Fintech in the Eye of the Storm A fintech investor’s view of the industry in 2020 and beyond “What does fintech and the wider financial services sector look like in a post-Covid-19 environment?” No one can yet answer this with any certainty, but little happens in the European fintech space that does not cross our radar screen and we believe there are some notable trends that can help to better understand some of the possible outcomes. It is those factors that we elaborate on below, through exploring the banking, lending, brokerage and infrastructure sub-sectors. Summary ● Fintech challengers are far better-suited than incumbents to respond to the structural opportunities that will emerge from Covid-19, due to their inherent agility, culture of innovation and use of the latest technologies and data. The opportunity for fintech remains greater than ever. ● Incumbents pursuing gradual progression to digital offerings will need to accelerate transition: existing partnership and acquisition trends will continue with increasing vigour. ● The UK government’s commitment to fintech and supporting a world-class digital economy will be challenged by the institutional response to the crisis. The outcomes of well-intentioned government initiatives such as BBILs and CBILS would be dramatically improved with wider inclusion of fintechs, such as alternative lenders. ● The funding environment will weaken in the short term with a greater focus on positive unit economics and stronger balance sheets. Consolidation and opportunistic acquisitions will become a feature of the coming 12 months. Valuations will be impacted but will likely recover in the second half of 2021. ● The trend of technology companies staying private for longer (due to availability of capital and attractive M&A opportunities amongst other reasons) will be strengthened in light of public market volatility. About Augmentum Fintech Augmentum Fintech plc (​www.augmentum.vc​) invests in fast growing fintech businesses that are disrupting the financial services sector. Augmentum Fintech is the UK’s only publicly listed investment company focusing on the fintech sector in the UK and wider Europe, having launched on the main market of the London Stock Exchange in 2018, giving businesses access to patient capital and support, unrestricted by conventional fund timelines and giving public markets investors access to a largely privately held investment sector during its main period of growth. Our portfolio of 18 fintech companies includes Tide, interactive investor, Onfido, Zopa, Monese, BullionVault and Farewill. Fintech in the Eye of the Storm Since lockdown, many in the investment community have asked us how fintech might fare in a post Covid-19 environment. It is still too early for the data to provide definitive answers but the Bank of England’s prediction that 2021 will see a 15% bounceback from the GDP loss of 14% in 2020 is a reasonable working assumption. What we do know is that the crisis will create scope for accelerated innovation and change. While the majority of businesses will face challenges there will also be significant opportunities for those capable of meeting customer requirements in a changed and significantly more digital world. As is the case for many sectors across our economy, fintech faces a test of resilience in the months ahead. Today, the label of ‘fintech’ applies to companies innovating across the full depth and breadth of the financial services sector, bringing a huge amount of diversity under its umbrella. The scale of the opportunity across banking services, wealth management, insurance and infrastructure is unparalleled and we will continue to engage and ultimately invest in outstanding companies that will enhance our fintech portfolio. The fundamental attributes of successful fintech companies: world class technology, data driven processes, operational efficiency and customer-centricity, along with levels of responsiveness and agility unachievable in traditional institutions are advantageous under Covid-19-related economic uncertainty. Structural changes in our economy driven both by long-term trends and reactions to lockdown measures are also of benefit to the fintech sector. In this note we share our initial views on the positioning and possible outlook of fintechs and traditional institutions operating within four key areas of financial services; banking, lending, brokerage and infrastructure. In each case we consider how the economic environment and structural behaviour changes are likely to impact companies within each space. Fig 1: Macro outlook for fintech sub-verticals during the Covid-19 pandemic and recovery Source: Augmentum Fintech Analysis Fintech in the Eye of the Storm ​ ​ 2 Banking Under the conditions of lockdown, digital channels have been essential to the continued delivery of key services, including banking. Challenger banking platforms such as ​Monese​ and ​Tide​, designed to serve customers on a fully digital basis, have found their value proposition and branch-free operating models to be advantageous in meeting customer needs, compared to traditional banks. Growth and revenue performance metrics across both traditional and challenger banks will reflect the negative economic impact of the Covid-19 pandemic. However, the step change in the uptake of digital services will favour challenger banks as they are better positioned to deliver a digital experience that aligns with modern expectations. Key elements to meeting these expectations include simple onboarding, low cost and personalised features. As digital banking has grown in popularity, more traditional banking interactions have fallen away, and behavioural shifts have accelerated with the Covid-19 pandemic. Bank branch networks were already in decline pre-Covid-19; 34% of the UK’s bank branch network closed in the years 2015-191 and many of those remaining operate with reduced opening hours. Under lockdown, branch visits are highly restricted, inadvertently pushing customers who might previously have relied on branches towards the convenience of digital channels. This boost to remote access banking in the immediate term is likely to have a lasting impact on branch footfall, leading to an accelerated rate of branch closure, as operating costs become untenable for traditional banks. Fig 2: Branch and ATM networks are a significant overhead for traditional banks Source: McKinsey Beyond Banking Report, 2019 The general decline in cash usage, in large part due to the widespread acceptance of convenient alternative payment methods such as contactless, has also been accelerated by the Covid-19 pandemic. While a relatively uniform reduction in ATM transaction volume was seen across 2017-19, data for 2020 shows a sharp decline2. Several dynamics are in play here, including lower overall spending, a reduction in in-person transactions (with a share of spend reallocated to ecommerce) and fears around virus transmission from cash. In response to virus transmission fears the British Retail 1 Which 2 Link Fintech in the Eye of the Storm ​ ​ 3 Consortium accelerated the decision to raise the contactless limit to from £30 to £45. In the month since, c.43% of card transactions within the £30-£45 range were conducted with contactless3. As with bank branches, the immediate term impact of lockdown measures is likely to have a lasting impact on cash usage in society by entrenching behavioural patterns across demographics. Fig 3: Weekly UK ATM transactions have fallen sharply under the Covid-19 lockdown Source: LINK ATM Data Banking goliaths, despite retaining dominant market share, have sought to emulate the success of challengers with their own digital bank propositions, with little success to date. RBS recently announced the closure of their challenger bank Bo, rumoured to have had a budget of £100m, after only five months of operation following disappointing traction. JP Morgan shut down their millennial focused mobile bank ‘Finn’ after one year of operation in the US, after failing to gain momentum with their target audience (JPM continues to operate an alternative digital offering under the ‘Chase’ brand). The Goldman Sachs digital banking brand ‘Marcus’ has had more success acquiring customers in the US, although three year costs stood at $1.3bn4. The mixed fortunes of incumbent entries to this space speak to the challenges of launching a successful digital bank, which evidently requires more than a trendy brand and significant capital. Creating the requisite energy, culture, talent and technology should not be underestimated in difficulty. Some say that fintechs can build more in a month with 100 people and £1m than a traditional bank could build with 1,000 people and £100m in three years5. While challenger banks are suited “operationally” to the current situation, revenue streams in the immediate term will be more exposed to a Covid-19-related downturn. In particular, transaction interchange and foreign exchange revenue streams will contract in line with reduced transaction 3 Barclaycard 4 Wall Street Journal 5 The Finanser Fintech in the Eye of the Storm ​ ​ 4 value and volume at home and abroad. In a low interest environment liquidity transformation activities will also be challenged. Challengers who have achieved some level of diversification across revenue streams - e.g. through account subscription fees, commission generated through marketplace offerings, or credit provisioning via a market place - will have a greater level of insulation. Adoption as a ‘primary account’ amongst