Fintech For Dummies
Fintech For Dummies
Fintech For Dummies
» Defining FinTech
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inTech has undoubtedly become one of the hottest topics in business. Web
searches for the term fintech in Google have grown exponentially in the last
several years, so it’s obvious that people are curious about it. But what is it,
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and why is it relevant to today’s financial industry? This chapter looks at those
very basic questions, helping prepare you for the more detailed information you
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career, because FinTech experts are in high demand globally. Reading this book
will also empower you to help your institution innovate and develop its services
faster than your competitors. Globally, the FinTech market is booming, and we see
investors investing across all stages of FinTech companies’ life cycles.
Each founder had already had great success in his own right. Michael Goodkin was
a quantitative analyst and author of the book The Wrong Answer Faster. Mitchell
Feigenbaum was a MacArthur Grant recipient and one of the pioneers of chaos theory.
Nigel Goldenfeld was a statistical physicist and director of NASA Astrobiology Institute for
Universal Biology. Alexander Sokol was a writer and professor at the University of Illinois.
Numerix was initially a think tank for mathematicians, computer scientists, and theoreti-
cal physicists in search of uses for a series of financial industry–specific projects. The
first Numerix product was a software tool kit leveraged to speed up Monte Carlo simu-
lations, tree and difference finite methods, and value-at-risk calculations. It sped up the
computation time by factors of four, while not negatively impacting the accuracy of the
results. Merrill Lynch and Price Waterhouse were the first companies to deploy this
product in 1998.
The use of the Numerix Monte Carlo method provided more accurate pricing faster.
This enabled banks to mitigate their intra-day risk more effectively.
Between 1998 and 2003, Numerix focused on creating many projects, some paid for by
clients but most based on a desire to solve perceived financial industry–related prob-
lems. By 2003, the company had amassed 20 different kinds of potential products in
search of clients. However, the company was distracted and unfocused and had spent
more than $25 million to create a business that was barely generating $4 million in
annual billings. During the summer of 2003, a multibillion-dollar financial service com-
pany attempted to buy Numerix for $5 million, only to have its offer rejected by the pri-
mary shareholder. The company at that time was a broken start-up building ‘“cool”
technology for the sake of it rather than solving real market problems. At this stage, it
was going out of business unless it could get backing from committed investors to pivot
into a new product or approach. Sometimes parallel changes in the market environ-
ment enable your pivot timing.
FinTech is also frequently used as an umbrella term for various subcategories, such
as WealthTech and RegTech. You find out more about these subcategories in
Chapter 2.
Coauthor and Numerix CEO, Steve O’Hanlon joined Numerix in January 2002 to lead
global sales, marketing, and support. In 2004, Greg Whitten, chairman of the board and
CEO, appointed Steve to run the day-to-day operations as president and COO. Steve’s
primary goals were to refocus the company and eliminate all the distractions. Steve set
forth five tenets of operations to bring clarity of purpose and focus to the 50 employees:
• Replace the “term software pricing model” with “recurring software subscription
model.”
• Complement direct sales initiatives with a partner strategy that licenses some or all
financial asset class pricing capabilities to financial software companies that require
Numerix’s caliber of analytics.
• Eliminate 17 of their then-20 products. Take the three remaining products and
merge them to create a groundbreaking multi-asset class pricing tool.
FIGURE 1-1:
The Fintech Cube
combines
financial sector,
business model,
and technology
factors.
Source: FINTECH Circle, 2020
Each of these dimensions can be further categorized. For example, Figure 1-2
expands on the concept by adding key areas of financial services that can benefit
from FinTech. All financial sectors are shown on one side of the cube, including
retail banking, trading, and insurance (among others).
Figure 1-3 summarizes the most important business models from business-to-
consumer (B2C), business-to-business (B2B), business-to-business-to-consumer
(B2B2C), to business-to-government/regulator (B2G), to platform-based business
models, crowdfunding, and peer-to-peer (P2P) lending.
FIGURE 1-3:
A dimension of
main business
models.
Source: The Fintech Cube, FINTECH Circle, 2020
Figure 1-4 shows the third dimension — the technology being used, which can
range from cloud computing, big data, artificial intelligence (AI)/machine learn-
ing (ML), blockchain (distributed ledger technologies), the Internet of Things
(IoT), and quantum computing, to augmented and virtual reality. Part 2 covers
these technologies in more detail.
FinTech start-ups, for example, can now be more easily categorized and com-
pared. For example, you may have a retail banking (financial sector x-axis) solu-
tion focused on the business model of B2C and using various technologies, such as
cloud, big data analytics, and AI. Such a company would be called a challenger
bank, sometimes also referred to as digital bank or neo-bank.
The financial software industry was fraught with legacy sales models. One of the most
common was the perpetual license model (PLM), which involves an initial license fee
(ILF) upfront and then an annual maintenance fee (AMF) of about 20 percent of the ILF
for each subsequent year to receive supports and updates. The ILF payment ensures
perpetual rights to use the software even if the client stops paying annual
maintenance.
The other popular software license type in 2004 was the term license model (TLM). It
required an ILF similar to a PLM, but generally the ILF for a TLM was lower, because a
TLM would generally have a five-year term, after which the client had to renew by
paying the original TLM ILF fee to continue to use the product. Like a PLM, the TLM
would have an AMF equal to 20 percent of the TLM ILF, and this too would be paid
annually.
Numerix successfully shifted from a TLM to a subscription license model (SLM), which at
that time was common for enterprise software but not for financial software. Since
Steve O’Hanlon came from the Enterprise software world, he moved Numerix into the
new world of a SLM. This change shifted the way clients paid for Numerix products. For
existing TLM Numerix clients, Numerix took the sum of ILF and five AMF periods, added
them together, and then divided by 5 to determine what the SLM would be for renew-
ing clients. For example, if a client originally paid an ILF of $100,000 and an AMF of
$20,000 each year for five years, where the client’s first-year payment would be
$120,000 and each subsequent year would be $20,000, the client would have spent over
five years the sum of $200,000, Numerix divided the $200,000 by five years, making the
SLM price $40,000 per year. Numerix then used the same logic when re-creating the
TLM as an SLM price book. This SLM enabled Numerix to have recurring billings of
83 percent of the gross in 2019.
As another example, you may have a WealthTech company that sells its software
to hedge funds. You could describe it as being focused on asset management
(x-axis), B2B business model (y-axis), and using several types of technology from
the z-axis in combination.
»» Just 20 years ago, it would have been very expensive to launch a FinTech
company, whereas today the required expenditure is much more affordable.
The decreasing technology costs have reduced the barriers to entry.
»» The funding landscape is also different now. Twenty years ago, there was little
funding available for early-stage FinTech firms, but today venture capitalist
and corporate venture arms of both financial institutions and tech companies
invest large sums in scalable FinTech companies. (See Chapter 16 for more
information.)
Established financial institutions should read this book to understand how the
tech giants embraced the digital age and transformed the industries they now
dominate. They need to appreciate how they can adopt their own transformation
rather than be disrupted by new firms entering the industry.
Traditional banks have already seen their revenues and margins decrease as
FinTech firms have undercut their prices on, for example, foreign exchange, lend-
ing, payments, and traditional banking services, particularly as open banking is
promoted by regulators.
Having witnessed the growth of Intel with its Intel Inside strategy, Steve reasoned that
Numerix pricing analytics could be licensed in part or whole to financial software com-
panies that lacked the ability to price complex derivatives. His mandate in January 2004
was to complete the software development kit (SDK) for the pricing analytics so that any
financial software vendor could easily consume Numerix pricing analytics. This strategy
has endured since 2004 and has resulted in 90 global partners that represented nearly
half of Numerix revenue in 2019.
Many FinTech firms today should investigate the potential to partner with complemen-
tary software providers, especially larger firms that have established sales with large
financial institutions, to piggyback on their success, while also reducing their own dedi-
cated sales force requirements.
In all of these organizations, boards need to develop new strategies based around
digital transformation and innovation teams that will work in conjunction with
existing product and business development. They must also work with technology
teams to help them determine how they compete in this new environment. Of
course, one of their biggest hurdles will be themselves as they need to instill a new
culture that embraces change from the top down. Flip to Chapter 17 for more dis-
cussion on this topic.
FIGURE 1-5:
FinTech hubs are
globally
diversified.
Source: Innovate Finance, 2019 FinTech Investment Landscape Report,
PitchBook. Data has not been reviewed or approved by PitchBook analysts.
FIGURE 1-6:
A 2019 drop in
global FinTech
investment.
Source: Innovate Finance, 2019 FinTech Investment Landscape Report,
PitchBook. Data has not been reviewed or approved by PitchBook analysts.
While FinTech investment decreased in Asia in 2019, long term we believe that
Asia will be a growth engine for the global FinTech sector. Meanwhile, all other
regions’ total investment increased, primarily due to the number of large size
deals that were completed (see Figure 1-7).
FIGURE 1-7:
FinTech
investment in
Europe and North
America
continued to
increase in 2019.
Source: Innovate Finance, 2019 FinTech Investment Landscape Report,
PitchBook. Data has not been reviewed or approved by PitchBook analysts.
The Numerix Toolkit was sold to financial quants as a stand-alone tool where they
would use an SDK to create their own applications on top of the Toolkit. Its sluggish
sales led Numerix to create the Numerix Engine product, a full application for pricing
fixed income, credit, equity, and foreign exchange derivatives. The Engine was built on
top of the Toolkit, so it effectively rendered the Toolkit product obsolete.
In 2002, Numerix’s then-CEO hired a financial software quant to build the next genera-
tion of the Engine, which was dubbed the Numerix Library. This dual focus of building
the same product twice became known in Numerix as the “Pepsi Challenge.” The then-
CEO created competition between the Engine and Library development teams. This
meant that the four sales reps were attempting to sell both the Engine and the Library.
When clients asked about the difference between the two products, the sales rep would
state that the Engine was legacy with more features, but the Library was next-generation
and would eventually catch up to the Engine features. Potential clients were understand-
ably not thrilled with that answer, and it was yet another reason for insignificant billing
growth at Numerix.
Steve identified the problem in the sales approach and sought to rebrand the products
to stop the confusion. He immediately took the Toolkit out of the price book so that
salespeople could no longer sell it as a separate product. He eliminated Toolkit, Engine,
and Library product names and instead began using the company name, Numerix, as
the product name.
Steve then renamed the Engine Numerix 3.0 and renamed the Library Numerix 4.0.
He refocused the Numerix 3.0 product (the Engine) developers on Numerix 4.0 (the
Library). Just a couple of developers were left to maintain Numerix 3.0. His goal was to
speed up the process of enhancing Numerix 4.0 with new features and features that
were only in Numerix 3.0.
(continued)
All this new work became known as Numerix 5.0, which was delivered at the end of
2004. The sales team could show the road map that took all the features of Numerix 3.0
and moved them to Numerix 4.0, resulting in Numerix 5.0. This sales story was very
focused, and prospective customers could clearly understand the benefits of licensing
4.0 knowing when they would get the gap fillers from 3.0. It was this single focus that
caused Numerix billings in 2004 to nearly double over the prior year!
The process Numerix went through in its analysis of the effect of conflicting software
and market perceptions is not unlike the analysis FinTech companies provide to their
banking customers. The need to identify redundancy, consolidate functions, and pro-
vide clear messaging both internally and externally is key to the modernization of finan-
cial institutions and a service that FinTech is integrally involved in.
»» Disruption refers to the way emerging FinTech firms and technologies are interfer-
ing or competing with the traditional way business has been done in the past.
»» Open source is software for which the source code is freely available to
anyone. Any capable programmers can then use, modify, and distribute their
own versions of the program. (See Chapter 10.)
CrossAsset software was losing $5 million per year, and there was no deliverable prod-
uct anywhere on the horizon. Therefore, when coauthor Steve O’Hanlon took over
Numerix in January 2004, one of the missions was to shut down CrossAsset Software
without incurring legal damage from ICAP or Toronto Dominion. By the end of March
2004, the partnership was successfully terminated and Numerix retained the rights to
the name CrossAsset Software, which was trademarked. The name CrossAsset eventu-
ally became the product name that replaced Numerix 5.0.
The company’s new approach focused developer efforts on creating a single pricing
platform that hedge funds, second tier banks, and partners could all use. During this
pivot, Numerix developed and used a tool kit of creative analysis that provided a way
forward to new and definitive software and services that would be utilized in the future
to support its FinTech customers in their transitions.
The problem the Numerix software was set to solve was to provide consistent and fast
pricing information across an entire institution’s workflow process. It was driven by
these considerations:
(continued)
• Customers needed to create dealer quality models that were flexible and provided
for customization.
Numerix software had the flexibility required to price the most exotic instruments and
was built on a world-class analytics library that had models in every asset class.
• Ability to price exotics for the business lines they cover (Equity, FI, Credit, and FX)
In Chapter 2, we continue the story of Numerix, and you discover how this path forward
took shape.