Without innovation the world stagnates and this is as true in financial markets as anywhere else, however I sense that people are starting to feel a little overwhelmed by the continued fintech revolution – there are, some people suggest to me, just too many ideas out there at the moment and identifying the good ones is becoming harder.
It was also suggested to me this week that the marketing of some fintech firms needs moderating, with promises of revolutionising the world – “disruption” remains a favourite buzzword – over-selling what is actually on offer. I don’t actually see how this is different to any other advertising to be honest, but there is no doubt that the level of white noise in the fintech space has gone up.
I read our report on the study of DLT from Greenwich Associates with interest this week, because it kind of crystalised the issue. Yes, there are elements of Distributed Ledger Technology that can undoubtedly help build efficiency around the edges, but the core process being “disrupted”, in this case the clearing and settlement system, actually doesn’t require changing. It could indeed be argued that this is change for change’s sake and, as the Greenwich report points out, this involves a crucial piece of the financial markets system. Extreme care should be taken when tinkering with critical market infrastructure.
This is actually part of a wider issue in financial markets because as more firms select third party solutions, not only is the selection process more complex, but there is also the issue of ensuring the service provider can maintain the level of excellence that caused them to be chosen in the first place. Just look back to the turn of the century when some banks went with third-party firms to build their single dealer platform, only to see that third-party drop investment and service levels because they were either too successful and couldn’t scale appropriately, or they tried to monetise the business through “efficiencies”.
This issue has not been solved either, for just a couple of weeks ago I was reading the latest Financial Stability Report from the Reserve Bank of New Zealand (yes I know I should get out more…), which notes how, in 2014, a New Zealand bank, now understood to be Bank of New Zealand, somehow managed to run up a large FX position due to “technical problems” that caused 1,280 trades to be generated from a single order of NZD 1 million. This resulted in an unintended position of over NZD 1 billion against the US dollar, which was equivalent to around 20 percent of the bank’s total regulatory capital.
BNZ has since told a media outlet that the problem was related to third party technology and while this can be seen by cynics as a “get out of jail free” card, this is not the first time such a problem has occurred. I have been told by at least three multi-dealer platforms and two banks that “technology problems” in their trading businesses were caused by a problem at a service provider and I am sure there are many more.
Any tweak to a technology stack has implications and there is no doubt that generally speaking the services and technology offered by third parties are excellent – errors are, thankfully, very rare. This does not mean, however, that in the rush to embrace all that is new and “hot”, that some old-fashioned checks should not be conducted. The operational risks associated with the use of third-party technology should not be under-estimated. I actually don’t think most institutions and platforms that are in partnerships with smaller fintech firms do take these risks lightly, but a conversation I had a couple of weeks ago did bother me. In it, a senior source at a bank in London told me that when it came to their fintech providers they do a diligence check on operational matters once a year at most. Annually seems too long a window to me, given the pace of technological change and how some firms – especially the successful ones – attract more and more clients, thus placing increasing strain on their still relatively limited resources.
A friend of mine in the fintech space told me once that the real threat to a firm is the transition period between being an excellent niche player and going “mainstream” with a portfolio of clients. A good idea, well-executed, can be easily managed, my friend told me, but when customers start asking for tweaks to the service, another opportunity is identified, or the client base just grows too quickly, the risks multiple even quicker.
I am not sure there is much that should, or needs to be, done about this issue, but it would help confidence in the industry if firms were perhaps more open about how they monitor their own service providers.