We recently held an event to discuss how the fintech sector has coped through COVID and what the future holds for this highly disruptive industry. Thank you to our panellists Anne Boden, MBE, Ron Kalifa, OBE, Anne Glover, CBE, and our facilitator, Renier Lemmens for leading this discussion.
In this article:
What impact has the pandemic had on fintech funding?
In order to appeal to investors, fintechs must be:
Able to demonstrate how they can take market share from incumbents
Overall, the questions asked to fund applicants haven’t really changed since the pandemic hit. For companies approaching early-stage technology investors like Amadeus Capital Partners(who also cover areas such as fintech and healthtech), investment opportunity has actually been advantaged due to the fact that the general population have become more used to using and understanding digital tools.
Access to customers and collaborative opportunities have also been positively impacted by the pandemic, as fundraising was made much easier on a practical level through the use of Zoom. During the first six months, most investors focused on their portfolio companies, making it difficult for incoming companies to build relationships with new investors, but by about September – after portfolios were secured and able to take advantage of government schemes like Future Fund for financing any loss-making companies – these doors began to open up again. Speaking on future opportunities, Anne Glover notes:
‘We’re looking forward to the opportunity to build new relationships. We closed as many deals in 2020 as we did in 2019, and we’re continuing the same pace in 2021.’
While this was true for Amadeus, Anne noted that some firms have had a more challenging time establishing new relationships. In growth capital/pre-IPO/later-stage investment, where lots of funding comes from international sources, there was an initial drop in traction due to travel restrictions. However, this didn’t last long – as soon as people began learnt how to conduct due diligence online with teams they perhaps had never met before, the number of deals being closed began to accelerate massively.
Despite its drawbacks, the pandemic has shifted investor expectations. Follow-on funding is more available, and the questions being asked by investors today are focused around showing business models, margin structures, traction and growth, as opposed to just basing decisions around short-term profitability (which is not a realistic marker for early-stage companies as many won’t be able to reach this stage in three years).
How has the pandemic impacted behaviour and ways of working?
Bank of England NED Ron Kalifa, OBE, spoke on how the pandemic affected the 2020 Kalifa Fintech Review, a comprehensive report on the UK’s objectives for supporting the growth, adoption and global reputation of the UK fintech sector.
As Ron recounts, moving meetings from physical to virtual was initially quite taxing due to the novel environment and internet connectivity issues. As people became used to remote working, however, a newfound global, interpersonal connectivity meant that researchers were able to reach much broader contributors and dig deeper, resulting in some extremely useful insights.
In terms of the report’s findings, Ron notes that society has seen a significant behavioural change in terms of digitisation over the past year. Consequentially, we’ve become more digitally savvy – in the first months of lockdown, 6 million (12%) of adults downloaded a banking app for the first time, and the majority will be expected to continue to use this going forward.
As Anne Boden follows up, she was initially anxious about how Starling Bank would survive, but these doubts were quickly quelled. Starling easily transitioned to remote working and customers fully embraced the business model, with many people keen to try something new. Through listening to customers and paying close attention to people’s stresses throughout the pandemic, the bank was able to react quickly to solve them, including creating a Connected card for those shielding so they could easily entrust someone to buy essentials on their behalf. Fast-paced adoption and a growing customer base created an energy within the organisation; development time decreased and, as Anne notes, the company was ‘more precise, more vigorous, and more controlled’ than ever before; ‘we will never go back to the old world’.
What negative effects has the pandemic had on tech?
As Anne Glover recalls, ‘the companies who were having a tough time were mostly from the hospitality industry’, such as online travel agents and hotel price optimisation companies.
However, as ‘tech is neutral and enables any kind of business’, there’s always an opportunity to pivot. By scaling back and repositioning accordingly, ‘95%’ of Amadeus Capital’s portfolio companies were able to remain stable.
Conversely, many companies actually saw increased demand throughout the pandemic. Semi-conductor businesses in the Amadeus portfolio had to address capacity issues as demand for digital devices exploded, indicating a much wider strategic challenge for global capacity. Similarly, within cybersecurity, an increase in tech reliance has enabled a rise in fraudulent activity such as spoofing and deep fakes. As Anne asserts, ‘our fintech industry will only be successful if it is also secure’, and the UK needs to stay on top of this – hopefully, emerging government laws such as the recently-announced Online Harms Bill will go some way to curbing financial crime.
How does the UK rank as a fintech ecosystem?
One of the key takeaways from the Kalifa Review is that we are starting from a very strong base and have a huge opportunity to increase our existing 10% global market share. Ron comments that the fintech market is continuing to grow internationally – worth £110 billion in 2019 – and predicts that it will triple within the next 10 years. He also claims that the UK’s strengths in fintech are based on a set of key principles that have allowed the sector to blossom:
Capital – Even through the pandemic, investment into UK fintech stood strong at $4.1 billion in 2020, which is more than the next four European countries combined.
Regulation – our innovative regulatory regime means the UK has been at the forefront of creating solutions such as Open Banking, as well as the FCA Regulatory Sandbox in 2017, an approach which has now been picked up by at least 50 different geographies.
Digitally active population – 71% of the UK population use a fintech service, compared to just 46% in the US.
Consumer fintech brands in the UK have continued to prosper year on year, and it is this strong footing which has helped us to keep a global lead. When engaging stakeholders from across the world as part of his research, Ron found that many countries tend to watch what the UK is doing and copy it in order to spur their own fintech sectors. This shows that the Kalifa Review has worldwide appeal, but it’s up to the UK government, business leaders and investors to leverage this opportunity to keep growing.
Too many investors, not enough investment?
The UK boasts a total of 950 VC companies; does this cause excessive competition, and why are innovators still struggling to scale?
As Anne Boden remarks,
‘Like all markets, there are classic 80/20 rules. Anyone can call themselves a VC – some are regulated, some who run their own money aren’t – but I think it’s a good thing. Like all markets, investors are on an exponential curve where you have a cluster of investors with substantial capital who are sector specialists, and then you have a long shoulder and tail of more generalist investors.’
Over the last 30 years, becoming a VC or an entrepreneur has become a career of choice, which indicates a massive change in attitude. Government support through tax incentives like the EIS has been instrumental in getting companies started, but the real challenge the UK faces is growing these companies to scale-up status. With specialist PE houses buying small businesses as soon as they become profitable, there is expertise at both ends of the spectrum but a gap in the middle. In order to grow our internal ecosystem, we need to find ways of enabling and encouraging innovators to grow their businesses and fill this gap.
In many cases, this is purely down to the fact that VC funds simply don’t have the scale-up capital to support growing businesses. In order to move past early-stage investment and reach PE funds, we need to ensure that rules are flexible, approaches are sensible, and founders can raise money in order to grow to a global scale (ideally through private, dedicated sources such as the Fintech Growth Fund, recommended off the back of the Kalifa Review).
How can big and small banks work together to improve the UK fintech sector?
Currently, there’s still some mistrust between big banks and emerging fintechs, with large incumbents concerned that if they support smaller players, they will end up taking their customers as they grow. However, this should not be the case – as Ron notes, ‘we have to find a way to collaborate’. Bigger players benefit from structure, whereas smaller companies have agility, and if we can combine these strengths through working together, we will emerge stronger as a result. The Kalifa Review's recommendation for a scalebox, now being implemented by the FCA, will provide an important first step in taking the onus off incumbents and allowing banks of varying sizes to collaborate and share the risk.
In Starling’s case, their success has come as a result of harnessing technology to optimise processes and consequently achieve a strategic advantage in their operating costs (at present, Starling spends up to 1/40th of the amount that big banks do in this area). While fintechs are built with technology at their heart, the risk for legacy banks looking to re-platform is too large, which has led some to look at building small, flanker brands to test out new technologies. The issue with this, as Anne Boden notes, is that it’s extremely difficult to replicate the ‘founder mentality” of smaller banks.
As in many sectors, big banks often want to ‘play nicely’ with fintechs for a few years before trying to acquire or take their staff, but as Anne Glover observes, new markets are formed when start-ups begin to ‘eat the incumbents from underneath’. As a market economy, we shouldn’t be focusing on winners and losers – as a collective, we should aim to facilitate disruptive change within the UK with the end goal of building more great companies. Bigger organisations are beginning to realise that they may have to work with smaller, more innovative companies to succeed, and through maintaining a regulatory environment which encourages innovation and collaboration above all else, we can ensure the fintech sector continues to grow and advance as a collective.
Are cryptocurrencies and CBDCs the future of banking?
According to Anne Glover,
‘Crypto is massively misunderstood because it means a complete range of things. Independent currencies like Bitcoin and Ethereum are antithetical to government in the sense that they want to have no regulation, but the Central Bank Digital Currencies (CBDCs) are full faith and guarantee currencies – it’s just about making the finance system, and in particular the wholesale system, much more efficient.’
She also notes that as free-market alternatives, Bitcoin and Ethereum will continue to exist, but that they are in fact an asset class rather than a currency, with use in investment but not much else.
A lot of new banks have begun to embrace crypto due to its profitability, however Starling have decided to wait until it becomes more mainstream for fear of attracting customers who are purely interested in playing with crypto – in order to maintain a sustainable customer base, the company have stayed away from fads, as in Anne Boden’s experience, these tend to attract transient customers who leave once they become disinterested.
In 2019, Mark Carney discussed the potential need for a global exchange mechanism (like an SDR) to be created by central banks across the world. With the ability to take cost, inefficiency, inaccuracy and fraud out of a system through a distributed ledger, Anne Glover firmly believes CBDCs will soon come into their own and be backed by governments.
Ron Kalifa agrees, predicting:
‘It’s absolutely inevitable that we’ll see distributed ledger technology being embraced in the ecosystem we’re going to be operating in.’
To reach this point, however, there are fundamental questions that need to be answered – namely, whether these CDBCs will be implemented for wholesale or retail first. Benefits of retail CBDCs include providing individuals with access to central bank money in a digital form – creating more efficiency and resilience within the UK payments network – and there being a variety of options and models to choose from. Starting with wholesale is Ron’s ultimate recommendation, as it will allow initial confidence and regulation to be built up, but a hybrid model involving both a central bank and intermediaries will optimise speed and resilience. With added involvement from PSPs, we will be further able to achieve greater flexibility and scope for innovation, but it will only work through a central body that has trust and validity – regulation is critical.
To summarise, we’re currently at an inflexion point within the UK fintech sector, and have a huge opportunity to become global disruptors, but this will rely on businesses and investors across the board coming together to achieve this goal.
Thanks again to our panellists Anne Boden, Anne Glover and Ron Kalifa for their time, and to Renier Lemmens for facilitating this event.