As part of our review of the past 12 months in fintech bobsguide is revisiting some of the standout interviews we have conducted in the past 12 months. First up is a joint bank/fintech interview we conducted back in May.
Industry attitudes to collaboration between fintechs and banks in the payments space have turned a corner in recent years. bobsguide sat down with Tony McLaughlin, Managing Director at Citi’s Treasury and Trade Solutions and Nick Pedersen, Managing Director, EQ Global, to discover how banks and fintechs are partnering to generate new payments propositions.
What is the relationship between EQ Global and Citi?
TM: The relationship started in 2006. Paymaster 1836 (one of the companies which merged to form Equniti) specialised in paying private and occupational pensions and Citi had just won the mandate from the UK Government to make pension and other payments to retirees overseas. Paymaster was paying many of the same beneficiaries, so we decided to join forces on international pensions payments.
Citi also formed a relationship with Lloyds Registrars around cross-border dividend and share plan payments. These two relationships came together under the Equiniti banner when those companies merged.
Then a market opportunity was identified in the UK SME market, where foreign needs are not always well served. Citi has a clearly defined and limited target market centred on larger enterprises so we were not able to reach into the UK SME space directly, even though we had superior product capabilities. That’s when we formed the relationship with EQ Global, through a contractual structure where EQ Global would be the front-end of the business supported by our global network, and enter the marketplace as a next generation transactional foreign exchange provider.
This is a perfect example of a fintech working with a bank; where two different organisations come together and do something that they couldn’t do individually. There is no reason for EQ Global to replicate the foreign exchange dealing or the payment processing that Citi performs at global scale.
By the same token Citi found it difficult to reach all the market segments that our capabilities were applicable to. By marrying the capabilities, the domain expertise, and the market reach, we created a completely new business that was primed for growth.
Has the partnership developed in the way you expected to when the deal was first signed?
NP: When I became involved in the partnership four years ago the thought was that EQ Global could provide competition to some of the major cross-border payments companies, and go after traditional core SME payments. The result of changes in the digital economy is that our front-end technology, added to Citi’s network, is quite compelling; it’s not just a payments network anymore. We can turn around development in a couple of weeks and solve a very narrow problem for a very particular sector e.g. global payroll.
Are there any banks and fintechs that could or should be looking at this relationship model?
NP: I think most banks would be wise to find a small number of specialised partners to work with, rather than the approach of partnering with 150 fintechs and seeing which technology works. The approach Citi takes, which I think is the better one, is a focus on a smaller portfolio that the bank can really work closely with. We are looking for feedback from Citi on the products we are developing because they see the high level macro trends in the market and we see the minutiae. When you put those perspectives together you can create something quite powerful.
Does the integral nature of your relationship with Citi preclude you from working with other partners?
NP: When we are focused on building products it is preferable to not be burdened with a dozen customer relationships to nurture and satisfy. Every bank will always want to do more business with you if you are performing well and it is much easier to do that when you only have one or two banks that you work with. So the relationship with Citi may preclude us from working with other banks, but that is not something I am missing.
What are the characteristics of fintechs that the bank looks for when seeking out new partners?
TM: We partner with fintechs in a number of different modes. We have a Citi Ventures arm, which acquires minority equity stakes. Here we’re looking for businesses that offer a unique capability that we don’t already have ourselves, or a business that can take us into markets that we can’t reach ourselves.
We also have several innovation labs where we co-create with fintechs, and we run the Citi Mobile Challenge and the Citi Tech for Integrity Challenge to engage with fintechs through thematic competitions.
From a business perspective, we’re quite selective about the partners we work with. Citi’s compliance requirements are high; we can only work with companies we believe are very high quality counterparties. We also examine opportunities through a commercial lens by asking who we think can be successful in a highly contested field.
Apparently 40% of all fintech is payments, and there are hundreds of start-ups in any given niche. We like to work with people who have differentiated value propositions.
Having worked for both a bank and now a fintech, do you believe that you have a unique perspective of how banks and fintechs should collaborate?
NP: Being on the banking side trying to identify differentiators within fintechs gave me a good insight on where we could take EQ Global’s business, because that’s the really crucial challenge that a fintech has. It’s not so much about forming that relationship, it’s how you make the most of it once you have the doors open to a bank like Citi – you don’t want to squander it by spending years building products that no one wants, so the trick is to decide quite quickly how you are going to differentiate yourselves and build something the market needs.
Do you think that one of the reasons fintechs and banks have been so combative in the past was that neither could see the industry from the other’s perspective?
NP: If you look at a lot of the more aggressive fintechs that have been anti-bank and not that collaborative, they tend to be run by consultants; very few are run by bankers. Or serial entrepreneurs that enjoy disrupting legacy systems and see banking infrastructure as something to be disrupted. I think what they are realising now is that to really achieve scale they are going to have to rely on banking infrastructure, and that is not going to go away overnight.
There is a trend of more and more bankers going into fintech and I think that is an element that is changing that attitude to collaboration. There will always be fintechs that are out there and designed to disrupt banks and take them down, but the trend is moving towards the model that we operate.
TM: EQ Global and Citi have built a business together that we are scaling and that the clients find value in – so we have found a common opportunity that we approach from a single perspective and there is no clash of interests.
There are many fintechs that are absolutely reliant on riding on banks‘ rails, but they may find their access limited. In cases of perceived market failure, regulators then step in to force banks to open up and allow non-bank competition to flourish.
Have you considered how PSD2 might affect the working relationship between Citi and EQ Global?
TM: PSD2 has two aspects; account aggregation and payments initiation, and we are particularly interested in the payments aspect.
For a business such as EQ Global, you are either paying on behalf of a client, or you are receiving money on behalf of a client. PSD2 will open up new ways to receive money on behalf of a client, so there is definitely an opportunity.
NP: I think that is where collaboration becomes so necessary. You can be a small fintech playing around with open banking infrastructure, not really know what you are doing, and quickly fail. When you are able to collaborate with a bank that is going through the same thought process you quickly understand what PSD2 means for us as a fintech and the bank.
TM: We see PSD2 in a global context. Understanding a new market factor is reliant on having a framework for understanding it – you can only understand something if it looks similar to something you already understand. We understand PSD2 in the light of Alipay in China, in the light of UPI in India and in the light of faster payments developments all around the world. These create reference points so when PSD2 is implemented it is not a strange animal.
What do you think are the issues or trends that are going to have the biggest effect on international payments in the next 12 months?
NP: The concept of being able to pay and receive from the same institutions – the outbound payments space and the collection space - have been quite separate for a number of years. You have our traditional competition which is primarily focused on outbound international networks. Then you have the card acquiring networks that focus purely on the collection side, but there is no one place for the next eCommerce giant to go to in order to solve both problems of paying and receiving money overseas. I think this is the dynamic many of us are trying to work out, without becoming all things to all people but instead solve it in particular niche areas.
TM: For Citi there are four macro developments in the payment space that we are tracking very closely.
First is the proliferation of faster payments schemes. We’ve had faster payments in the UK since 2008, but many countries are now implementing faster payment schemes. By 2020 there will be an incredible global structure for making and receiving payments in real-time that will benefit national economies, but also what you’ll see is people who are running global networks such as Citi tapping into those networks to enable real-time payments and receivables across the globe.
As Citi lays those pipes locally (and we’re likely to be members of more of these faster payments schemes than any other player), we will make that network available to partners like EQ Global and that will take EQ Global’s proposition to the next level.
The second is the development of bank APIs and sometimes that is being encouraged by regulators such as with open banking in the UK and PSD2 in Europe. The trend goes much wider - many banks are deploying APIs, so that creates another layer of infrastructure into which Citi can connect to provide new services that become available to our partners such as EQ Global.
A third area of interest is the developments that are taking place in the distributed ledger space. At the moment these are in a sandbox mode rather than production, but they might have relevance in the payments space with further development, so we’re studying those things very deeply.
The final potential development people are talking about is national digital currencies – digital dollars, pounds and yen. These are more at the conceptual stage at the moment and already there is much commentary on their potential unintended consequences, such as damaging commercial banking systems.
The first two trends are in production, and are creating usable infrastructures, while the second two are more conceptual or experimental at this point in time.
Do you foresee blockchain being a potential competitor in international payments?
NP: I would only see blockchain as a tool from a back office reconciliation perspective, I don’t believe in blockchain as a cryptocurrency tool. We would only look at it to make our back-end processing more efficient.
TM: Blockchain is a new technology and new technologies can take some time to find their feet. The relational database was invented in 1970 and only commercialised in 1979 by Oracle. Now almost all of the technology that we take for granted contains relational databases, so it shows that many foundational innovations go through long gestation periods.
Payments are made up of two layers, a messaging layer and a settlement layer. For a blockchain or distributed ledger to be adopted by the marketplace it has to be superior in at least one of those two layers.
On a settlement layer, the usage of a cryptocurrency for payments is problematic. For example, what is the currency worth? How easy is it to steal? Are banks expected to hold that currency on their balance sheet? There is a bid/offer spread every time you make an exchange, and by buying and selling a cryptocurrency you add an unnecessary currency exchange into the transaction.
Many of the blockchain providers are moving away from the idea of using a cryptocurrency in their payment schemes, but if you take out the cryptocurrency element then you are back to normal settlement routes. Settlement is either done through commercial bank money or central bank money, so in a sense by not having cryptocurrency you remove potential benefits from a blockchain solution.
From a messaging perspective, blockchain electrons move at the same speed as any other electrons, so there is nothing about blockchain that is inherently faster. The payments world has spent a lot of time building very ‘fat’ and extensible message formats, ISO 20022, where you can fit thousands of lines of invoice data. If you want to write ISO XML messages to a blockchain, you may have to build new power stations to power the computers doing the cryptographic calculations.
In addition, we also examine likelihood of adoption. There are two SWIFT networks; the FIN network and the IP network. It would appear that some of the benefits of blockchain would be delivered if every bank in the world connected to the SWIFT IP network and adopted XML message standards.
NP: Global payments networks are so complicated with so many incumbents already in place solving a lot of the problems, I would rather see blockchain solve a smaller problem first, such as reconciliation of air miles, and that might generate some adoption in payments.
TM: If a tool cannot solve a simple problem it seems a stretch to extrapolate it to very complex problems. Let’s see the demonstrated use of blockchain in a simple domain in production, not in sandbox, and then that tool may move up the curve of complexity. But to my way of thinking, attacking very complex domains before you solved very simple domains isn’t the correct approach.
NP: If you look at the main criticisms that are levelled at cross border payments, they are price, speed, and accuracy. Those three issues are steadily being solved by other methods to blockchain. In principle a blockchain concept could solve some of those things, in particular around speed and price, but what you have seen in the past few years is the drive of price down in any case; you can send money overseas as a consumer at extremely competitive prices.
The big challenge for cross border payments going forward is not price, it’s more speed, potentially the accuracy of delivery, but particularly using technology to solve an end-to-end problem around making a payment.