Why Financial Services in London are over-ripe for disruption.
We say: The financial services sector – from huge exchange providers to personal lending – is overdue for disruption because there are inefficiencies from legacy practices, no unique asset or resource at the heart of the business and massive latent demand for cheaper access to the services on the part of the public. Regulatory and compliance issues will not prevent this taking place.
Step out of the London Underground at Old Street and two distinct and separate worlds meet your eye.
Look southwards down City Road and you’ll see the gleaming towers of the City of London, the traditional centre of financial services for the UK. Cast your gaze a little further East to Shoreditch and you’re looking at a very different world, one populated by a tight network of digital startups, design companies and grass-roots entrepreneurs.
It’s taken for granted that the City and its legions of suited traders, financiers and insurers are a major driver of the UK economy. However according to one of the UK’s leading economists, it’s the bearded, exotic coffee and craft beer drinkers who run the country’s startups who are now massively transforming the economy right now.
And the two worlds which previously rubbed up against each other but remained separate ,are about to collide and unleash a wave of disruption on the economy, argues Anthony Hilton, journalist and commentator.
In a recent business briefing, Hilton argues that the existing growth figures on which we base our preconceptions are hopeless for understanding the size and scale of the transformation going on before our eyes. Hilton draws on the ideas put forward in The Flat White Economy, a recently published book by controversial economist Douglas McWilliams (1),currently on sabbatical from his job as chairman of the Centre for Economic and Business Research.
“The Growth figures are wrong.” says Hilton, pointing instead to the yearly double-digit surge in travellers using Old Street station and the 32,000 companies registered in the EC1 postcode since the 2012 Olympics.
“In and around Old Street you have the most colossal dynamic digital economy right now, says Hilton.”More jobs have been created in EC1V than in the whole of Leeds.” Digital is already the 5th largest sector in UK, larger in revenue terms than the oil and gas or motor industries and will represent more than 15% of GDP by 2025.
“The UK has embraced internet in a way no other country has,” noting 14% of retail sales now come from digital channels. Hilton used a convenient shorthand to conflate digital activity with Old Street – the economic growth is driven by digital activity in regions across the country. But it’s not for nothing that the area around Old Street is called Silicon Roundabout, and Google Campus and Tech City have offices on or within a stone’s throw of the unlovely traffic island.
Only in London
The digital economy has taken root in London for a number of reasons, argues Hilton, citing McWilliams. Eurozone stagnation and lack of opportunity in Southern and Eastern Europe has led to an Influx of digital talent from the continent. More than half of those employed in the digital economy are are non-British.
It happened around Old St, Shoreditch and Hackney, due to the cheap accommodation close to centre of town, where young unattached talent can live the outdoor life in exotic coffee shops and workspaces. Thus is borne the flat white economy, where techies fuse work and play.
In a smaller tighter and more networked version of the Bay Area in California, demand and skills come together, and the network effect of physical proximity creates a critical mass of digital activity.
What does this mean for the rest of the UK economy?
Firstly, it means that the exponential speed at which the entrepreneurial digital sector can grow is leaving larger, linear companies behind. Established players take a long time to innovate – they have a vested interest in status quo, argues Hilton – and within their structures, innovators and innovation get squashed.
And for FS?
Zooming further in, the implications are most acute for the financial services industry. According to Tomas Philippon, professor at at Stern Business School in New York, this sector has seen no improvement in efficiency for the last 100 years. Philippon argues that despite domain specialisation and the expected gains from massive IT investments, the FS sector has continued to take around 2% of all net flows into and out of the business over the last century.
“When flows double financial services fees go up pro rata. All increases are captured internally.” says Hilton, arguing that the increasing burden of regulation and the $10bn annual cost of compliance has taken a significant proportion of this.
Financial Services – You’re Next
Given that digital has disrupted media, personal banking, personal fitness, retail and just about any other sector you can name, and Financial services have remained relatively untouched by the digital revolution “it’s only a matter of time until financial services get disrupted, says Hilton. “We can expect that flows will shrink. Banking is a essential a high cost way of getting money from a to b. There’s no reason that the entire stock exchange can’t be on something like eBay.”
In fact the disruption has already begun. Tech accelerator Seedcamp is seeing an upsurge in applications from startups looking to disrupt an area of FS, from solving the challenges of Bitcoin liquidity to enabling customers to manage their own Exchange Traded Funds (ETFs). In Canary Wharf, where many FS giants now house their operation, accelerator Level 39 is an accepted part of the FS innovation landscape.
And this clash is likely to be the focus of Disrupt Finance, taking place on the borderline between Shoreditch and the City on April 15.
In every industry which has been disrupted, incumbents have consoled themselves with the fact that they have a unique asset which protects their market position. Music producers took refuge in their copyright laws in the fight against Napster; travel operators consoled themselves with superior advice and knowledge in the face of internet search, now taxi drivers are feeling smug about their “knowledge” while Uber erodes their business. Regulation and customer trust are now the twin factors which the FS business believes can save it.
Given the history of digital for destroying traditional structures, it’s a given that the impact of the flat white economy will be felt in the towers and streets of the neighbouring City. Those existing players which recognise embrace and co-operate with the inevitable disruption will stand to gain most. But for all involved it’s going to be the next chapter in how software ate the world.
(1) At the time of launch of his book, McWilliams was due to face trial over allegations of assault and stood down from his role at the CEBR.