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Investing
22 Jul 2021 6 min read

Buy, build, or partner – that is the question

Investing

Buy, build, or partner – that is the question

Thu Jul 2021 6 min read
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Banking and wealth management have faced considerable headwinds in recent years. Stricter regulations, macroeconomic challenges, and the rapid emergence of fintech players have combined to create extraordinary pressures on profitability. In fact, a 2020 McKinsey review suggests that financial service firms stand to lose 14% or US$3.7 billion revenue between 2020 and 2024, triggered by the pandemic1. This provides strong impetus for firms to adopt new strategies to mitigate their risk.

Of the possible strategies, digital transformation is arguably one of the most critical, as it can entail the introduction of new lines of business such as neo-banks and online wealth advisory platforms. In an August 2020 survey, McKinsey found that developing new businesses was fast becoming a priority for financial service firms.

“About 50% of the firms said that developing new business was among their top three priorities, up 18% from the period 2017-19.”

McKinsey also reported that customer interest in online financial products has grown throughout the COVID-19 pandemic.

“30-40% of the consumers in Singapore, Indonesia, Greece, and Mexico are now “more interested” in digital financial products such as wealth management, payments, and lending.”

The question then is not whether wealth firms should jump onto the fintech bandwagon but rather, how. There are three routes to doing this. The first is to build in-house capability. The second is to buy existing companies and the third is to partner with incumbents.

Build new fintech architecture

Building from scratch can be advantageous, if executed correctly. It provides bespoke
in-house solutions that can streamline all client transactions on a single platform. It can also leverage and strengthen a firm’s brand and establish it as a partner of choice for customers.

However, this route is generally only feasible for the largest players due to the associated cost hurdles that render it risky from a Return of Investment perspective. The cost of hiring the right talent for the new venture, engaging vendors, and replacing legacy systems to address security, scale and maintenance is no small amount.

In fact, S&P Global’s analysis of 15 US financial service companies in 2019 indicated that the highest spenders allocated 20-25% of their annual expenses to technology, with the total amount exceeding US$10 billion2. This is no small change and creates an extremely uneven playing field for the mid-sized and smaller players.

Secondly, even for large corporations, the time taken to conceive and execute a project of this scale can range from one to three years. Such time frames can be unrealistic for the smaller firms already struggling to catch up with new products, amid swiftly evolving customer experiences and expectations.

Finally, greenfield fintech projects can be risky for firms due to their vastly different core competencies. The core competencies of a brick-and-mortar wealth manager typically include investment research capability, relationship management, and strong middle- and back-office support. These are distinct from the competencies of fintech, which are technology, creativity, and agility. This difference poses a considerable challenge to any top management spearheading the transition.

Buying fintech architecture

As with building from scratch, this is an option that may only be available to the largest companies with the strongest balance sheets.

With fintech’s growing capabilities and credibility, many fintech firms are now valued according to their potential and their public listings are predicted to grow, backed by strong technology valuations in capital markets. Software Enterprise Group’s study of fintech valuations in 2020 supports this. It indicates that their enterprise value to trailing 12-month revenue hit a high of 15x in the fourth quarter of 2020, the highest in two years3.

Even when attractively valued targets can be found, mergers and acquisitions are not easy to execute, especially when it comes to integrating operations, technologies, talent and cultures. Substantial costs and risks are involved.

Finally, with an acquisition, the long-term costs of continuous innovation, customer retention and talent management accrue to the acquirer. As such, even though buying is faster than building, in the long term, it is just as costly.

Partnering with fintechs

On the other hand, banks and wealth managers are starting to seek partnerships with fintech incumbents as a means to fill the gaps in their online capabilities and product range.

It’s win-win for the wealth tech industry as well. Overall, 2020 was a weaker year for wealth-tech, especially in H14 and this encouraged many fintech companies to be open to partnerships – a trend which KPMG expects to continue.

Partnerships allow both parties to overcome barriers, as the traditional firm is able to defend its market share and offer flexibility to its customers, while the fintech trailblazer forges ahead with its innovations in artificial intelligence, machine learning, and enhanced cyber security.

Partnerships also provide for a vibrant community that is balanced between innovation and traditional wealth management. With partnerships, expertise and technologies that are considered nascent or niche can enter the mainstream much faster, and most importantly, several services can be brought together under a single trusted umbrella to support a richer customer experience.

Structuring fintech partnerships for success

But, even though partnerships are among the fastest, most flexible, and cost-effective approaches to digitalisation, they too are not without risk. Identifying the right set of partners is critical.

Banks and wealth managers must seek out partners that are able to enhance and complement their existing range of services. They should have a clear idea at the outset of the gaps they are seeking to fill. This is crucial to singling out the fintech firms that can bring them the requisite value.

Wealth managers should also build their own growth strategies and ensure that their selected partners can cater to their desired trajectory. The aim of their partnership should be seamless integration and growth in order to bring new products to market quickly. Accordingly, partnerships should be sought between parties with the depth and capability to scale in tandem.

That means, the chosen fintech partner should have a strong track record in their chosen market, along with an existing product suite that is a good fit and bench strength in terms of talent. They should also be well-funded and supported by strong shareholders, to anchor their continuous growth and innovation. Watertight agreements between the partners must be crafted to address issues like intellectual property, operational alignment, and roles and responsibilities.

The bottom line

No brick-and-mortar firm can afford to ignore the march of digitalisation. In the current environment, fintech’s agility and speed can bring huge competitive advantages, including operational and cost advantages and brand enhancement.

Wealth management firms have an added imperative to digitalise fast, as the sector is in the midst of a profound generational shift. A Deloitte study estimates that a massive US$50 trillion worth of assets will be transferred from one generation to the next between 2017 and 20605 and with Generations X and Y piling onto the driving seat, the demand for information, innovation and new channels will only continue to grow. Wealth managers need to be well-positioned to address their needs.


LU Global is a wholly owned subsidiary of Ping An Group and Lufax, two of the most prominent financial services institutions in China. We bring deep expertise and experience to digital wealth management, and we partner with leading private equity asset management companies as well as global private equity experts to deliver bespoke and flexibleChinese private equity investments throughout Southeast Asia. We believe collaboration is far better than competition and would love to explore any partnership opportunities.

For details on our partnership opportunities, please contact [email protected].

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