Financial services continue to go through major disruptive changes that are redefining their role and structure.Recognising this, the Bank of England (BoE) launched an initiative on the “Future of finance”^1. The themes tackled include: infrastructure, ageing population, technology, low carbon economy and emerging markets. This initiative will set out a vision for the future of the financial system and inform the BoE’s thinking on future policies and capabilities.
These themes already pervade the strategic challenges Deloitte helps financial services firms to solve. Ahead of the publication of the conclusions of the BoE’s initiative, we brought together experts^2 from across our UK firm to help us consider the current focus in financial services and what the future will look like. For the purposes of this note, we have only presented the most important focus against each theme.
Infrastructure: How can we improve the infrastructure so that UK households and businesses can transact anywhere, anytime and with anyone?
The major changes in infrastructure are being driven by: increasing use of emerging technologies, changing customer demands, the growth of e-commerce, and shifting regulatory frameworks.
The payment infrastructure is core to this. In the future it will need to be built on real-time execution (resulting in the immediate or close-to-immediate interbank clearing of a transaction and crediting of the payee’s account) and be highly portable. This future will need to be more global to help alleviate customers’ pain points around cross-border payments which are currently characterised by high costs, high authentication standards, and slow speed. In addition, the payment infrastructure will need to offer a high degree of optionality (e.g., payment can be done at the “click of a button” through various channels (including instant messaging apps)). Collaboration between financial services and non-financial services will also become more mainstream as part of the future landscape, partly to reduce the costs of building the payment infrastructure from scratch.
The key challenges to realising this future will be for financial services firms to overcome consumers’ trust and data privacy concerns (due to the risk of payments fraud and security breaches) and to hold a higher level of liquidity (as real-time execution of payments increases liquidity risk). In addition, newcomers will need to overcome the challenge of breaking through the barriers to entry.
Payments authorities will need to ensure that the underlying payments architectures are flexible enough to adjust to future changes including by simplifying the rules, standards and processes. In this connection, initiatives such as that led by Pay.UK – the UK’s retail payments authority – to develop a new payments architecture to process Bacs, Faster Payments and imaged cheque to catalyse innovation and the BoE’s upgrade of the UK’s real-time gross settlement system, are bound to spread. In addition, regulators can continue to help to increase competition and propel innovation by identifying how to lower market entry barriers. A major challenge for regulators will be how to put in place a global framework to facilitate cross‑border activity. Current signs point to increased regulatory fragmentation, not integration.
Ageing population: How can the investment industry better serve an ageing population?
The major changes in the investment industry are being driven by rising life expectancy and the steady devolution of responsibility for pension provision onto the individual, a trend that may well extend progressively to the financing of care costs. Further, far-reaching changes result from: the sustained low interest rate environment and the incentives this is creating to switch into higher yielding but also higher risk and often less liquid assets; the shift towards passive investment and the margin and consolidation pressure this is generating; and intensifying regulatory and competition scrutiny on a wide range of both conduct and prudential fronts.
The investment industry of the future will need to innovate to provide consumers with products more closely tailored to their life-cycle position, personal circumstances and risk appetite. Given the likely continuation of the “advice gap”, this will require clear, straightforward explanations of investment strategies and the associated risk of capital loss or of fund liquidity problems, particularly in periods of market stress and disruption. There will also be a need for comprehensive explanations as to how products can be mapped to individuals’ circumstances and needs. This will be especially important for those consumers considered vulnerable on a wide range of tests, extending well beyond economic circumstances to embrace such considerations as heath and cognitive ability: by its nature, the ageing population is certain to increase substantially the number of such consumers.
The income needs of an ageing population will also require the investment industry to reassess conventional wisdom in asset allocation, for example on such questions as whether it is appropriate for those already drawing pensions to maintain a sizeable equity exposure. Given the extent to which pension savers and pensioners are becoming directly exposed to market risk for much of their retirement income, the industry will also need to revisit how it can best provide some element of guarantees, or, at the very least, a greater degree of income predictability, within its product suite.
In short, the ageing population is creating a powerful need for investment product innovation. However, the investment industry will need to overcome an equally powerful inertia caused by low customer understanding and engagement, itself driven by low levels of consumer trust. To win this trust and manage its inherent reputational risks as a steward of other people’s money, the industry will need to respond credibly to massively intensifying regulatory scrutiny of cost transparency, value for money, fund liquidity management, and conflicts of interest between fund managers and their distribution and asset administration chains. The industry will also need to remain highly responsive, again in its role as steward, to rising popular concerns in such areas as the environment and ethical investing.
Regulators will continue to press for full transparency on the “real” costs of investing, in terms of absolute charges and resulting reductions in yield, and in a manner that enables meaningful comparisons across investment products provided by different sectors. They may need to revise their expectations of what types of investments are “suitable” for those investors already drawing a pension. And, in terms of demand for products with guarantees or inbuilt income predictability, regulators will need to balance the social benefits of such products with the need to ensure that providers hold sufficient capital against the risks. Regulators will also need to ensure that firms are managing the substantial liquidity risks of investing in higher yield alternative assets and promoting greater consumer awareness and understanding of those risks.
Technology: How can technology enable cheaper, better and faster provision of financial services and improve the efficiency of markets?
The major changes in technology are being driven by: customer expectations; competition and margin pressures; the availability of greater computing power (including through Cloud computing); the ability to draw customer and market insight from structured and unstructured data using artificial intelligence ; and the willingness of customers to engage with digital interfaces.
This has refocussed attention in two key areas – the industry-wide opportunities to reduce friction and challenges arising from the way new technologies are deployed within firms.
The future of finance is expected to be on-demand and flexible with firms offering tailored products on a point‑in‑time basis and enabling customers to switch between providers and products seamlessly. This will accelerate the expansion of platform-based financial services, where all customer interaction is consolidated in one interface or platform. Firms and the governments will also increasingly explore the role of utility-based functions (for areas such as Know Your Customer and onboarding requirements) to reduce customer friction and costs.
One of the inherent challenges with increased automation is the significant increase in speed and potential lack of transparency around decision making and related controls. How firms govern these innovative technological solutions, and identify and manage risks, from the design stage through to execution and post-deployment, is a challenge for them, and will be an area of focus for regulators.
In addition to reviewing the regulatory perimeter, regulators are expected to experiment with innovation themselves specifically in areas such as regulatory reporting, market surveillance and enforcement. In the longer term, the ability to interrogate and draw insight from firm and market level data at a granular level will have a significant influence on supervision, enforcement and policy development.
Low-carbon economy: How can finance support the transition to a low-carbon world?
The major changes under way in the low-carbon economy are being driven by: rise of new technologies, increasing pressure from customers, and increasing regulatory response to the financial risks posed by climate change.
The transition to a low-carbon world in the future will need to be accelerated by the access of financial services to “green” data. Therefore, for financial markets to work efficiently, new third parties will emerge to provide estimates of firms’ carbon footprint based on a stream of different data sources (e.g., satellite data, market sentiment and disclosures could be overlaid). In addition, financial services will (need to) think about what role they can play in reducing their customers’ carbon impact. As such, financial services firms may increasingly include a penalty factor or an incentive factor as part of the terms on which they provide finance to both business and personal borrowers. This will ultimately help reduce the inequality of carbon consumption across end users.
The key challenges will be for financial services firms to ensure a shared understanding of the low-carbon strategy across product development, risk management and sustainability teams. In addition, firms will need to boost their climate change scenario analysis capabilities (e.g., by exploring foresight over forecast) so as to price the climate change externality. As some “brown” firms will continue to exist, another key challenge will be for financial services to assess the utility of “brown” firms – in addition to their cost and carbon-efficiency.
Regulators will need to accelerate this transition by helping financial markets measure “green” data by framing and standardising it in order to allocate resources efficiently.
Emerging markets: How can we facilitate the increasing integration of emerging markets into the global financial system?
Major changes are under way in emerging markets, driven by the rising share of global growth that they account for (forecasted to grow to almost 65% of global GDP by 2022^3). The BoE expects that deeper global financial partnerships with emerging economies” will be the most important drivers of global growth in the decades ahead.”^4
As capital flows between developed and emerging markets increase, financial activity will naturally follow. Emerging markets will become better integrated into the global financial system through a combination of increased issuer participation, broader investor base and improved market access and efficiency. This integration is likely to lead to greater market liquidity and lower capital costs, and will present investors with new opportunities for investments and risk-sharing.
Regulators will need to ensure that this ever-greater integration is matched by increasing integration of rules and standards, and supervisory oversight. There is of course precedent for cross-border cooperation, but for a variety of reasons it is less well established with many of these economies. A plan announced by the UK government in May to expand a programme that sends BoE officials to help emerging economies reform their financial sectors^5 is an example of how this cooperation will be built. The agreement between the UK Financial Conduct Authority and Chinese Securities Regulatory Commission on the "Shanghai-London Stock Connect", which will support mutual access to each country’s capital markets gives an indication of how integration may developed.^6
The BoE (as the central bank) will also play a role in developing infrastructure to support cross-border capital flows in the currencies of emerging markets.^7 Analysis also points to emerging market debt and equity funds being more responsive to prices falls than advanced economy funds, with implications for financial stability.^8 Authorities in the UK are considering system-wide stress scenarios and macro prudential tools.
- Bank of England, Future of finance, 28 February 2019.
- We would like to thank the following experts: David Myers, Stephen Ley, Tony Gaughan, Andrew Bulley, Louise Brett, Jack Pilkington, Suchitra Nair, Mike Barber, Katherine Lampen, and Tasha Clarbour
- International Monetary Fund, World Economic Outlook, October 2016.
- Bank of England, New Economy, New Finance, New Bank, Mansion House speech by Mark Carney, Governor, June 2018.
- Reuters, UK to send more Bank of England advisors to emerging economies, May 2019
- Cf footnote 4.
- Bank of England, ‘Pull, push, pipes: sustainable capital flows for a new world order’, speech by Mark Carney, Governor, June 2019.