and scale, I bet you that nobody has specified exact numbers for that. It is so far into the future. But then it becomes a question of, okay, what is big enough? How long do you wait?

[00:47:37.16] Ben: And it’s not obvious that all customers will want that kind of service. And it’s not also obvious, to me, at least, that the regulator will allow it, because what happens to rural areas? What happens to non-digital customers?

Leda: The answer to that will be many-fold. I haven’t seen a regulator yet force banks to have branches. So, that could be a very interesting legal case that says, “If you allow Revolut, and Monzo, and Starling to have a banking charter without the responsibility to maintain branches, why are you putting the onus on me?” It’d be extremely difficult to have rules for one and not for the other, right? So, there is currently no obligation to serve the rural areas, there’s currently no obligation to have branches, there’s currently no obligation to serve the elderly. So you could see challengers that emerge that cater to those communities or you could find that actually, the way things go, they become even further underserved and marginalized. But with no obligation to retain a physical presence and the mounting cost of retaining a physical presence, I am not sure that the considerations you raised would carry the day — valid as they are.

[00:48:52.22] Ben: I guess there’s another reason to move fast, otherwise, you’re left with this sort of rump of hearts of expensive-to-serve customers. And I think it also maybe depends on something you said at the start, which is, whether this ultimately becomes some sort of public service utility, in which case, maybe there does become requirements about serving rural customers and things like that. A slightly different topic. So, I think we’ve been through the hype cycle with everything to do with cryptocurrencies, and digital assets, but it feels like we might be back into some sort of slope of enlightenment. What do you see is the role of digital assets in banking?

Leda: There are three different pieces there, right? And when this whole thing started, we couldn’t imagine them separate to each other. One is digital assets, the second is crypto assets, and the third is distributed architectures. I would say that distributed architectures and what we understood as smart contracts were a revelation, it blew our mind. But there are now ways of doing them that are much kinder to the environment than a traditional blockchain. There are ways of having a distributed architecture that isn’t DLT. There are reasons why you might still choose DLT, but you can have a distributed architecture in immutable records without DLT. So you would need some good reasons to have DLT that would go beyond those basic functionalities that, for a time, we couldn’t fathom outside DLT, but now we can.

Leda: The second thing is digital assets. And I think we were going in that direction anyway but the advent of blockchain and other digital assets forced us to create security of holding and transacting in assets that don’t even have any magic, physical representation. Because we have been dealing in digital assets and digital ledgers for a long time, but the assumption was that there was capital adequacy, that if I make a transfer to you, if the bank has that physical cash or that physical gold somewhere in its coffers, that doesn’t exist anymore. So the transition to regulating and understanding digital assets and creating a certain degree of complexity is there and is now also decoupled from crypto cash and crypto-assets. Which means that crypto has become its own segment, where part of what you’re doing is creating the distributed architecture and crypto and digital assets with the added layer of not having that provenance and ownership — essentially becoming a bearer asset, like money would be in the physical world, but in the digital space. And I think it’s not a space I personally have a massive interest in anymore. That’s not that I don’t find it interesting, is that there are only so many hours in the day. But I do find that for the industry, decoupling those three things has been helpful because then you can have the benefits of the architecture and the benefits with digital asset without getting into the moral and regulatory conversations around the crypto side, unless it’s absolutely what you were trying to achieve.

[00:51:59.13] Ben: Yep. Okay, last question. So, we’ve got this far and we haven’t talked about the technology giants — Google or Apple — moving into banking and finance. What’s the role of those mainly American and Chinese technology giants in banking in Europe?

Leda: I would say that the Chinese giants and the American giants represent a very different type of challenge because the Chinese giants have a very well-developed financial proposition. It’s not just payments, it’s investments — if you look at the two big Chinese entities, they started with payment, sure, but that’s not where they stopped. So, I would say that them coming into Europe presents a very interesting challenge because they’ve worked out how to become financial services provision players and they don’t need to build scale in Europe to become profitable, because they can leverage their scale in Asia. They already have scale. What will be interesting is how the regulator will treat their entry point, whether they will expect a lot of infrastructure separation — in which case they would need to rebuild their support, and their infrastructure in Europe in order to have that scale — or whether they would allow them to cross leverage. But I think it’s a very interesting thing with the Chinese giants in particular, that their regulatory framework has very much allowed those entities to grow because of how the regulatory framework is in China. You don’t have anything of that size in Europe, and that’s not an accident. That’s partly because the regulator is pointing growth in a different direction. From a US perspective, the giants that are being looked at as potentially entering our space are only dabbling in payments. So, they’re looking at extending whatever it is they’re currently doing into the next step, as we were talking about — the embedded infrastructure makes it natural for these entities to offer payment services, and facilitate some of those. There is no indication that the deeper credit lending and investment pieces are being addressed. The only pieces we’ve seen have been through partnership — you know, that short-lived partnership between Amazon and Wells Fargo and then more successful, but equally limited for now partnership between Goldman Sachs and Apple. We’re not seeing an appetite for those guys to become regulated financial services providers the way that Alibaba and Tencent have.

[00:54:33.01] Ben: Where do you think the bigger challenge comes from?

Leda: If you’re talking about the biggest challenge to profitability for banks in Europe, actually, I think it comes from the regulator, who’s increasingly demanding unbundling and transparency and simplicity and pushing for technology transformation without allowing the banks to pass that cost on to their customers. The business models that both of those two geographic units of giants represent would have to be tweaked a little as they enter Europe, but from a bank, multiple payment providers that sit on top of their infrastructure doesn’t provide an existential threat. Neither does a Chinese tourist making all payments through WeChat. It’s what happens about pushing them up and down the value chain, and how they monetize the place where they land, which is why I find the model that Standard Chartered is doing very interesting, because they’ve had to deal with those Chinese giants and have taken, to me, the logical path of, there are certain battles that are not worth fighting, because we weren’t winning them before these guys appeared. Therefore, let’s focus on the things that we’re still needed for, that we do well, that we have scale for, and then we can even still partner with those guys and give them depth where they don’t need to build infrastructure. Because one of the things that both the Chinese and American giants have in common is the fact that they are clear as to what it is they’re for. And what it is they’re for may be multifaceted, because they have many different business lines under their umbrella, but they’re clear as to their purpose, and they don’t carry unnecessary infrastructure if it’s not aligned to their purpose. So I think it’s important for European entities to learn that lesson.

[00:56:18.08] Ben: If an incumbent is clear about what they stand for, and they align around that, and potentially also pursue some sort of ecosystem-based model, then there’s no reason why banks can’t surf this wave of digitization and emerge on the other side with happy customers and profits.

Leda: I mean, I am not going to foretell such a happy ending for anyone because they’re potentially too many banks, and what passes as profitability for the average bank is possibly not to be seen again in the market. But I would say that anyone who refuses to do that will definitely not have a seat at the table. Consumers — and I don’t just mean retail consumers, I mean, customers across all value chains — and regulators are much more demanding, and rightly so, in terms of service provision, focus, transparency, and pricing. And therefore, unless you really know what it is you provide, what it is you’re for, you can become overwhelmed by options. Think about it, you can revamp your lending infrastructure in 10 different ways. If you can’t decide whether lending is important to you, how will you know what the best way of revamping is?

Ben: Thank you very much, indeed, for your time. That was great.

Leda: Absolute pleasure. Thank you so much!

Post-pandemic Wealth Management (#20)

Structural Shifts with Anna Zakrzewski, Lead Wealth Management atBCG; Christine Schmid, Head Strategy at additiv, and Laurence Mandrile-Aguirre, Head Switzerland & Monaco for Citi Private Bank.

Your host, Ben Robinson, sits down with Anna Zakrzewski who leads Wealth Management globally, for Boston Consulting GroupChristine Schmid who heads up Strategy at additiv, and Laurence Mandrile-Aguirre — who heads up Switzerland & Monaco for Citi Private Bank. We cover the opportunities around Digital Wealth Management and what that truly means, how ready are wealth managers to take advantage of the shift to Assets under Intelligence, where new entrants fit into the market and what the future of wealth management will be.

Resources and transcript

  1. For Wealth Managers, COVID-19 Is a Wake-up Call” — Boston Consulting Group
  2. Post-pandemic Wealth Management Opportunities” — additiv
  3. What society needs from the financial sector — now more than ever before” — additiv

There is no way that we’re going to go back to a less-digitized world post-COVID19. It will have a lasting impact in that respect, on the client experience, on the way relationship managers and investment advisors interact, but it will also have a lasting impact in terms of how you onboard, how you run KYC, what your future compliance model is going to look like — Anna Zakrzewski

[00:01:57.09] Ben: Anna, thank you very much for coming on the podcast! I want to start with the white paper that you recently issued, called “For Wealth Managers, COVID-19 is a Wake-Up Call”. It begins with the following line:

“Outsiders might think that wealth management, after a 10-year bull market should be in good shape to weather the storm. But this is not what we find.”

Anna, have wealth managers been complacent and failed to prepare for the future while times were good?

Anna: I would say a lot of the topics that we see that wealth managers have to focus on today, they should have already been doing the last two to three years — and I would say they haven’t really done too well in implementing them. Whether they fail to make the world shine, I would say they never really had the huge pressure on which they had to act because margins were still quite okay. On the other side, a lot of them had such a thin profit margin, that right now, with the crisis and with COVID-19, there will be not that much leftover.

[00:02:55.26] Ben: Do you think that they now realize the severity of the situation — i.e. that what we’re facing is a downturn, of course, which will affect assets, but the fact that it’s more than that, that it’s also going to catalyze some bigger structural changes?

Anna: Well, I think what they are realizing is two, three things. The first one that they are realizing is that the topics that they have to act on now, the actions that they have to take on now, are not all necessarily new — with very few exceptions — but they have to accelerate and they actually have to really implement them well. For example, structural cost changes; for example, rethinking how they deliver advice, and actually enabling and embracing the opportunity to work remotely, to work digitally — at the moment, it’s the only way for wealth managers to interact with their clients. And before that, it used to be a threat. So, I think that’s the one bucket.

Anna: The second one, in terms of major structural changes, in the past, most wealth managers have not really embraced and adapted their complete operating model. It’s always been relatively a good business — 10 years of a bull market, a high volume of transactions — which means basically, their long-term view on profits hasn’t really been distracted. So, that also means that they never really had to make more cuts than just little salami slices on their cost and on their operating model — so you have a lot of duplications, you have a lot of complexity, you have a lot of processes that are not necessarily scalable, and most of these structural topics haven’t really been implemented well so far.

the banks that have invested in digitization, they were within a few days able to completely shift 80% of their workforce to working from home, even in functions you wouldn’t have imagined before. They were able to contact, reach out, and provide advice in a digitized, faster way to their clients, far more personalized than anybody else — Anna Zakrzewski

Anna: I think the other catalyst that we see is that after COVID-19, there will be a lasting impact in terms of interactions and also servicing. There is no way that we’re going to go back to a less-digitized world post-COVID. It will have a very lasting impact in that respect, and it will have a lasting impact on the client experience, on the way relationship managers and investment advisors interact, but it will also have a lasting impact in terms of how you onboard, how you run KYC, what your future compliance model is going to look like. These are the three big blocks where we definitely see strong acceleration. And lastly, if you look at the smaller banks and the smaller players in the market, who on average have really high cost:income ratios, the question is, if they will not focus right now, how many of them will really survive? And we actually do expect, as an acceleration, also industry consolidation to start happening.

[00:05:38.20] Ben: What you lay out there is quite a clear blueprint in terms of how wealth managers should be responding. How do you see them responding so far, especially the speed with which they’re now tackling what they arguably should have done a while back?

Anna: What they have been doing quite well — not all of them, but most of them — is the short-term actions directly linked to the COVID crisis: ensuring working from home, ensuring some acceleration on digitization, upgrading a little bit some client experience piece, start to run some scenarios, managed liquidity. I would say those short-term actions — keeping their own people safe and engaged — all of that, I would say that that has been done quite well. The part where they have also, at least some of them, become quite creative, I would say — and some have definitely surprised us — was also how they onboard clients, how they now run KYC, how they now manage compliance and enable work from home, especially in an environment and in a business, where confidentiality and also regulatory elements are very strict. So far, they haven’t been able to even onboard a client remotely, and now, in COVID, some have really been creative. They optimized digital signatures, they were able to do client identification through video calls. Before COVID, nobody really thought video calls, especially around Europe, would be something the clients would want. At the moment, it’s actually one way of getting onboarded. So I think some of these reaction times have been surprisingly quick and surprisingly agile. The thing that hasn’t really gone so well, for some of them, was really the decline in communication. So, some of them where weaker content that was not necessarily personalized it was talking about the crisis, but partially not individualized enough or solution-based — and that is an angle which should have been an opportunity for wealth managers to do really well. And I would say, on average, that part hasn’t been the strongest.

[00:08:05.00] Ben: In your report, you definitely identify that — as you said — is one area where digitization should be able to deliver a much better experience at scale. Do you think now that we’ve had this acceleration and digitalization, that wealth managers appreciate that, and they’re starting to make those kinds of investments? And then, how difficult is it to make longer-term investments in an environment where there’s such a focus on guarding liquidity and managing communication — things that seem so much more pressing?

Anna: There is one major shift in terms of how investments are being done, and also how levers are being prioritized in terms of where the focus and the action of the wealth managers are moving towards. So, to give you one example, one bank actually had a quite broad and ambitious digital roadmap before the crisis — most of the topics and most of the angles were completely focused purely on the front experience, the client experience, and that part. And there was quite a big budget behind it. They have revisited it, not cutting on that client experience piece, but adding a component in the whole digital roadmap, which actually allows them to reduce costs, to unlock some flexibility in the processes, to help them partially in an end-to-end view become more scalable, and through that actually leading to an efficiency increase of up to 20%. And that actually funds the partial investment also into the front and into the client experience piece. So, you see a much stronger balancing of complexity reduction and front client impact. And before COVID, it was mostly focused purely on the front and just on the client — and I think that is just one of the examples that we see in terms of a mindset shift.

Anna: Another one that is very interesting is, how do you ensure that you have a stable and continuous revenue flow mid to long term. And it’s about really thinking how you make your clients more sticky, how you make your clients stay with you and invest more money with you by truly tailoring on the one-hand side, and on the other side, also making parts of the portfolios in a short term — and it’s not easy — a bit less volatile to potential upcoming future shake-ups. But that’s, I think, one of the big notions. And in terms of reassuring — and, I guess, it also goes in that way — is, in times of crisis or COVID right now, with everybody working from home, you also have quite a large part of your employees in marketing and events or in the client front-facing angle, not necessarily being able to do what they’ve been doing before. So, some players have actually done a creative approach in rethinking and re-skilling some of their employees to now help where you have the big bulk of the work happening, driven by COVID, and allow them a more flexible engagement across the organization, and it actually puts them in a nice position to now experiment what their future working models could look like.

if you actually look at wealth managers today, they are still very strongly vertically integrated and it will require quite a change of mindset to let go of what is not core, in terms of, you know, “We do our own products”, “We build our own app”, “We have our own reporting”, instead of actually leveraging some of the players that are out there in the market — Anna Zakrzewski

[00:11:33.29] Ben: Going into the pandemic, we’re already starting to see a growing differential in performance between those wealth managers that have made big investments in digitalization — I think you call them ‘digital leaders’ in your report — and on the other side, those that hadn’t yet made those type of big investments in digitization. Presumably, that differential in performance is getting magnified during the pandemic, do we already have any evidence that that’s happening, or is it too early to see that divergence in performance?

Anna: You already have seen that divergence in performance before the crisis — and that’s a fundamental difference in performance. So, we have looked at 150 wealth managers last year, across the globe, in all business models, in all shapes and sizes, and we have also looked at the top performers in terms of profitability. There are two major differences that really make the top performers, top performers. First of all, they absolutely excel in the revenue margin because they already, through digitization, are able to deliver better to the client, cross-sell better, they have the right tools, and they really focus their front to deliver. Plus, they have also redefined their pricing model. And the difference, globally, I mean, we’re talking about a delta of approximately — depending on the regions — 15 to 18 basis points. So, it’s really significant. And these top performers, they also invest double and have invested double the amounts in digitization over the course of the last two to three years. So, there is a direct correlation already, before the crisis.

Anna: And thirdly, what was a very insightful angle for us was, we also looked at the cost difference — is the cost over assets of those top performers significantly different than the one of the average? And the third proof point here is that, actually, the difference globally-seen is something like three or four basis points, so it’s not as significant as on the revenue side. But the reason for that is that these top performers have already started to invest: they have invested into the changes in operating model, they have invested into the new talent, into the new and accelerated ways of working and, like I said, double the amount in digitization, not just in the front, but across the value chain.

[00:13:59.29] Ben: Is it too early to have any data points from the pandemic?

Anna: I wouldn’t say it’s too early. One thing that you already see is that the banks that have invested in digitization, they were within a few days able to completely shift 80% of their workforce working from home, even in functions you wouldn’t have imagined before. They were able to contact, reach out, and provide advice in a digitized faster way to their clients, far more personalized than anybody else because they could just review the portfolios. So yes, they were clearly at an advantage when the pandemic hit the market.

[00:14:39.24] Ben: But we don’t yet have data points on financial performance, right?

Anna: No. On financial performance, we don’t have it yet. However, in terms of onboarding clients, in terms of winning new business, in terms of maintaining clients, and in terms of tailored communication, this is what we see, these were the players that have been able to do that better than the others.

Let’s not forget that the customer acquisition cost is quite high. So, I wouldn’t necessarily see the digital players being the consolidators in the market. I would see some of the bigger players trying to acquire the capabilities of the digital players or even more, a partnership model where some of the traditional players have great access to clients and they do have the client relationships, to actually tap into the digital capabilities of the other players, to have it as an integrated service model and as an integrated offering towards these clients — Anna Zakrzewski

[00:15:02.11] Ben: We talked a bit about what digital servicing looks like. What about analytics and the capabilities that wealth managers are using there, in order to build more tailored products for customers? How strong would you say the data analytical capabilities were of wealth managers? And do you think this might be one area where they’re at risk from some of the digitally-native new entrants?

Anna: So, it’s maybe a bold statement, but I don’t think wealth managers yet are really very advanced and reaping the full benefits of the power of analytics today. So, I think that’s where they are, compared to other financial services places. With a few that can already do it, a lot of the times it’s still a bit of analytics here and a bit of analytics there, but very few have a truly centralized data lake, which allows them to on one-hand side, fully personalize their client interface, fully personalize their offering and the value proposition to each one of the clients, and thirdly, also, leverage analytics to allow them to scale up their processes and operating model. So, what we hear more is that the analytics capabilities will significantly accelerate now, in terms of enabling cross-sell, enabling pricing, taking into account client price sensitivities when we’re thinking value proposition design, etc. It’s going to really be a big focus now, and before the pandemic, I would say it’s been there — it’s been a great buzzword — but in very few cases it has been truly implemented, end to end. In Asia, I would say, yes, it’s been there, and it’s been definitely in the tech fins and in the more technology-averse digital wealth managers, it’s been playing to their complete advantage. In Europe, we’re still quite far away from that.

[00:17:10.10] Ben: One other aspect of the report I wanted to pick up on, was that I think you said this also, “in addition to changing operating models and servicing models, banks should also look at their sourcing models. But rather than just try to source things that are cheaper, they should also tap an ecosystem of partners to help deliver improving quality at scale.” I totally agree with what you’re saying, but it’s such a difficult area to get buy-in from banks because this is something that potentially threatens to cannibalize existing revenue streams. And so, I guess the question is, do you think that, culturally, banks and wealth managers are ready to look at changing their sourcing models in that kind of way, to actually insource even parts of their asset management?

Anna: When you mean sourcing, like outsource parts of their asset management? That’s what you mean, right?

Ben: Yes, outsource functions to India because they’re low cost. What about finding somebody who could offer a better-automated investment service than the one the bank has, for example.

Anna: I guess what wealth managers are facing today is a true definition of what their core competencies are and it is not like a process or your technology is going to be a key differentiator for you to win in the future. And we already see today that some wealth managers and private banking players are actually setting a primary focus on client servicing and investment servicing while some of the rest in the value chain, in terms of the middle back office, etc, is already quite radically and can be even more radically outsourced to third-party providers. On the other side, if you actually look at wealth managers today, they are still very strongly vertically integrated and it will require quite a change of mindset to let go of what is not core, in terms of, you know, “We do our own products”, “We build our own app”, “We have our own reporting”, instead of actually leveraging some of the players that are out there in the market. So, I would expect going forward, to also accelerate some of the changes that need to happen and accelerate some of the digitization elements that have to happen, that actually FinTechs — who are very focused on individual capabilities — will be a great source to pool and a great source to actually integrate to deliver some of these capabilities required.

The large wealth managers will clearly gain in market share, but they will only be able to do that if they do the right investments and the right level of personalization and client experience, and they will also act quite fast. The broad middle play, they will only survive if they stop being a big-bang, but they will also really refocus and turn around the operating model — Anna Zakrzewski

Anna: And then, the question is, in the future, what will wealth managers be? Will they be the ones that focus on wealth management, financial wellness, client experience? Will they be the players that will have everything in-house across the value chain? And then, the challenge is how do they get to scale in terms of the number of clients, etc. to really put the volume on their platform. And then you will have the players that actually are purely driven by technology — which are the tech fin and the digital wealth managers who actually are already having the digitized business model and don’t yet have the direct access to the customers.

[00:20:30.25] Ben: You said earlier on that you expect consolidation in this market because what COVID and then subsequently what an acceleration digitalization will do, is it will clearly separate the winners from those that are less strong and less able to adapt. How soon do you think that phase of consolidation will happen? And is it just the question of the large consuming the small or is it more nuanced? And then, if you allow me a third question, do digital leaders really need to buy assets? Because won’t superior value add just see them win those customers anyway, from those that aren’t able to provide that kind of value add?

Anna: Let me take one question at a time and try to bundle it. Today, nearly half of all wealth managers have a cost:income ratio of over 80% and some are close to 100, which means they’re already not very profitable today. The degree and the speed of consolidation, in our view, will depend on the severity of the crisis and also on how long the crisis will last. What we see is that size and profitability are definitely correlated, although, also here we see some examples of small boutique banks that are very successful and they are very focused.

Anna: So in terms of the speed at which consolidation will happen, comparing it to the previous crisis from 2008–2009, we have seen the big shift in terms of reduction, in terms of the number of wealth managers, approximately 18–24 months post the crisis. Now, in times of COVID, I would partially expect an even earlier kick-in of the M&A and consolidation wave driven by two drivers. The first one is, already today, a lot of wealth managers that were strong before the crisis are thinking and seeing this as an opportunity how in a relatively short period of time, they can acquire scale and acquire capability to make them stronger post-COVID — And typically, you will have 15 to 20% of players that come out stronger after the crisis. So, they will be the consolidation drivers and they have already started to screen and look for these opportunities, partially, today. And then, you will have the ones that will be so severely hit because they’ve already been in such a poor position before the crisis, that it’s going to be more a matter of decision, when do they sell to still get good value compared to how long can they last to somehow keep their business afloat. And this balance, I think, is going to drive the speed at which the consolidation wave will start.

Anna: On your other question, we already see today that some of the large wealth managers have significantly grown in the share of the market that they owned in the past few years. So, yes, it’s definitely going to be the mid-sized and larger players acquiring some of the smaller ones, which on average, are, today more unprofitable than some of the larger players, of course, because of the scalability of their business. But, like I said before, we will always have a few small boutique plays and niche plays that will continue to be very successful, already like we have today. But they are very focused.

[00:24:09.13] Ben: And then, the last question was around whether it’s actually necessary. So, the really successful digital leaders in this space, do they need to buy up the frail competition, or can they just take their customers through better execution anyway?

Anna: Okay. So, a lot of the pure digital players that we have in the market today, they have simple and nice, pragmatic client experience. They are very customer-oriented and friendly, but what they do not have is access to the clients. And let’s not forget that the customer acquisition cost is quite high. So, I wouldn’t necessarily see the digital players being the consolidators in the market. I don’t see that. I would rather see some of the bigger players trying to acquire the capabilities of the digital players or even more a partnership model where some of the more traditional players have great access to clients and they do have the client relationships, to actually tap into the digital capabilities of the other players, to have it as an integrated service model and as an integrated offering towards these clients. I don’t believe that the entrants such as robot advisors are actually going to be acquiring the smaller chunks of the clients that we see in the wealth managers today that may be up for sale at some point in time.

[00:25:36.23] Ben: What do you think the end state is? Does the middle just disappear? And what’s the final number of wealth managers you think we’ll have, once this consolidation phase is over?

Anna: Once we will definitely see in the future that the long tail of small wealth managers will actually disappear and only a few boutique plays will remain. The large wealth managers will clearly gain in market share, but they will only be able to do that if they do the right investments and the right level of personalization and client experience, and they will also act quite fast. The broad middle play, they will only survive if they stop to be a big bang, but they will also just really refocus and turn around the operating model — be it outsourced or be it really focused on a few segments and a few real credible value propositions.

The digital entrants focus on the younger population, most of them. I haven’t seen a digital entrant that focuses on retired persons yet — Christine Schmid

[00:26:33.27] Ben: Christine, thank you very much for coming on the podcast. Let’s maybe start by asking you, what is additiv?

Christine: Thanks a lot, Ben! Additiv is a technology company. It was established in ’98 and it helps the leading financial institutions to capitalize on digitization. The most known product is the Digital Finance Suite — that’s an orchestration engine for wealth management in particular. Newly, we have launched the KickStarter campaign that’s even a faster enablement for wealth managers to digitize. Additionally, it provides some expert systems, basically data analytics, but also credit tools. I would say it is global, excluding the US — this has some regulatory reasons — the US is a beast of its own. So, it is doing business out of Zurich, Singapore, Nairobi, and Frankfurt.

[00:27:25.17] Ben: And what’s it like trying to sell technology to banks and wealth managers at the moment during a global pandemic?

Christine: I think it’s the right time. For the ones that haven’t set up a servicing model through digital channels — i.e. where their advisors could serve their client through digital means — they’re doomed.

[00:27:47.16] Ben: So you’re saying almost counter-intuitively that this has actually risen to the top of their corporate agenda because, quite simply, they can’t service their customers in this environment without better technology?

Christine: I would say so, for the ones that are very still more towards the old dine & wine, that’s really over.

[00:28:05.02] Ben: Okay. Let’s assume they have the motivation to implement new technology and they have the budget even in the pandemic to implement new technology. How can they do it practically, if the IT staff are working remotely?

Christine: Working remotely doesn’t harm work. It just shifted. And, if you look for the wealth managers, they were used, I would say, on the IT staff side to work out of different locations — that’s common standard. So, just to give you an example, we were able with a large Swiss bank and it’s public with post finance to launch their new digital wealth advice during the pandemic. So, that’s no limitation at all, in particular, if you talk to IT staff on their side.

[00:28:55.11] Ben: So, Christine, before working at additiv, you used to work in the industry, right? You were in the wealth management industry. What’s your view on how bad a financial correction we’re looking at and how that will affect the wealth management industry?

Christine: So, yes, we will have a negative correction. We don’t know if it’s a V or a U or a W in the end, but it looks definitely like a correction. The numbers that are coming out from either the banks, on their estimate, but also from the IMF, are simply staggering. So, how does that affect wealth management? Certainly, we will have to refocus back on trust in quality, and people will focus more on the preservation of capital. But the line with what I would call stability and service at a fair level, at a fair price, a second thing is what we would expect and we see that also on the government side, is a refocus towards more sustainable investing again. It is already growing like there is no tomorrow but it will continue. So, if you look on the government side, they link their lending, often these days, to a greener approach of doing business. The same will happen on the investment side — this will continue. And on the retail side, I think we need tools in wealth management that allow for saving, that combine it with budgeting, and that have it in a transparent and fairly-priced way. I think the term that is often used and coming out of the UK where I hear it from often, is financial well-being. It’s really, on the retail side, how helping to save, but also helping to fund through a more difficult time on the economic side for every retail client.

I think that’s the ‘new’ normal model we see throughout various countries in Europe, in particular as well, Switzerland. They team up. It has become a ‘together’ and not only an ‘against’ — Christine Schmid

[00:30:51.03] Ben: You recently published a report on post-pandemic wealth management, and I think we’ve seen a number of these types of reports come out, where people try to anticipate what the future holds. And so, there’s a bit of that in your report. But the other thing I really liked about it is, you actually explain what you mean by digital wealth management — because I think a lot of times people either just assume we know what is meant by digitization or they — for me — minimize what it is and just assume it’s about, as you say, servicing clients through digital channels. So, can we start by having you explain what you think and what additiv thinks is digital wealth management?

Christine: Let me explain it from two views — first of all, from the view of a bank for wealth management, and secondly, then, from a client view. From the view of a bank, it transforms its business model. We always say, at additiv, it changes the operating model, it changes the servicing model, and it changes the sourcing model. So, operating model, it allows a cheaper production on wealth management. It allows on the servicing side an easier, simpler interaction with advisors to the clients, even taking all the regulatory means we have out there into account. And, on the sourcing side, it allows that you benefit from an engine in between, an orchestration engine in between, that already sources either the best partners for solutions or the best investments for solutions — and you can build upon that. So, you don’t have to do it on your own. And these three layers together, it’s not only wealth management; for the banks, it makes the risk management easier, it makes the compliance side easier, but also the audit side easier. So, it’s really various layers where it helps — coming back to where it all had begun — to transform the business model. That’s from a bank’s point of view.

Christine: From a client point of view, digitization in wealth management is partially about democratizing. It’s, from an exclusive offering, open to a broader number of clients. Honestly, it allows, as well, to produce cheaper, it allows as well to have lower fees in and lower costs. It can be personalized. So, in the past, you had a fantastic product and this fantastic product had to fit for a majority of your customers. You know more about the customers by combining different data sources and you can start to personalize that, you can start to personalize the offering, the information you provide. It’s not only that it has to be included within the e-banking but also it can be banking as a service. So, it has to be of becoming even more seamless to include it, for example, in a super app where you do all the transactions as a client, but you have banking services as well, aligned. This is how we break it up. But it will always be about trust, it will always be about a safe way to store your wealth. What is newly added — it has to be convenient. So, where the clients do their transaction they expect, as well, banking — and it has to provide a value add. I think that’s where digitization or digital wealth management really changes from the old world.

[00:34:21.24] Ben: Essentially, the trade-off that used to exist between quality on the one hand and scale on the other has sort of disappeared. We can provide better quality at better scale or higher scale. Would you say that’s fair?

Christine: And to lower assets under management levels. So, to lower levels of wealth per end client.

If you look in the Western world, pensions had quite a decent level of cost of living covered. The risk is, with the demographic pattern we have, with the lack of reforms we have seen, but also with the low interest rate level, you face a pension gap in which your targeted cost of living will not be covered by your pension anymore, and thus, you have to find a way to decumulate your wealth during the retirement period in a most efficient way, by not giving up completely on risk, by having the right investment products, which then allows you to live a life free of financial concerns. That’s a huge opportunity— Christine Schmid

[00:34:40.03] Ben: And in that kind of world, it would suggest that we can provide wealth management to a much larger population of customers? And so, how much bigger do you think we could grow the addressable market? Because I guess, most of what we talked about up until now is how we’re talking about a crisis in reduction in assets. But, on the flip side, if this accelerates the push to digitalization, then it also accelerates the opening up of a much bigger market for those wealth managers that can capitalize on that shift.

Christine: It’s a huge opportunity. It allows the scale — be it either self-serve with call center or with an advisor behind. At the moment, the only small amount is really advised of the assets out there. If you take the growth we are expecting in Southeast Asia but also partially the growth we are expecting in Africa, it’s really a super, super multiplier. So, from today’s around 50 million of people that really are fully advised, certainly at a lower scale of complexity, up to nicely into the 1.7 billion number of people — if you can scale it properly.

Ben: So, I’m not going to try to do the maths but that’s, as you say, it’s a big multiplier.

Christine: It will come at a different price tag and it will come obviously for way lower assets on the management per client, but there is where digitization helps to open their client groups.

[00:36:09.15] Ben: And what’s the share of your business that’s coming from existing wealth managers versus new entrants? You’ve got kind of all the right ingredients for new entrants here because you’ve got a large profit pool, fast-changing technology, fast-changing customer needs, which would suggest that there’s a once-in-a-generation kind of opening for new entrants. To what extent are you working with new entrants? And to what extent do you think they can enter the market successfully and build trust?

Christine: We are working with both sides. With new entrants, in particular on the pension side, it is not that simple because it is a highly regulated area. But they’re faster in terms of the platforms and the offerings. And normally, the new entrants then offer their model as a white label for the incumbents, so they follow fast behind. I think that’s the normal model we see throughout various countries in Europe, in particular as well, Switzerland. So they team up. It has become a ‘together’ and not only an ‘against’. Payment was different. On the payment side in particular, if you look at the case of Revolut, this was different because it really heated into a highly profitable area of foreign exchange. But here, it’s more a collaboration and a service model in the interest of the end clients.

[00:37:34.24] Ben: You’re saying that so far new entrants are more friend than foe, but how hard would it be either for banks to replicate these kinds of simple digital services that new entrants have provided? And also, how hard would it be for these new entrants to move up the value chain towards larger, higher net worth customers?

Christine: For the bank, if they start on a greenfield, it is doable. For the bank, if they integrated into their existing systems, it is rather expensive and a long-term project. So, it really depends on the incumbent side how willing they are to start businesses from scratch and maybe even cannibalize some of their still attractive earnings streams. How easy is it for the new entrants to scale up? We are seeing most of the digital banks, really, at the boundaries of wealth, I would say. They started with payment. They had a lot of success by cannibalizing into high-profit areas like foreign exchange. Now, they are really at the border of wealth management.

Ben: Barbarians are at the gate, as it were.

Christine: At the gate, exactly! They’re at the gate of wealth management. And what we see is they’re not growing as they were originally expecting, and this has really to do with the trust where you store your wealth. If you have a chatbot on the other side that sends you in circles, or if you at least can call a call center, or can call your advisor, that’s different. That’s really a difference. So there are some limitations in Europe. In the US, we have seen a completely different picture. If you look at the aims of Acorns, for example, they’ve entered in particular the 401k business quite successfully, and they’re growing nicely there.

[00:39:27.17] Ben: What you’re saying is, to be truly digital requires a business model change, and to some extent, is going to involve cannibalizing existing revenue streams. But, what you’re also saying about the additiv system, if I understand it correctly, is this can be introduced in a much more phased fashion, right? So in other words, you can both help banks to deal with the immediate need to service customers better, but also provide a simpler route to fundamentally changing their operating and sourcing model over time. Would you say that’s fair? So you can either, for those that are really progressive, they can immediately switch to a new business model with a new operation, a new business venture. But for those that are a bit more conservative, they can do it in a phased fashion using additiv’s orchestration engine.

Christine: Absolutely. So, the beauty is that they can transform their business model in steps if they want to, or they can even become more aggressive. The way it is built, if you look at the hybrid wealth management, it’s really tailored to a new servicing model. New servicing model by allowing working from home and serve the client as best as possible, and certainly better than through a simple phone call. At the same time, you could go fully towards accumulation robo, even being more aggressive out there, in the wealth management side, combining with other sourced options. So, it allows both.

[00:40:56.16] Ben: Decumulation versus accumulation. Why is that decumulation opportunity A so big and B, as you wrote in your report, so overlooked up until now?

Christine: Accumulation is growing wealth. So, you start to save preferably as early as possible, at the age of 25, and you grow your wealth through savings and obviously through smart investing over time, towards where you start to live partially from the wealth you have accumulated. It also can be that you grow your wealth at a young age and then start to decumulate because you start your own venture — for example, startup — or you go traveling around the globe for 12 months and you have saved 20K and you want to live off that for a year. Things like that are possible. That wealth will be decumulating — a reduction of wealth. Why is decumulation these days such a large opportunity? Why has it been neglected till now? If you look in the Western world, pension had quite a decent level of cost of living covered. The risk is, with the demographic pattern we have, with the lack of reforms we have seen, but also with the low interest rate level — which we now had for quite some years — you face a pension gap so that your targeted cost of living will not be covered by your pension anymore, and thus, you have to find a way to decumulate your wealth during the retirement period in a most efficient way, by not giving up completely on risk, by having the right investment products, which then allows you to live a life free of concern or free of financial concerns. That’s a huge opportunity. If you look into numbers, the gap is estimated up to 400, I think it’s trillions — a staggering number — which will be needed to close the gaps, either through savings, but also through smart investment offerings.

The paradigm we worked alongside was optimizing for return. Well, the problem was that not all the costs were internalized. That was really the problem — the costs that were taken by society and, in particular, by the planet. And if all the costs would have been taken in properly, certainly then, the financial market would have priced it differently. And therefore, it’s really the goal of the financial industry to start to not only recommend sustainable investments, but also to lend on the corporate lending side, according to the rules that take this cost into account— Christine Schmid

[00:43:04.01] Ben: If you look at all the FinTech entrants into Wealth Management, they seem to be mostly focused on accumulation — people like wealth from betterment. Why so few people focus on decumulation?

Christine: I think it’s a natural pattern. The digital entrants focus on the younger population, most of them. I haven’t seen a digital entrant that focuses on retired persons yet — maybe that’ll come, but I haven’t seen that yet. So, obviously, if you focus on a client group — 20 to 40 years old — you do not look into decumulation into pension savings, yet; you look into accumulation. You want these fun products, these easy to use, you want to cover traveling — or you wanted, in the past, to cover traveling — and foreign exchange, payments made easy; it’s the lifestyle that covers to that age group. Therefore, obviously, the ones entering that market were not focused on the needs of the elderly population. But also we all become older at some point. And, if you look at the age of 55 into your pension, it’s too late to cover the gap. You have to start earlier. We believe this is a huge trend and wouldn’t be surprised if market entrants not only start to look into accumulation but also on the way to build up into retirement. The best example will be Acorns, with its 401k plans. They do that. It’s still in the accumulation phase, but at some point, their clients will be retired. It might take a bit longer if they’re 25 years old today, but they will be retired, so it will become a normal business for them.

Assets under intelligence, how we call it, or return on intelligence, it’s not using only an investment product per se, but using multiple data sets, combining them and then giving even more personalized advice, optimized risk advice, and therefore, as well as optimized returns. So, it’s not the product per se that’s in focus. It’s really the whole construction within wealth management, but also other data sets around, that are more important to advise the clients going forward — Christine Schmid

[00:44:49.21] Ben: One of the concepts that I really, really liked in the report — in fact, it goes as far as to say I loved it — is this pivot in value proposition from being about return on assets to being about return on intelligence. Can you just go into slightly more detail about what that fundamental shift is in the value proposition of wealth managers?

Christine: In terms of the return on assets, you look at your assets under management, and you look at the profitability of the investment products that could have been sold within that group of assets under management. And obviously, therefore, the focus was on the best products to source. The best advice, then, to give to the clients that the level of sales, with hopefully, the best product was the highest. We expect this to change. Assets under intelligence, how we call it, or return on intelligence, it’s not using only an investment product per se, but it’s using multiple data sets. It’s combining it and it’s giving even more personalized advice, it can give even optimized risk advice, and therefore, as well as optimized returns. So, it’s not the product per se that’s in focus. It’s really the whole construction within wealth management, but also other data sets around, that are more important to advise the clients going forward than simply the pure investment product focus.

[00:46:28.18] Ben: You don’t see that many wealth managers yet ready to cannibalize their business. How ready do you see wealth managers are to take advantage of this move to return on intelligence, which presupposes that they’re ready to take this role as a kind of concierge and act to introduce customers to all sorts of different products and services?

Christine: The shift towards return on intelligence, that’s something they’re very keen on doing. It is linked, obviously — and we briefly touched upon base — before it was well linked to the whole area of sustainable investing. Sustainable investing has a lot of intelligence behind to select the right investments, but also the willingness if an investment wasn’t or hasn’t proven as sustainable to shift the transparency therein, I think the banks are really willing to go that extra route, as well to unbundle. At the moment, we have a clear shift towards ETFs and index products, but we don’t know what’s really in there — the detailed level of know-how we have per index is limited. And therefore, there will be another layer of intelligence that you could add, but really looking into the portfolio, unbundling all the ETFs, unbundling all the indices and adding it up then, again, on investment level. And guess what? You might be surprised by some concentration risk that’s in a client portfolio. And you might advise the client differently. That’s another level of adding intelligence to advice or combining it with payment data. If you know the client’s behavior on the consumer side, on the consumption side, you might know products a client would like, so you can, again, use this intelligence and provide it in a better way. Or, last but not least — and I think the industry has discussed that for quite a long time — you bring the intelligence of various clients — clients behaving the same — together and leveraging that for every single client.

[00:48:42.04] Ben: Last question. So, we’ve talked, I think, reasonably narrowly about wealth management. But I wanted to, if you’re okay with it, to zoom out and talk about another paper that you recently issued, which was about the changing needs of society when it comes to financial services. Financial services haven’t provided the insight that it needs to, and have those needs become more urgent in light of the pandemic?

Christine: The big question mark, is it the financial services who haven’t provided it, or is it the general economic, academic rules we are all behaving alongside? The paradigm we worked alongside was optimizing of return. Well, the problem was that not all the costs were internalized. That was really the problem — not all the costs that were taken by society and, in particular, by the planet. And if all the costs would have been taken properly, certainly then, the financial market would have priced it differently. And therefore, it’s really the goal of the financial industry to start to not only recommend sustainable investments but also to lend on the corporate lending side, according to the rules that take the cost into account. For the society to live on this planet — and I believe we just have one; there is no alternative, no planet B — the financial sector has a key role because it’s still the engine that keeps the funding alive. So, from savings, deposits into lending, into economic growth, into job creation. And obviously, this cycle has to be profitable, yes, but at the same time it has to take the costs for society and has to take the costs for the planet — climate change is a big topic — into account.

[00:50:45.17] Ben: So that was my last question, but as it turns out, it was actually my penultimate question because, how do we do that? How do we take those externalities and bake them into the price of assets and transactions?

Christine: How do you do that? That’s the question this industry is looking into, for the last 20 years. If you use the market to do it, then you would need to take the majority funding for each corporate. And the majority of funding for a corporate normally is bonds, and not equity. So I’m a big believer in the international capital market — the ICMA — rules for green bonds and for social bonds. These are rule sets that are not only legally enforceable but also international. So, if a corporation can issue a bond under a green bond ruleset the requirements have to be clear and they have to fulfill that. And the market, then, can price a green bond more attractive than a normal bond from the same company.

Christine: So, let’s take, for example, Volkswagen. They want to fund a new plant where they build the new e-cars. The new plant has to be according to certain standards — the buildings are done — but also about alternative energy use, so solar panels on the roof — all that set. They get cheaper funding than if they built a plain vanilla plant next to a nuclear power plant, for example. It’s a very basic example but you start to shift the funding towards greener, towards more social — by social I mean, for example, if you have to fund the bond for Inditex — and obviously, they have to fulfill certain rules in the way their clothing is produced, even if it comes from Bangladesh. And only if these rules are fulfilled, they are controlled, then they can issue the bond under these standards and they can issue cheaper. And the more the companies shift toward that standard, the more the rest in the old style will become expensive. That’s a way of market mechanism starting to include the pricing and using the market to do the pricing. Because what’s not working out there, if we’re trying to find out who is doing what and externalize the price into, this won’t be of thrive, this is not working. And through the bond side and through the debt side, you could use the market mechanism to start a pricing mechanism. That’s important.

If anything, this crisis has indeed accelerated the way we look at the digital world — Laurence Mandrile-Aguirre

[00:53:33.02] Ben: So, Laurence, I wanted to start off by just asking, what, so far, as we’re living through this pandemic, has been the hardest thing for you to manage in your job?

Laurence: Coordinating everything. We had to adjust to a lot of changes. Usually, when we need to adjust to change, it’s about your manager is changing or something is changing — but one element. In this case, we had to adjust to how we deal with clients, how we ensure continuity in the way we service our clients, how we deal with our people, understand their personal circumstances, how we communicate among each other internally. So, it’s more of making sure that we had everything under control to ensure continuity of business. And I must say that on the technology aspect, it took us a few days, but because we are a global bank, and we are used to having people traveling all over the world and working from a laptop, we were pretty well set up. The challenge was more coordination with the clients and the people.

[00:54:48.18] Ben: Because, I suppose it was not only with the normal channels of communication disrupted, but at that very time, you probably needed to speak more often with customers and with employees or with coworkers than normal because they needed reassurance and so on. Is that true? Would you say that’s a fair statement that, at the very time you needed to speak most and communicate most, the mechanisms you would ordinarily use for communication were disrupted?

Laurence: Absolutely! I mean, in a very short period of time, we had to get used to a lot of technology-related jargon — how to connect, which system to use, are we on the cloud, are we on the network, are we inside our own safe environment at work, terms of network. And the same for clients. Our clients are ultra-high net worth. They are global citizens, they travel a lot. They were not necessarily used to dialing to Zoom. They were used to go to a meeting and meet actual people, so we had to revisit entirely how we communicate among each other internally — it’s important as well — because we needed to be mindful of the bandwidth that we were using; audio/video had consequences on the network. And with customers as well. But, I must say that it took about a week or two to get used to this, and it’s almost common practice now.

I think digital is the way forward, and it was clear to the wealth management community even before this crisis. But it’s also a world that is constantly evolving. There are new technologies all the time. Things are being tested — whether it’s blockchain or artificial intelligence to see how we can use our clients’ preferences or behaviors to deliver a better tools to service them more efficiently. But definitely, I don’t think clients would want us to go back after this crisis and be less digital — Laurence Mandrile-Aguirre

[00:56:35.10] Ben: Yeah. I was reading somewhere that it takes something like 60 days for people to form new habits. Would you say that your customers and your team members have formed new habits? And to some extent, even if we could get back to normal, we won’t go back to the way things were exactly before the crisis.

Laurence: We have completely reorganized the way we communicate. So, we have large forums internally where we like to communicate the important features and the decisions that we are taking for the Private Bank. And, at the same time, we have smaller forums where everybody can voice their own concerns and ask their own questions. And I think we are going to keep that for a while because, obviously, in Switzerland, the economy has reopened. But, at the same time, we have not sent anybody back to the office. We are thinking about the safety of employees. So, we will need to continue communicating that way, definitely, for a longer period of time. And even when we will be able to go back to the office — we’re trying not to say ‘go back to work’ because we feel we are efficiently working — but when we go back to the office, because of the distancing and the security measures, I don’t think we will be able to do large meetings anyway and it will be from our desks, and therefore, phones and videos will continue to be the way forward.

[00:58:21.15] Ben: Looking back on this, you can argue whether this was a black swan or a white swan, whether we should have anticipated or not, or whether we couldn’t have anticipated this crisis. So, we’ll leave that question aside for a second. But, I guess, if we could just argue that what the pandemic is doing in some form is just accelerating the pace of digitization, right? So, we’re moving much quicker than was the case before the crisis in terms of remote work and digital interactions. Do you think that the wealth management community could have been better prepared, and maybe should have made more investments in this digital future while the times were good and ahead of this crisis?

for large banks, I would say — and Citi is focusing on the ultra-high net worth, what we are trying to do is to focus on keeping the full-service offering. That’s very important to us. Therefore, when we look at technology and outperformance, it’s under a more strategic long-term basis. — Laurence Mandrile-Aguirre

Laurence: Well, what I would say is that for sure, there was a strong level of awareness of the disruptive technologies — the need to become digital. We were all exploring our options. I would say that the smaller players could benefit from adding some new digital tools quite easily and for larger wealth managers it had to be compatible with a broader network and system. But I think we’ve been spending a lot of time looking at the options that were around us, how we could become more digital, how we could use AI in the way we improve client’s experience, the tools that we make available internally to our bankers. And we actually created a group called the Investment Innovation Lab, dedicated to that. So that’s what they were doing all the time — talking to FinTech companies, technology companies, looking at the new options, and what could take us forward. If anything, this COVID-19 crisis has indeed accelerated the way we look at the digital world. Just to give you an example, we had started to onboard clients digitally, but we still had a few hurdles to overcome. Most of the time, it was around regulatory requirements that we couldn’t fulfill completely easily. So the fact that we had to work from home triggered a lot of conversation to solve these points and basically, we managed to be 100% digital in onboarding and opening new clients in a week, while if we had not had this crisis, we would be probably still trying to work on the hurdles. So it has accelerated, definitely.

[01:01:20.02] Ben: So clearly, the most pressing problems that the bank is solving very quickly, like, how do we onboard a customer completely digitally? But, do you think you now prioritize more digital spending, particularly for things that are deeper down the technology stack, or for things that affect not just client servicing, but also the operating model and the sourcing model of the bank? So, do you think now there’s an appetite to make bigger investments in digital beyond the stuff that you absolutely had to do because you couldn’t function as normal without it?

Laurence: Absolutely. I think digital, anyway, is the way forward, and it was clear to the wealth management community, I’m pretty sure, even before this crisis. So, all this has just been an accelerator, and I’m pretty sure we will lock in what we’ve managed to achieve in that field. But it’s also a world that is constantly evolving. There are new technologies all the time. Things are being tested — whether it’s blockchain, which is a technology we use a lot at Citi — or artificial intelligence to see how we can use our clients’ preferences or behaviors to deliver a better system or better tools to service them more efficiently. But definitely, I don’t think clients would want us to go back and be less digital, especially the new generation and the millennials that are used to connect and access everything — and making information available efficiently and quickly is very important.

[01:03:12.24] Ben: Would you say that you’re clear on what the next big priority is in the digital journey for your bank?

Laurence: It’s clear we have a full team dedicated to exploring our options and are talking to technology companies all the time. If anything, a big portion of our budget, I know, goes to technology and anything digital. So, I have no doubt that we will continue to lead in that field. Absolutely.

[01:03:47.19] Ben: So, pre-crisis, I think it was clear that we were starting to see the big banks operating at a massive scale. We’re starting to outperform smaller wealth managers. What do you think happens post-crisis? And do you think this acceleration in digitalization also creates the potential entry point for new players? Maybe more FinTech-oriented players.

Laurence: I think indeed there is an opportunity for smaller banks or FinTech players, to enter the industry and be extremely good at one particular thing — for example, online payments or robot advisory. In one particular field, if you start from scratch and you don’t have the legacy of a large database and a full network, it’s, by definition, an opportunity to be very competitive and very good in one particular line or segment. But, for large banks, I would say — and Citi is focusing on the ultra-high net worth, what we are trying to do is to focus on keeping the full-service offering. That’s very important to us. We’re not trying to be extremely good in one area, but we are trying to continue to provide the full breadth of service. Therefore, when we look at technology and outperformance it’s under a more strategic long-term basis.

[01:05:31.26] Ben: Do you think that we’ll see consolidation as a result of this crisis? I.e., if what we’re seeing in other industries happens in wealth management, there’s a bigger separation in performance between the winners and those that are left behind. Do you think that will lead to consolidation?

Laurence: There should be opportunities as well in that field, and it’s been a trend anywhere, especially in Switzerland, for several years now. If you count the number of small banks, mid banks, and large banks, clearly there is a trend for consolidation. So, I guess that should continue. Whether it creates opportunities because of the current situation? Probably. We can see that, for example, access to lending is still available, but it’s becoming a bit more restrictive. So, I guess, at some point, there will be some difficulties for smaller banks to continue to provide certain services and therefore they could be open to merging. But it also triggers the questions on, when we think about consolidation and we try to merge two teams, two systems, two client database, there is a culture element to it. So, it’s also complicated. So, I guess the M&A activity will continue because the trend had started before, but it’s not that simple to buy a smaller bank and integrate culturally with the systems and the client base. It’s not that simple.

[01:07:25.14] Ben: What are you telling your clients? What advice are you giving your clients about how to position their portfolios and their assets in response to COVID-19? Are you advising them to sit tight, try not to worry too much about the volatility and just hold for the long term, or are you actively getting them to reposition to more defensive assets?

Laurence: So, that’s an interesting question because obviously, the market’s reaction has been quite sudden in March, and we had very limited time to review our recommendations. So, we had just finished our outlook for 2020, for example, which was quite promising — so, we had to do a lot of groundwork trying to understand when we had been in previous situations, if markets tended to recover quickly, if we were in a situation completely new that needed to be reassessed completely. So it took us about two weeks just to reassess the situation, take a bit of perspective. And we are taking always a strategic long-term view when we issue recommendations to our clients and guide them to manage their wealth. For example, advising to remain invested. We feel that trying to time the market in this environment is very tricky, and if you missed the best 10 days of the market over the last years, you could significantly miss out. So, we are telling clients to remain invested, but we’ve increased the quality of the underlying investments. Diversification, which is a very common concept, has never mattered that much than today. But we are also taking a thematic view — I give you an example: investing in private equity today, putting new money at work, giving money to a manager who would be able to invest post-COVID and deploy the money as the opportunity arise, I think could be a good recommendation to look at this space. To try to generate some returns that are less correlated to the traditional markets, I think it’s very good thematic investing. We were very engaged before this crisis in technology, healthcare, digital disruptions — the key themes that we believe will have superior growth going forward because they have their own trends. We continue to focus on, and we commit to invest in them.

Laurence: At the same time, what we are telling clients is that it’s very important to measure the impact of this crisis on the EPS earnings, and I think EPS growth has been revised downwards quite significantly, but it’s not clear yet how much it will hurt in Europe and in the US or Asia because the crisis is evolving at a different pace and economies will reopen at a different timing, and we don’t know whether there will be a second wave, etc. So, what we are telling our clients is to be careful about the equity markets, to invest in high-quality, high-dividend paying stocks and thematic investments, but to be ready to deploy more money along the way, because we might see market lower before it actually turns back. We’ve also advised our clients to explore opportunities in the capital market area — volatility has increased, our clients are trading a lot and by selling volatility, at least short-term is a good way to enter the market at a lower level. So, we are trying to be cautious but and remain invested, but there are some opportunities around volatility and private equity that we are recommending to capture.

To turn Adversity into Advantage, Banks need to Renovate in Winter

Crisis is not the time to stop all IT projects, but to double down on the ones that really matter.

Don’t pull up the drawbridge

Beware risk and opportunity cost

Bag some quick wins

Enterprise Software Stack Systems of Intelligence
How the Banking Enterprise Software stack is splitting

Consider Impact on the future

The Future of Banking
The Future of Banking and the Strategic Imperative

This a data play. It requires understanding customer context (interaction preferences, financial situation, needs) and be able to match to the right offering. In the first instance, financial services companies will do this for their own labelled services, but increasingly — to maximize utility and convenience — they’ll need to do it for third-parties services as well (requiring an extensible product catalog) and intermediating and bundling if necessary (which necessitates managing real-time risk). As a third phase, these same institutions can then orchestrate value between the different parties on the platform, stepping back from intermediating and becoming a system of collective intelligence.

Don’t waste a crisis

Articulate the change narrative

Use stop/go triggers

In summary

The new moat in financial services (and why P. Thiel, not W. Buffett,…

In the networked age, scale of production is no longer a moat. Instead, network effects are the new moat. Peter Thiel gets this; Buffet doesn’t.



I look for economic castles protected by unbreachable ‘moats’ –Warren Buffett

The quote above from Warren Buffet, a statement he first made in a 1996 investor letter, is one of his most famous. It neatly encapsulates his investment approach: invest in giant companies that can achieve a “moat” by operating at a scale that others can’t reach.

By spreading the fixed costs of expensive, non-transferable assets like machinery or a banking licence, as well as highly-geared operating expenses like brand marketing and regulatory compliance, over a larger revenue base than competitors, these companies could be better known and cheaper. And, if you look at Buffet’s portfolio, it’s full of companies operating in industries with high fixed costs and high operational gearing: capital goods companies like BYD, consumer goods like Coca Cola and, above all, financial services companies like Wells Fargo, Amex and Bank of America.

The investment approach was massively successful — until it wasn’t. In the period 1979 to 2008, Warren Buffet outperformed the S&P 500 by 12.6% a year on average, cementing his reputation as the Wizard of Omaha, the most successful investor of all time. But — a less known fact — since the financial crisis, Warren Buffett has underperformed the S&P. One might be tempted to attribute this relative under-performance to the heavy financial services weighting in the Berkshire Hathaway portfolio. However, while a factor, deeper structural changes are at play.


Problem number one with the Buffett investment philosophy is that, in the digital age, critical mass is within most companies’ reach. Critical mass — or minimum efficient level of scale — is the scale of production a company needs to reach where it won’t have a major unit cost disadvantage compared to its competitors. After this point, diminishing returns to scale kick in, which means that even if a competitor has greater volume it won’t translate into the same order of magnitude differential in unit costs.

However, as we’ve written before, companies can now plug into the scale economies of third-parties like AWS, which spread fixed costs over the volumes of all customers, to get to scale faster. In banking, you see the emergence of banking-as-a-servce providers, like Railsbank or SolarisBank, levelling the field for new entrants. All in all, this means that scale does not represent the barrier to entry it used to.

Scale can become a hindrance

The second problem with Buffet’s investment philosophy is that diseconomies of scale, or negative returns to scale, manifest themselves more frequently and earlier.

In the industrial age, the trick to achieving an unbreachable moat was to produce standardized goods at mass scale and then invest in marketing to create sufficient demand to sell all of these goods. The challenge now is two-fold. Firstly, the broadcast channels that companies used to advertise are being eroded at the same time as there are many more demands on the consumer’s attention, making it harder to engage in the same type of mass-marketing.

The second issue is that, since consumers are now online, we can know much more about them, as well as have a direct relationship with them. This means that at the same time as it’s become possible to operate profitably at smaller scales of production, it’s become possible to produce goods which cater to smaller customer demographics, and to reach these customers directly — which explains the rise of artisanal goods and direct-to-consumer brands.

But, for digital goods, it goes further, artificial intelligence increasingly allows platforms to match services to customers as well as personalize services to each customer.

To put it another way, in the digital age, the mass consumer is dead.

The new moat

This begs the question, is it still possible to create a moat in the digital age? One answer could be that the idea of a moat is obsolete, a relic of the industrial age, sort of what Elon Musk said when he challenged Warren Buffett recently. But, the reality is a new moat is possible and it’s the diametric opposite of what came before.

Scale isn’t the barrier to keep out new entrants, scale is what attracts new entrants to work with you. Scale doesn’t allow you to push a mass produced product to the mass consumer, scale is what enables you to tailor an individualized product to every consumer.

“I think moats are lame. If your only defense against invading armies is a moat, you will not last long” – Elon Musk

This definition of scale is one that accepts and capitalizes on the new realities of the digital age. Maximizing production scale by itself is less of a competitive advantage and, increasingly, a competitive disadvantage. But the fact that consumers and business are connected means that a new competitive advantage can be achieved by maximizing network size.

Where a network has strong social engagement, like Facebook, adding more users increases the value of the network for everyone. Where a network matches buyers and sellers, like Amazon, increasing the network size increases choice and, by extension, value. Where a platform analyzes data to serve up the best results, like Google, the more data that comes from adding users, the better the results become. And most platforms are a combination of these social, two-sided and data network effects.

What is more, the new moat is a superior moat. Supply-side economies of scale, while a formidable barrier to entry in the industrial age, always suffered from diminishing returns.

Demand-side economies of scale, however, are subject to increasing returns to scale since more users create more value for other users in a self-reinforcing positive cycle. This is why in markets where network effects are strongest, there are winner-takes-all dynamics.

Does this mean that supply-side economies of scale are irrelevant? Not at all, as we wrote a few years ago, these platforms based on demand-side economies of scale (network effects) often become asset heavy as a way to reinforce the strength of these network effects and maximize profitability. But the difference is that maximizing scale economies was not the goal in itself. Instead, these companies found a route to mass adoption and, from there, put in place the assets to sustain the network. In other words, a business grows its assets top down like the roots of a tree.

If the new moat is to achieve network effects, how can these be achieved in banking? In our mind, this is probably asking the wrong question. Banking is inherently a transaction-based activity. This makes it unsuitable to most types of network effects.

For example, most companies that have tried to build social network effects into banking, either as part or whole of their USP, have failed. We don’t want to chat with our friends specifically about money, we don’t want to share all of the information on our assets and liabilities. Which means that, although the new banks sprouting up might be cheaper and more convenient than what came before, they aren’t able to arrive at meaningfully and sustainably lower costs of customer acquisition numbers once they’ve gone beyond the early adopter audience.

It is possible to create marketplaces for financial services, but because banking is transaction-based (and fundamentally not a social activity), the surface area around which to create a marketplace is limited. Basically, we don’t spend much time on banking apps, which makes it difficult to introduce us to other products and services, which we then don’t purchase frequently anyway.

This podcast was recorded at FinTECHTalents’19 Festival: we’re exploring the potential of unleashing network effects in financial services. Ben Robinson is joined into the conversation by: Evgenia Plotnikova (Partner @ Dawn Capital); Martin McCann (CEO at Trade Ledger); Oliver Prill (CEO at Tide Business Banking).

Some banks and fintech providers get round this by targeting specific demographics and then giving them the tools they need to run their business/life, such as Tide, which understands that freelancers and small businesses will send invoices and submit expenses more frequently than they’ll apply for a loan. But, these business are niche.

When this is attempted on a bigger scale, it comes back to the same problem of unit economies: high CAC in the absence of social network effects and low lifetime value in the absence of the engagement.


The mistake we think many people make when they think about banking and network effects is to apply the following logic: banking is a massive market, therefore we must target it and find a way to generate network effects. We believe it is smarter to turn the logic on its head and think about how to put banking into channels and services that have high engagement and strong network effects, what Anthemis calls “Embedded Finance”.



As Amazon is showing, the goal isn’t picking off a few high value revenue lines, but making value flow ever more easily within the Amazon ecosystem, removing friction and making it easier for buyers and sellers to trade. Similarly, the Alibaba and WeChat models both serve a higher purpose: to embed financial services into people’s lifestyles.

The direction of travel can go in the other direction too: that is, starting with banking and seeking to embed it in other services with higher engagement. This is what Moneo is trying to do and what TinkOff Bank in Russia has done so successfully. Through partnerships as well as launching its own products, Tinkoff has created a super app akin to WeChat in China where consumer can do everything from booking theatre tickets to giving their kids chores.

But, in general, it seems more probable that banking will get embedded into other services than vice versa for the reasons already stated: it’s a high CAC and low engagement starting point from which to build out an ecosystem or Super App.

That doesn’t mean that there won’t be plenty of opportunities to build big businesses in banking, that enjoy strong network effects. But, to our mind, these are unlikely to be directly client-facing.


Earlier this year, we wrote a piece about systems of intelligence in finance. The piece looked at these systems mostly from a supply-side and architectural standpoint, arguing that solution architecture needed to change in response to the split of distribution and manufacturing and to capitalize on open banking. It concluded that systems of intelligence would emerge as the most valuable parts of the Enterprise IT value chain.

Here we make the same argument, but from more of a market standpoint. If we accept that banking will become increasingly embedded in third-party services and channels, it doesn’t necessarily follow that, as many people argue, banking will become completely commoditized.

As markets digitize, two types of intermediaries tend to emerge: those that seek to internalize network effects by commoditizing supply, aggregators like Amazon or Facebook, and platforms that externalize network effects by empowering suppliers, like the Apple AppStore or Shopify (Ben Thompson sets out this distinction very well in this much recommended post).

In financial services, then, the same pattern will play out: aggregators like Amazon will commoditize financial services suppliers, while platforms will emerge to intermediate between suppliers and distributors in a non-zero-sum, value accretive way. These platforms will be systems of intelligence.

Systems of intelligence are evolving. Today, most systems of intelligence are deployed for individual clients and with the end of digitizing services. But this is just the first step. Digitizing services makes them consumable through non-proprietary bank channels, but it also generates a new stream of data that can be used to make the services better fit consumer needs. So the next step will be that systems of intelligence will then use that data to help providers more intelligently price and package financial services.

But once that has been achieved, the opportunity will exist to then serve up the right service to the consumer at the moment of need, which mean systems of intelligence become systems of network intelligence, matching the needs of consumers with the inventory of suppliers in the smartest way.

This is the evolution we observe happening at companies like additiv, Assure Hedge and Trade Ledger. Trade Ledger is digitizing the origination of credit services so that lenders can supply credit at the right price and with the speed needed by fast-growing SMEs. But beyond that, it is able to use data to give lenders a real-time picture of asset quality, even for intangibles assets, allowing lenders to offer new types of services better matched to changing customer needs. But, ultimately, the opportunity exists to then link lenders with the different players in the ecosystem, helping embed banking into whatever is the right channel to serve the customer at the point of need. Martin McCann, Trade Ledger CEO, puts it well in this excellent blog:

“Within business finance, the opportunity exists not just to connect banks with their customers, but banks with banks, corporates with corporates, corporates with complementary third-party services providers and so on.”

If Warren Buffett has missed the shift from supply- to demand-side economies of scale, there is one investor who most certainly hasn’t. That is Peter Thiel. His investment in Facebook, a business underpinned by massive network effects, made him a billionaire. Conversely, Buffett passed on Facebook, like Google and Amazon, because he couldn’t get comfortable with the valuation, saying “I didn’t understand the power of the model as I went along.”

And the performance of the two investors also couldn’t be more divergent. Whereas Buffett has underperformed the S&P since 2009, Thiel’s Founders Fund has more than two-fold outperformed the VC fund industry since 2011 (the only figures we could find in the public domain). Since 2011, the Founders Fund is up by $4.6 for every $1 invested.

And where is Peter Thiel investing now? If you look at his holdings, there are many B2C companies there for sure. But, more than anything, there are systems of intelligence — across many industries, but especially in financial services. This leaves Peter Thiel well-placed to capitalize on what Matthew Harris, another venture capitalist, sees as the fourth major wave of digitization after internet, cloud and mobile; one that, in his view, will create more value— $3.6 trillion — that its three predecessors combined.

So, you don’t need to believe us that systems of intelligence are the next big thing. Just look to Peter Thiel, the new investment wizard.

Do Traditional Banks Really Still Own the Customer Relationship?

Conversations and sessions at FinTECHTalents last month covered many hot topics, but one theme dominated: the customer relationship is at stake.

Banks continue to draw a false comfort from retaining customer current/checking accounts, without realizing that data, engagement and monetization opportunities are seeping away to other players.

Despite many banks having already embarked on digital transformation projects and despite many having launched an array of fintech/tech partnerships and initiatives, more is needed for them to prosper in the digital era. During FinTECHTalents, Jim Marous put it frankly:

“Banks have willful blindness; they don’t realise that they are losing business. Just because bank customers don’t switch doesn’t mean that they love you.”

Jim Marous, Digital Banking Report CEO, The Financial Brand Co-Publisher and Forbes Contributor speaking to Ben Robinson of

This ‘blindness’ comes from studying attrition rates which don’t show the bigger picture. Jim explains how this gives false comfort by talking about his own banking arrangements: “With my business bank, I still give deposits and get withdrawals, but most transactions are handled by PayPal, they understand my business intimately. PayPal can offer me a pre-approved business loan instantly. If I went to my bank, it would probably take me 4 maybe 5 days to get approval and that’s assuming that they will approve it at all. I can get this immediately from PayPal. My bank may have my business, but they don’t have my relationship.”

This view was further reinforced during the keynote session on Day 1 of the event when Aritra Chakravarty, Founder and CEO of Project Imagine and Dozens highlighted that:

”The number of customer accounts a bank has doesn’t reflect customer behaviour. People change partners more regularly than their bank; just because you have a large customer base it doesn’t mean that they are engaged and profitable.”

In short, then, for the incumbent banks, headline customer might hide the extent to which their business are being disrupted by new competition. So, what is needed for banks to truly engage with the millions of headline customers?

“We spend 3 hours a day on our mobile phone. On average we look at our phones around 80 times. We scroll through 300 feet of news-feed every day, that’s the equivalent height of Big Ben!” said Russell Pert, Industry lead, Financial Services at Facebook on Day 1 of the conference before concluding:

“people want to do their banking through the services where they live their lives.”

The point being made here is a profound one. It is easier to embed financial services into a service where customers already have a lot of engagement than trying to create engagement in a banking channel. Think how many times you visit, say, WhatsApp (another Facebook property) compared to your banking app.

Also, where banks are using artificial intelligence (AI) to understand customers better, they’re often introducing more, not less friction into the customer relationship. As innovation and entrepreneurship professional at RBS, Roshan Rohatgi said in the Behavioural Science panel,

”Stopping a card transaction due to a possible fraud risk may protect the customer, but can lead to embarrassment and negativity with the bank.”

Bradley Leimer and Theodora Lau, Co-Founders of Unconventional Ventures speaking to Ben Robinson of

And it has never been easier to embed banking into other services. Open Banking opens up access to customer transactional data, creating a unique opportunity for third-parties not only to serve embed banking into their services, but also to do it more personally by meshing up contextual and locational data with bank data. As Bradley Leimer put it to us,

“The promise of open banking to a High Street bank is a degradation of their relationship with the customer. For a fintech, it’s an inroad into a relationship. For a tech provider, it’s a way to take more data in, understand and profile a customer better, and further entrench them into the ecosystem.”

So should banks despair? Not all, sometimes the answer is to go back to basics, rather than to try to emulate Facebook or WeChat.

Roger Vincent, Chief Innovation Officer at Trade Ledger pointed out there is a global funding gap of £1.2 trillion, defined as the shortfall between the capital SMEs require to grow their businesses and what they receive in lending, and that gap continues to grow.

Roger Vincent, Chief Innovation Officer at Trade Ledger

The problem, says Roger, is that

“the economy is becoming increasingly intangible, but banks aren’t yet comfortable lending against these intangible assets, which requires them to capture and process new datasets in real time.”

But taking advantage of new datasets to get credit flowing to SMEs is exactly the kind of opportunity banks should be seizing with digitization.

Likewise, helping to create financial services that are better moulded around people’s changing lifestyles is another major opportunity. As Dharmesh Mistry put it, the way to create a deeper relationship with customers is give them “everything they need for a given context”.

He used the example of a freelancer: banks should adapt their own services, for example, by giving access to credit to top up volatile incomes, but in addition they should provide all of the ancillary services that a freelancer might need such as filing taxes, raising invoices, submitting expenses and so on.

James Perry of BUD at FinTECHTalents
James Perry, Head of Client Delivery at Bud speaking to Ben Robinson of

This might entail a move to more of ecosystem-based business model, but platforms are emerging to facilitate these models. Trade Ledger is building a platform that could easily facilitate this, while Bud is doing this now. As James Perry, Head of Client Delivery at Bud, says:

“We open the platform where banks don’t have to do procurement for 8 to 10 providers, you only have to do it with Bud. We open the door to a network and allow lots of different providers to come “

But going back to basics even further, the route to more meaningful customer interaction may lie simply in helping customers to make better decisions.

Banks sit on rich datasets, but when they’re used well (if at all), it tends to be in the pursuit of up-selling and cross-selling. In part the issue is that customers might get the wrong products for their needs and also that they might find it intrusive — as Poojya Manjunath from Lloyds Banking Group said within the Behavioural Science panel,

“when a personalised message forces the client into a transaction/money exchange that’s when the customer will often back off.”

But the issue is bigger, the products might end up reinforcing bad behaviours.

Like the Facebook algorithm that serves us up more of the content we like, serving up more loans to an over-spender can perpetuate their problems and amplify the cognitive biases from which we all suffer. Instead, banks should help customers to understand themselves better and help them to achieve their long term goals.

Dr. Peter Brooks, Chief Behavioural Scientist at Barclays, put it well on the Behavioural Science panel,

“If our customers aren’t managing their money well, it is our job is to help them to manage it better. The result is that they will become better customers and their lives will improve and they will become stronger economically which helps both banks and society as a whole.”

And he went on to say that the problem often sets in with the product design, “the typical focus of a product manager is about delivering the end product and launching, rather than how to design it in the first instance. You need to get the design right first. Look at the customer journey, look at how the customer uses the product and ask if it encouraging positive behaviours.”

Pol Navarro, Digital Director at TSB with Ben Robinson of

In terms of using data to put the customers’ needs first, Pol Navarro, Digital Director at TSB, used a good example from the SME space.

“There are lots of opportunities to anticipate things. Imagine with Open Banking where you can easily get data from all your accounts wherever they are, and combine that with your accounting software in the cloud, banks can easily help customers predict their cashflow, for example, saying that in two weeks there are all these payments coming but you do not have sufficient funds and therefore something must be done whether it be taking out a loan or bringing money in from another account to avoid an impact in your cashflow.”

The imperative to make this shift to helping customer make better financial and commercial decisions was underlined starkly by Bradley Leimer, who sees it as the existential challenge:

“Banking is an industry today that continues to take profit rather than give profits. It’s a value proposition that’s about how much value I can derive from you rather than how much money I could derive for you. That to me is the biggest opportunity — along with a long term view — that the industry needs to shift or it will completely give up and recede the relationship entirely to big tech and a series of platforms that banking itself will no longer be a part of.”

Any bank looking at headline customers numbers and giving itself a pat on the back should be wary that disruption continues to abound. There remains the big threat, heightened since the advent of Open Banking, that the large technology platforms will eat their lunch.

But the challenge seems to be at one more profound and simpler. Banks more than anything need to change philosophy by promoting customer need above their own. Practically, this means using data to help customers understand themselves better and, in turn, helping introduce them to the services they’ll need and the banking services to support it. Trying to be Facebook won’t work, just try to be better banks.

To see the full interview with James Perry from Bud click here.

Network Effects in Financial Services (#8)

Structural Shifts with Evgenia Plotnikova (Principal VC @ Dawn Capital); Martin McCann (CEO at Trade Ledger) and Oliver Prill (CEO at Tide Business Banking).

This podcast was recorded at FinTECHTalents’19 Festival and in it we’re exploring the potential of unleashing network effects in financial services. Ben Robinson is joined into the conversation by: Evgenia Plotnikova (Principal VC @ Dawn Capital); Martin McCann (CEO at Trade Ledger) and Oliver Prill (CEO at Tide Business Banking).


This podcast was recorded at FinTECHTalents’19 Festival, at Printworks, London (

What we’re essentially trying to do is create a network of quality data that provides the potential for innovation in terms of services which can be built on top of that data. But the problem we’re solving initially is that convenience and trust problem of both sides of the network. — MM

What we’d like to distinguish within our business is three things — network effects themselves, then the virality factor and economies of scale. […] in my view, you can actually create significant businesses without having network effects -EP

The platform generates a lot of data […] so we invest a lot in data science and machine learning to basically do all non-simplistic decision making. […] Every time you can’t make a simplistic decision, we deploy machine learning and machine learning gets better the more data points you get from different users because the models become whack. — OP

We’re internalizing, but I think other people who sit on our platform can externalize. So it’s too big a problem for anybody to solve, so we’re trying to do the bit that we know how to do really well, which is to organize the data services and provide them so that other people can create other business models on top of that. — MM

But the key for us at this stage, we don’t think too much about, I guess the detail of what the network effect will be. Because if we don’t get the momentum and the traction and the scale, we don’t get the opportunity to create the network effect. — MM

I mean we currently open more business current accounts than Lloyds or RBS group per month on a flow measure, and the reason for that is very simple that the network effects just don’t exist. There used to be a degree of virality, which really was just brand awareness. You would default to the Big 5, because you just didn’t know that was another. — OP

It’s the regulator. It could probably be more market share with network effects — because the winner takes most of the market — which is actually one of the debates we’re having with all the social networks, should the regulator not start to intervene because they have all of us, right? But we fundamentally believe in financial services. There may be niches where this doesn’t apply, but in general, 15 to 20% in any country exposes you to regulatory intervention risk. — OP

Platforms take a while to build. This is very different to a product vertical that you were talking, in Europe with 20+ countries or, you know Revolut that goes into 30–45 markets. Effectively, they are single product or similar product-centric propositions that very rapidly can go across borders because all they do is marginal change. — OP

There is nothing to stop us from creating a monopoly. So we’re not like a financial service provider. Whether we get to do that depends on the decisions we make about building up the business. A lot of that has to go back to what I said earlier about momentum and scale and the ability to keep creating additional value add and value adding services for the participants of the platform, in different regions. — MM

I love the fact that we’re a technology company. I mean, I would never want to be a bank because I think that model has so many constraints with it that you have to work within the system, whereas being a technology company, you’re completely unbounded and you can re-imagine completely what the value proposition in the marketplace looks like. — MM

I’d say in the beginning, it can be poor product that can accelerate network effects. You mentioned LinkedIn, you might remember So that kind of became a large business driven by network effects before LinkedIn came. And so I think that’s actually a case in point of eventually poor product falling on its own sword despite the network effects that existed there. And so for me, ultimately, it’s not about sort of internalizing and externalizing. Ultimately it’s about category dominance. And so the way that we think about opportunities to invest is we don’t just look at a market that’s large. We’ll look at a specific value chain and where the business positions itself within that value chain. — EP

Ultimately I wouldn’t say that you necessarily get a huge premium for the network effects. It’s more your ability to have your cost base being linear, whether it’s your revenue is exponential. And so whether it’s network effects that that got you there or whether it’s your virality factors or your go-to-market, ultimately the great businesses will get the right price tag, regardless of what made them get there. — EP

We’ve been raising money, we find that the investors we spoke to honestly couldn’t give a c*** about network effects. All they care about is financial fundamentals and team. That’s it. All they care about is how much money are we currently making? What’s our attraction and how fast are we going to grow our revenue? And when are we going to make profit and how are we going to make profit, and do we have a good team and do we believe we can execute? That’s all they care about. — MM

Digital Era Banking Systems

The banking software market is reconfiguring around the demands of the digital economy — and value is accruing to new systems of intelligence

In Clayton Christensen’s Law of Conservation of Attractive Profits, he talks about the “reciprocal processes of commoditization and de-commoditization” that occur in technology value chains when product architectures change:

“The law states that when modularity and commoditization cause attractive profits to disappear at one stage in the value chain, the opportunity to earn attractive profits will usually emerge at an adjacent stage.”

Our view is that this same process of commoditization and de-commoditization is playing out in the market for banking software. Changes in technology (cloud and AI) as well as changes in regulation (real-time payments and open banking) are causing a formerly integrated system to become modularized and new players are emerging to exploit this shift— new core banking systems but also new systems of intelligence that, akin to operating systems, orchestrate value across their networks.

A brief history of banking software systems

When we look at the technology debt in the banking industry, we might forget that banks were once IT pioneers. Banks were among the first industries to use software, adopting branch accounting systems to keep records of customer bank balances as well as to calculate interest, fees and tax.

But, because banks were such early adopters, they wrote their own applications — there was no software industry at that time from which to buy applications. This might not have been a problem except that 1/banks didn’t stop writing applications when commercial software arrived and 2/they have kept and extended those same branch accounting systems ever since — producing the kind of unwieldy system architecture depicted below.

A typical universal bank system architecture (source BCG)
A typical universal bank system architecture (source BCG)

Smaller and newer banks (from the 1980s onwards) skipped the branch accounting system and instead moved to packaged software, integrated core banking systems. These systems had many advantages: they could run on much cheaper hardware (and software) than S/360 mainframes; they could keep separate records based on parties and products (so that it was possible to have the same customer across branches and products and to provide consolidated views of customer holdings); and, they were integrated front-to-back — from the teller to the general ledger — meaning that changes could be applied across the whole system, reducing significantly both the run-the-bank and change-the-bank costs. And so banks running integrated core banking systems were in a position to achieve scale economies as well as to cross-sell effectively and, when product builders were added, to launch new products to market quickly.

System S/360

Bank systems in the internet era

With the arrival of the internet, banks opened up proprietary channels (apps and internet portals) which allowed customers to query their own bank records and set up payment instructions. But that was the extent of the upgrade: neither branch-based accounting systems nor integrated core banking systems were significantly re-architected in response to internet banking. In fairness, some core banking systems were already real-time and most have been scalable enough to cope with the rise in customer interactions. But the situation is changing.

Integrated to Internet Banking

The open banking era

In most industries, product manufacturers have a choice about whether or not they sell through distributors. In banking, in Europe and an expanding number of other places, this agency is being lost. Open Banking legislation is forcing banks to put their inventory online by obliging them to share customer transactional data with third parties (where customers give consent). In effect, banks face a stark choice: become aggregators of own-labelled and third-party products or risk being disintermediated by other aggregators, whether from inside the industry or outside (e.g Amazon or Alibaba).

The Open Banking era
CB Insights showing the spread of Open Banking legislation across the globe

In addition to open banking regulations, most jurisdictions have enacted — or are enacting — legislation related to real-time payments. This will likely have a profound impact on value chains outside of just banking — for payment schemes, for instance — but in banking it will usher in an era of not just higher volumes, but lower fees per transaction, requiring a step change in scalability if banks are to be able to keep up — and to do so profitably.

In response to these two changes, the integrated nature of most banking systems is unsustainable. If banks are to distribute third-party as well as own-labelled products, they will need a separate system for distribution. If banks are to cope with the demands of ever-increasing payment volume as well as continually rising interactions, they will need to separate channels from manufacturing to boost straight-through processing (STP). To put this last point in context, if a bank moves from 99% STP to 99.9% STP, this would likely translate not to a 1% reduction in costs but more likely a 10x reduction in costs.

The future model for banking systems could be the retail industry where the major players have all created distribution systems independently of accounting systems. But there is precedent that is much closer to home: when regulators pushed for higher STP in capital markets in the early 2000s, the industry very quickly split between front office (the buy side) and middle office (the sell side) and systems were re-architected accordingly. And, whereas in capital markets there was a push for faster transactions, in banking there is both a push for faster transactions and a push to open up the industry to new competitors. As such, this split seems all but certain.

Systems of intelligence

At the moment, there is a tendency to try to put more and more logic into banking channels, but this is flawed. Proprietary banking channels are likely to disappear as banking becomes more “embedded” in other products and services (such as WeChat), making these investments increasingly pointless.

Instead, this logic needs to sit somewhere else, where it can be used to produce a high level of engagement across multiple channels, where it can be combined with data from multiple other parties and systems, and where it can handle inquiries independently of orders and order entry asynchronously from order execution. This somewhere else is a system of intelligence.

Systems of Intelligence Basic.png

We borrow the term “system of intelligence” from this seminal article from Jerry Chen, a Partner at Greylock. In his article, Jerry describes how application software is splitting into three layers: systems of engagement, systems of intelligence and systems of record. If we apply the same taxonomy here, customer channels are the system of engagement (although we prefer to use the term system of interaction because we see these as thin clients, integrated using REST principles); core banking systems are the principal system of record; and distribution systems are the systems of intelligence.

In Jerry’s article, he highlights the importance of technology changes in creating the opening for new systems of intelligence. One is cloud in that it adds a new level of scalability on which to build these systems, but the more important is AI, which fundamentally changes the amount of data we can process and the insights we can draw from it. Echoing Clayton Christensen, Jerry Chen says that, because of AI, 

Systems of intelligence in banking

In Jerry Chen’s article, he makes the point that providers of systems of record often have an advantage in creating systems of intelligence because they have privileged access to their own data. This is true for banking also, although open banking removes part of this advantage (for transactional information). A bigger advantage for incumbent banking software comes by dint of serving hundreds or, in some cases, thousands of banks; creating the pull to attract other data sources to mash up with data from their own system of record.

The playbook for incumbents, regardless of industry, remains Salesforce. A lot of people get excited about the Salesforce AppExchange, a marketplace for complementary applications, since it created a platform business model with two-sided network effects. But at least as important in amassing the data to become a system of intelligence are (now the Lightning Platform), its platform-as-a-service on which third-parties build native applications, and Mulesoft, its API integration platform, which allows third-parties to integrate their existing applications and datasets. Lightning and MuleSoft don’t just provide a route to data but lock-in and switching costs around that data. And then, working on this data and giving an additional incentive to share the data is Einstein, the Salesforce system for artificial intelligence, deriving insights for Salesforce and its customers. We would argue that it is ensemble — MuleSoft, Lightning, AppExchange and Einstein — that makes up the system of intelligence.

Salesforce’s system of intelligence

And so in banking it is unlikely that creating an AppExchange equivalent will be sufficient to create a system of intelligence.

It is likely to need all of the above components: an API platform, PaaS, AI and an app store. And let’s not forget that because of open banking, the distribution play for a banking system of intelligence goes further than distributing apps — to helping banks distribute third-party banking services.

This extends the list of necessary capabilities to include, for example, order management and an extensible product catalogue, as well as customer engagement tools that, among other things, would help identify the right content and services to offer up to customers at the right time and over the right channel.

In addition, we believe a key component of successful systems of intelligence will be to share intelligence across their ecosystems.

The idea, very well articulated in this blog by Peter Zhegin, is that the source of competitive advantage (the moat) is constantly shifting. Processes— and software — are declining in importance relative to data. And within data, Peter argues that the moat is moving away from data collection — amassing the largest possible data set with which to train a model that benefits the company’s product — to improving the collective intelligence of the network.

In banking software, therefore, advantage is moving from having the best application to having the most value-added ecosystem around that application (app store) to helping customers make smarter decisions (system of intelligence) to helping the whole ecosystem perform better (a system of network intelligence).

As a practical example, this could mean moving from providing independent banks with the best credit scoring model to facilitating an open banking network.

Commoditization and de-commoditization — the emerging vendor landscape

As in any market where the value chain is being broken up, there is likely to be a significant shake-up in the competitive landscape for banking software. The keenest fight will be to dominate the market for systems of intelligence, since this is where value will accumulate. But we are also seeing new entrants into the core banking market.

Since the system of intelligence aggregates logic away from the system of record, the system of record is required to do less. Effectively, the most important characteristics of the system of record will increasingly become speed and cost.

As a result, these systems will be re-architected for speed (into microservices) and they will be deployed in the public cloud. And it is no surprise, therefore, that we are seeing the arrival of new cloud-native core banking systems such as Mambu, one of the first and the most successful so far.

Furthermore, as the need for scalability increases, we predict that we may even see these systems further fragment, with the accounting capabilities (fees, limits, etc) splitting from the manufacturing capabilities, which, incidentally, seems to be how Thought Machine is architected.

Digital Banking to Real-time Banking

As regards the systems of intelligence, we foresee a three-player race.

The first players are horizontal systems of intelligence. Insofar as the system of intelligence is like an operating system (nCino actually calls itself “a revolutionary bank operating system”) — providing a consistent set of interfaces, mashing up and running analytics on multiple data sets — these systems do not need to be as domain-specific as systems of record.

Accordingly, there is the potential for horizontal players to make bigger inroads into banking software — such as Salesforce, which already has good traction in wealth management and is pushing aggressively into retail banking.

The second players are the incumbent providers of systems of record. Many are well-positioned — having the pull of large customer bases and investing in the tech infrastructure. Finastra, for instance, has assembled many of the underlying components of a system of intelligence — an app store (Fusion Store), a PaaS (Fusion Operate) and an API platform (Fusion Create). The bigger question is likely to be whether management at these companies will place enough importance on a platform strategy to be able to overcome the immune system challenges.

The third set of players are the new entrants. With a couple of exceptions, such as nCino, these are chiefly vertically focused: for example, additiv is focused on wealth management (and increasingly credit), The Glue is focused on retail banking, and Trade Ledger on lending. While there are likely many more shared than vertically-specific components in banking systems of intelligence, which makes a cross-banking strategy possible, an initial vertical focus makes sense to build a network quicker (the micromarket strategy to overcoming the chicken-and-egg challenge) and conforms with the pattern of disruptive innovations, which are typically commercialized first in smaller and emerging segments.

To sum up…

In response to regulatory and technology changes, the banking market is undergoing a digital upgrade with new networked business models emerging.

The most successful banking technology companies will be those that align themselves with — and enable — this change.

Our bet is on those that can create the best systems of intelligence.