Sarah Maber, Managing Consultant at World Wide Technology (WWT).
The introduction of Open Banking and the Payment Services Directive 2 (PSD2) disrupted the financial services space, unlocking the potential for a wave of innovation, by opening up swathes of anonymised customer data to third parties. Banks now have the opportunity to collaborate in the creation of truly ground-breaking services. But they’re failing to seize it.
Learning from fintech
Open Banking and PSD2 could put banks at the forefront of a revolution in consumer financial services. New capabilities enabled by the legislation are already giving people control of their finances in ways previously impossible. Consider the ability to view the status of multiple financial services in one place, or to make quick and easy payments direct from your bank. Customer experiences such as these, and the further innovations that Open Banking enable, can support banks in expanding their customer bases, especially among the lucrative 24-35 demographic who are currently being courted so successfully by the fintechs.
This understanding that the “mobile generation” expect convenience, speed and transparency in digital financial services has seen mobile banking start-up Revolut acquire eight million customers to date. Indeed, to capitalise further, it has recently created an offering for children aged between 7 and 17, which provides the functionality of a bank account (a current account, a Visa card and transaction push notifications), but is delivered under the watchful eye of a parent or guardian, who can set up a regular allowance.
But while Open Banking and PSD2 offer the chance for banks to collaborate with these exciting fintech players, and bring their expertise and agility into organisations, they are mostly failing to take it. One reason is that banks differ so markedly from fintechs. They typically move more slowly and have such different cultures that competitive tensions are inevitable.
Building blocks for big tech
Technology giants such as Apple, Google, Alibaba and Facebook have also entered this sector through the launch of financial products such as Facebook’s Libra and Apple’s Card. These companies are innovating through an aggregator model, leveraging the capabilities of fintechs and banks to build new financial products and services.
In a rare sign of things to come, HSBC recently partnered with Chinese logistics firm Cainiao to offer rapid trade finance loans to online merchants through Alibaba’s Tmall platform. HSBC uses third-party data on customer background, real-time inventory and operational status provided by Cainiao to approve the loans. This innovative partnership enables HSBC to get a greater share of its product into the market much more rapidly using an existing technology platform.
What is often misunderstood by the banks is that technology players don’t want to become banking operations. They prefer to offer the consumer-facing services for which they are so well known. Unfortunately, the majority of banks are unlikely to see the situation as HSBC does, viewing the moves of technology players as land grabs. This means many opportunities to expand their offerings through collaboration are being missed.
If they are to seize the opportunity presented by Open Banking and PSD2, banks need to change how they think and act. They need to shift mindset to realise that they are no longer perceived as the innovators of the financial services market, as consumers can gain access to the services they need from a far greater ecosystem of businesses. If banks want to prosper in this new reality, they must be more open, agile, flexible and collaborative.
One essential step to opening up collaboration is for banks to provide more APIs – and crucially, more useful ones. These are the tools upon which third parties can build the next generation of financial application and services, using the financial institution’s service backend and transactional capability as a foundation.
Consider SMEs, whose owners want automatic and simple integration between their software and their financial accounts. Banks have the opportunity to support that link between business accounting software and financial accounts by introducing the right API. The benefit to banks of developing an interface of this sort is that it’ll increase the probability that SMEs continue to bank with them.
The example above illustrates how APIs enable collaboration but can also foster much greater service innovation. Rather than seeing APIs as a tick-box exercise to satisfy the financial regulator, banks need to think of them as their opportunity to drive the collaboration and innovation necessary to retain and expand their customer bases.
The financial products that will emerge from partnerships between banks, fintechs and the tech giants represent a lucrative opportunity for all stakeholders. To create them, each will need to be tolerant of different ways of working and open to new business models. Banks, in particular, must learn to embrace agility and collaborative thinking.
A good example of what could be achieved is UK-based Metro Bank’s recently forged partnership with Lending-as-a-Service (LaaS) provider ezbob. Ezbob applies AI to Metro Bank’s data to provide fast and secure access to finance, enabling Metro to deliver a seamless, web-based lending process to its business customers. Applications take minutes, and funds can be made available the same day.
As collaboration increases, it is very likely the culture of banks will move towards that of fintechs. Banks can never be start-ups, but they can be fleeter of foot and to embrace innovation more deeply, which, in turn, will seed the ground for a stronger ecosystem.
An exciting future
Open Banking and PSD2 will deliver services that consumers may not realise they want but will soon find they cannot bear to be without. The driving force behind Open Banking is the fact that customers are willing to hand over their data if they get tangible benefits in return. What has worked so well for the likes of Facebook and Google is also the case for financial services – and beyond Open Banking, this truth is underpinning a longer-term journey towards Open Finance.
Open Finance enables organisations beyond banks to provide the same level of access to data that PSD2 has provided for Open Banking. By facilitating easier switching between financial products and financial transfers, it could for example see the development of services that promote consumers’ financial health, automatically optimising the products they use to match their financial standing.
A new Open Finance regulation – the Pan European Pension Product – will also provide interesting opportunities. Its aim is to eliminate the barriers to customers moving their pension between European providers, finally elevating a very traditional service into the modern world.
Just as is the case with Open Banking, ambitious partnerships will need to be formed between relevant stakeholders to make services like these a reality. Ultimately, whatever is done must serve the needs of the customer. The organisations that evolve fastest to deliver the most painless and seamless ways to meet those needs will see the greatest success in future.
COMBINED RISE OF M&A AND CYBER RISK CREATES STORMY SEAS FOR INVESTORS
UK organisations carrying out merger and acquisition (M&A) activities must improve pre-acquisition due diligence of software vulnerabilities
By Philippe Thomas, CEO at Vaultinum
At present, the UK is seeing a sharp rise in M&As. Indeed, in the first quarter of 2021, the UK saw a £1.1 billion increase in domestic M&As when compared with the same period in 2020 (Office for National Statistics). This trend is set to continue, with 57% of UK executives reporting that their companies intend to pursue M&As in the next 12 months, and 65% of these respondents focusing on cross-border acquisitions (EY). As such, UK businesses have given a clear vote of confidence in moving forward with M&As, making them a focal point for accelerated organisational growth and development.
Traditionally, organisations and investors have conducted due diligence covering financial, legal, operations, and human resources. Comprehensive software due diligence is not always carried out systematically, which has significant adverse consequences given that a company’s technology is increasingly its primary asset. As non-tech organisations use more and more tech for their day-to-day operations, and as the number of tech-forward companies grow, new issues have arisen which are overlooked in traditional due diligence.
A crucial time for tech security
Data breaches during M&As have become infamous during the last few years, with more than 1 in 3 executives surveyed by IBM reporting data breaches associated with M&A activity during the period of integration. This figure could be set to increase, as statistics highlight that cyber-attacks are rising sharply in the UK. According to Sophos data, 51% of UK organisations were affected by ransomware attacks in 2020, with criminals successfully encrypting data in 73% of these attacks. Cybercriminals are increasingly targeting organisations in ransomware attacks with the eventual goal of large-scale business interruption. Carrying out comprehensive due diligence that assesses both software and source code during the pre-acquisition phase enables the early identification of data breach risks, providing the acquirer with a full view of the financial and legal consequences at this stage of negotiations.
Acquiring or merging with a secondary company that has hidden data vulnerabilities can impact the primary company’s business operations, investor relations and reputation. The most well-publicised example of this occurred in 2017, when Verizon revealed a pre-merger data breach at Yahoo!. During negotiations of the merger, it was revealed that Yahoo! had experienced a data breach during which a hacker stole the personal data of at least 500 million users, followed by a second data breach in which 1 billion accounts were compromised and users’ personal information and login credentials stolen. In this instance, Verizon had done their due diligence, and were able to make an informed decision about going ahead with the deal. If Verizon had not carried out any tech due diligence, and this data breach had not been revealed during the negotiations, Verizon could have overpaid for Yahoo!, as well as experiencing long-term legal and reputational damage. Instead, both companies understood the liabilities before entering into an agreement.
Other companies have not been so lucky. In 2016, Marriott International purchased Starwood Hotels & Resorts for $13.3 billion. Two years following the merger, Marriot revealed a huge data breach in Starwood’s reservation system that occurred pre-merger in 2014, in which 400 million guest records were exposed through a security flaw. This resulted in a $123 million GDPR fine by Britain’s Information Commissioner’s Office, as well as reputational damage for both Marriott and Starwood. This is an example of an instance in which insufficient software due diligence prior to the merger has catastrophic consequences for both the acquirer and the target company later down the line.
Software due diligence highlights risks and weaknesses in digital assets. This can bring to light data security issues, as well as other vulnerabilities such as intellectual property risks linked to the use of open-source software (OSS) licences and maintainability complications. All of these risks can affect the overall quality of the asset, and thus its value for the acquirer and so uncovering them through comprehensive due diligence at the pre-acquisition stage is essential.
Understanding open-source software (OSS)
For any M&A activity in which the target company’s software is a significant asset of the deal, which is now the case in most start-ups which have AI or algorithms at the heart of their offer, the issues do not end with hidden data vulnerabilities. Today, software developers often rely on public code repositories available on websites like GitHub or Stack Exchange, as OSS has a number of significant benefits, most notably that it appears to be free at the point of use. However, many OSS licences are often offered subject to conditional restrictions. When using OSS to create derivative products or linking source code to OSS, the integrated product becomes subject to these conditional restrictions, which can include making all or part of the code public or paying a fee for its use. In other words, a company may not have full rights to their product or software.
This is problematic for any tech-enabled company in general, but can be uniquely catastrophic during M&As. If acquirers carry out comprehensive due diligence in the pre-acquisition phase and discover any such OSS embedded in the target’s software, they may walk away from the deal entirely, or at the very least adjust its value and/or terms. If acquirers do not implement comprehensive due diligence, they become liable for the target’s previous use of OSS, and any terms relating to its licencing.
Algorithms add robustness to tech audits
Carrying out comprehensive software due diligence is essential during the pre-acquisition phase, to avoid the aforementioned issues associated with data breaches and software licencing. Today’s advances in AI technology enable these audits to be thorough, analysing every line of code to identify possible cyber vulnerabilities, intellectual property issues (usually linked with the use of open-source code) and maintainability risks. These methods enrich traditional tech due diligence, by making audits more objective and less susceptible to human error.
Ultimately, this approach protects the acquirer’s reputation, ensures business continuity, and helps avoid possible legal liability for the target’s previous vulnerabilities.
THE GROWTH OF DIGITAL BANKING: WHY COLLABORATING WITH FINTECHS IS CRUCIAL TO ADAPT TO CUSTOMER DEMANDS IN LIGHT OF THE PANDEMIC
The growing customer demand for a seamless digital banking experience looks set to transform how the entire banking industry operates. Traditional banks have been left playing catch up with the emergence of new fintech players and challenger banks. The demand for slick digitally finance solutions is led by the digital native generations, the millennials and Gen Z. However, the coronavirus pandemic accelerated the uptake of online shopping and remote working for whole swathes of the population. Even the older generations have been left wondering why accessing banking services online remains so cumbersome.
Consumers’ growing desire to access financial services through digital channels has already led to a surge in various new banking technologies which are reconceptualising the banking industry. Consumers have rapidly moved to adopt payment solutions such as those offered by apps like Revolut.
Retail banks continue to launch platforms in the Banking as a Service (BaaS) space, in an effort to remain competitive. An example of this in the UK is how NeoBank (Starling) used to only offer business to consumer (B2C) retail banking services. However, once it launched its BaaS platform, Starling was able to rapidly diversify to include consumer services.
New technologies like blockchain and artificial intelligence (AI) continue to evolve, and look set to have an enormous impact on banking over the next three to five years. The type of cryptocurrencies that we have seen to date look set to be far more tightly regulated, given significant governmental concerns about their potential for misuse in cybercrime and money laundering.
In the blockchain space, the transformative development which will accelerate the rise of digital finance is the advent of central bank-backed digital currencies. The US Treasury has described the creation of a digital dollar as a high priority project. China is already trialling its digital Yuan. Meanwhile, the ECB is actively pursuing its plans to launch a digital Euro. The launch of stable, highly secure digital currencies, underpinned by major central banks, looks set to ensure that digital finance will permeate every area of our lives in the not too distant future.
How we use digital finance is also set to change radically. We are used to seeing new technology emerge from Silicon Valley. However, an analysis by KPMG Australia suggests that a new breed of apps which prefigures the future of digital finance has already emerged in the East. The report notes that “super apps” are “already encroaching on traditional financial services territory”.
Super apps are defined as apps which “essentially serve as a single portal to a wide range of virtual products and services. The most sophisticated apps – like WeChat and Alipay in China – bundle together online messaging (similar to WhatsApp), social media (similar to Facebook), marketplaces (like eBay) and services (like Uber). One app, one sign-in, one user experience – for virtually any product or service a customer may want or need.
“Due in large part to their versatility, super apps have quickly become ingrained into users’ daily lives. It is not unusual for a WeChat user in China to set up a date with a friend via instant messaging, make dinner reservations, book movie tickets, order a taxi and pay for every transaction along the way, all using one single app.”
We are already beginning to see trends in this direction in the Western world, with Facebook launching a marketplace and even a dating service within its social network. Facebook also attempted to launch its own digital currency, Libra, but this move stalled when it ran into significant governmental opposition. However, Facebook hasn’t given up, and it is determinedly pursuing the launch of a revamped stablecoin, Diem, which has been redesigned to address regulatory concerns.
A group of Citi analysts recently wrote an interesting research paper, which predicts that “the story of digital money in the 2020s will be the growth of tokenised money”. Noting that both Big Tech and Central Banks “are building new payment formats and rails,” they say that “while stablecoins such as Diem await regulatory approval, they could benefit from the huge network effects of their Big Tech sponsors. In fact, Diem could be an effective tokenised payment format inside the Facebook universe.” The paper predicts that “Stablecoins, such as Diem, could benefit from the huge network effects of their Big Tech sponsors”. With 3.3 billion monthly users, Facebook certainly has remarkable global reach.
The idea of an integrated tech platform which enables people to interact and purchase goods and services – including financial services – is now being pursued by many major players.
Amazon has long been rumoured to be planning to launch its own bank. Yet, research by CB Insights concludes that, “from payments and lending to insurance and checking accounts, Amazon is attacking financial services from every angle without even applying to be a conventional bank.” This is perhaps not surprising. After all, tech companies rarely replicate existing models. They usually find disruptive new ways to achieve the outcomes that consumers want. Even the messaging service, WhatsApp, has recently moved into financial services with the launch of WhatsApp Pay.
As money becomes digitised and tokenised and ever more areas of our lives move online, the distinction between an online marketplace, a social network and a financial services provider will continue to blur. How traditional financial services companies react to these developments remains to be seen. Some may partner with tech companies in creating new services. For example, Visa and Mastercard were involved with Facebook’s Libra stablecoin project. Visa also responded to the popularity of peer to peer payment services such as Revolut by launching Visa Direct, which enables users to make payments directly to another account in 30 minutes. Most major banks now support Apple Pay, which enables users to authorise payment by scanning their face or thumb.
Banks can also collaborate with tech companies in terms of data sharing, in order to better understand what their customers want. A company like Amazon knows what books people like, what music they listen to and what they purchase. By combining such data with wider financial data, remarkably predictive Big Data models could be created. Some banks might increasingly pursue opportunities to monetise data, while others might make privacy their unique selling point.
The banking sector fundamentally deals with money. Yet, the very nature of money is set to change, as it becomes digitised. Banks are no longer merely competing with each other, but they are both competing and collaborating with tech companies and social networks. Looking ahead, the only certainty we have is that we are in for a period of remarkable change.
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