What’s driving change and where’s M&A activity in the fintech sector?
There has been much deliberation about what disruption means to the traditional financial services sector by fintech, and where the activity is happening.
Whilst technologies focused on retail banking, payments, and blockchain have received extensive coverage, the uptake of technology within the capital markets should not be understated.
What is in no doubt is that transactions in the sector are at record levels, both in terms of volume and value, with a large proportion of this activity driven by companies looking to sustain innovation and protect market share.
Consolidators, such as Broadridge, Nasdaq, and Intercontinental Exchange (ICE), as well as data and information services businesses like Thomson Reuters and FactSet have been particularly acquisitive as they have sought to strengthen their position as dominant providers of technology at a time when capital markets participants are engaged in a “technological arms race” to digitise processes and drive efficiencies. In tandem with this trend, there is ongoing convergence, with leaders in one segment branching out into adjacent areas; the recent acquisition by FIS of Worldpay, Fiserv acquiring First Data, or the roll-ups being completed by Ion Trading and IHS Markit.
What is increasingly apparent is record levels of dry powder amongst private equity firms has also driven M&A activity, as investors have sought to deploy capital in a high growth sector.
Regtech, post-financial crisis—with MiFiD II, Basel III and GDPR—may have been the initial external driver to ensure full compliance, and this has ensured a dramatic rise in technological solutions, and crucial in increasing efficiency, for example, by reducing gap-analysis time. However, in conjunction with regulation are core business drivers to make systems more efficient and productive; to optimise trading processes, automate risk management, and improve decision-making.
This has created massive opportunities for incumbent technology providers and has given rise to a large number of start-ups, many of whom are being welcomed by capital markets providers such as Tradle, a developer of a know your customer (KYC) compliance application and blockchain technology for banks, and RSRCHXchange, a developer of research aggregation, procurement, and management platforms to provide institutional research in compliance with best practices, by providing the most needed technological improvements for increased flexibility.
As such, it has become an extremely lucrative area for investment, and this looks unlikely to change in the near future. According to our research, acquisitions of trading platforms have been especially common and account for a majority of transactions (nearly 150 transactions) over the last five years. Fintech providers have gained significant traction in trading in recent years by automating processes and enhancing quantitative strategies of traditional broking businesses, despite the largest corporate trades still being made over the phone. Now, the efficiency and speed of trading platforms means that 90% of trading volumeis now done electronically.
However, data and the ability to analyse data is the continual source of competitive advantage. The sheer value and volume of data in capital markets has further driven both strategic and private equity investment in fintech.
Companies are increasingly looking to use unstructured data to inform investment decisions and next generation analytical tools, which include the platform Korpus, provided by Kensho, that uses machine learning (ML) and artificial intelligence (AI) to process vast bodies of unstructured and structured data and look for patterns and trends to simplify complex financial analyses. Kensho’s acquisition by S&P Global for $550 million in 2018, highlights the commitment of companies to stay ahead of the competition by providing real-time, comprehensive datasets. Other examples include Dataminr whose platform turns real-time data from Twitter and other public sources into actionable material, and iSentium which extracts sentiment from social media information and transforms it into actionable indicators.
While the US and Europe have dominated fintech transactions from 2013 to 2018, the Asia Pacific region has recently invested more heavily in fintech to overcome the limitations of their financial institutions, often beset by old legacy IT systems. This has seen the rise of sophisticated fintech that can usurp these legacy systems and allow, for example, trading to become an automated process. The region has witnessed a huge growth in financial services in recent years and the demand for fintech has increased alongside this trend. Research has found that between 2015 and 2020, the fintech industry in the region is expected to grow at a CAGR of 72.5% and the market for these solutions is predicted to be worth $72 billion by 2020, according to Frost & Sullivan. India and China, two of the fastest growing economies in the world, are leading this change. The Financial Express indicates that India has the second highest fintech adoption rate of 52%, only behind China, at 69%.
In conjunction with this market need, financial technology has also been highly attractive to financial investors, aware of the massive opportunity as capital markets participants shift away from these old processes. This has resulted in a significant increase in funding opportunities from both early-stage VC firms and large buyout funds. In particular, Blackstone’s acquisition of a majority stake in Thomson Reuters’ Financial & Risk division, which is the company’s largest deal since 2008, and was the biggest leveraged buyout of 2018, is evidence of investors’ confidence in the sector.
Looking ahead, M&A activity in the sector is likely to increase rapidly as private equity firms continue to back the investment thesis of increasing demand for fintech in capital markets and as these technology providers use strategic acquisitions to pursue inorganic growth and acquire more advanced technology.
By Mark Fisher, managing director in Houlihan Lokey’s Data & Analytics Group