Technology is redefining the provision of financial services -- it is cutting out the middle man and providing customers with quicker, direct and more convenient financial services at lower costs.
FinTech is the use of software to increase efficiency in the provision of financial services, and is a hot topic at the moment. FinTech is where finance and technology collide to disrupt the traditional banking and financial services model.
The Financial Markets Conduct Act 2013 has the purposes of promoting innovation and flexibility in financial markets and promoting and facilitating the development of fair and efficient markets.
So far, the FinTech innovation in New Zealand has been focused at the front end. Crowdfunding platforms and peer-to-peer lending services as well as the looming robo-advice revolution in the financial advisory sector are examples of FinTech innovation focused on front-end inefficiencies.
The major FinTech disruption to capital markets, however, won't be at the front-end.
We expect that disruption will come through the use of distributed ledger technology to remove inefficiencies in back office functions that currently facilitate transactions on the markets.
The use of distributed ledger technology (blockchain) is currently front of mind for major banking institutions and investment exchanges around the world. Venture capital and institutional funding for blockchain innovation is flooding in.
Originally developed as the technology that underpins Bitcoin, it has the potential to streamline capital markets transactions and reduce counterparty risk associated with the monitoring or enforcing contractual obligations.
It can be described as a digitally distributed, decentralised, unchangeable ledger for verifying and recording transactions.
Using this technology, parties can securely send, receive and record value or information through a peer-to-peer network of computers without the need for a third party intermediary.
It is a means of transferring value and holding records with each transaction being recorded as a "block" that is added to a continuously growing chain.
It is a permanent record and its security comes through the continual replication of the chain in the network and its decentralised nature.
It can also be used to develop a "smart contract". The terms of a traditional contract are coded and uploaded to the blockchain, resulting in a decentralised smart contract that is not reliant on third parties for record keeping or enforcement.
FinTech is where finance and technology collide to disrupt the traditional banking and financial services model.
Contractual clauses automatically execute when pre-programmed conditions are satisfied, resulting in the removal of ambiguity as to the agreed terms and any disagreement regarding external dependencies.
The opportunities for our capital markets to leverage an immediate, secure, permanent and unchangeable record of transactions and transfers of value without the need for intermediaries are vast.
• Clearing and settlement
The incumbent settlement and registration systems can take several days to settle trades. Both NZX and ASX currently operate on a recently reduced T+2 settlement cycle for cash trades.
Blockchain allows real time settlement without the need for an intermediary and has the real potential to automate the clearing and settlement process.
It could remove inefficiencies that result from the current need for counterparties and systems to undertake clearing, settlement and reconciliation processes.
Clearing and settlement disruption is already happening. At the end of last year, Nasdaq announced that it was using its Nasdaq Linq technology to successfully complete blockchain-based share sales.
This was described as the beginning of a process that could revolutionise the core of capital markets infrastructure systems and that would have profound implications for settlement and outdated administration functions. Closer to home, ASX recently paid A$14.9 million for a 5 per cent stake in a start-up focused on developing distributed ledgers.
• Smart contracts
Financial transactions are an obvious use of a smart contract. A smart derivatives contract could be pre-programmed with all contractual terms except for price, which could be determined algorithmically from market data fed into the contract.
Margin could be automatically transferred on a margin call and the blockchain would perform the record keeping, auditing and custodial functions, resulting in efficiencies and cost savings for the contracting parties.
Technology and regulation will need to evolve at the same pace to make it easier for both small and large firms to launch new ideas and innovate in financial services.
The Uber approach of acting first and dealing with regulation as an afterthought won't work in the capital markets. FinTech innovators will need to consider regulatory impacts at a very early stage.
Foreign regulators are facilitating innovation through a regulatory "sandbox". This is a safe space for testing innovative products and business models without immediately incurring all the normal regulatory consequences.
The UK's Financial Conduct Authority has recently opened its sandbox and Australian Securities Investments Commission will be consulting on its proposed sandbox later this year.
The UK regulator has also recently signed co-operation agreements with both Singapore and Australia to facilitate referrals of FinTech businesses between those jurisdictions.
The Financial Markets Conduct Act is already hard-coded to encourage innovation and efficiency in our financial markets. FinTech innovators should take heart that New Zealand's regulatory approach to FinTech will have to be one of encouragement and facilitation.