June 2016

Learning from the past: the OTT canary in thefinancial mine?

When you switch on your Netflix streaming service, listen to some music via yourSpotify app, or make that international call via Skype, you might want to pauseand reflect on the disruptive model underpinning those experiences – and whatit might mean for the future of financial services. Could what you’reexperiencing be the proverbial canary in the coal mine? Might what hashappened in telcos and media occur in financial services?

Last year, iiNet’s CTO Mike Dioguardi advised that Netflix was accounting foralmost 30% of its data traffic.1 Facebook also appropriates a similar amount ofmobile traffic2, yet both Netflix and Facebook pay zero dollars to networkoperators and ISPs. These digital media providers, including the likes of YouTubeand Apple, are what we call Over-The-Top (OTT) players: they sit on top of anunderlying network, using its infrastructure. The network operator has nocontrol over how the specific content is delivered, who views it or how it isviewed – even though the operator is aware of the IP packets flowing through itsnetwork and value of the service they’re providing.

1 itNews: iiNet is 'over the hump' of Netflix slowdowns, 20152 Sandvine: Global Internet Phenomena – Asia Pacific & Europe, 2015

At a glance

FOTTs (Financial OverThe Top players) useinnovative disruptions tore-appropriate value fromunderlying bankingcapabilities and reshapeindustry boundaries.

Banking on[top of] the future

Banking on (top of) the future | 2

The economic and strategic significance of these OTTs isthat they target and appropriate an increasingly largeshare of the internet’s value. In many cases, they getmore than the original network operators – the peoplewho bear the costs of providing, maintaining andupgrading the network. Although OTTs provide greatcontent and experiences, they also disintermediate thecustomer relationship away from the network operator.When you’re half way through House of Cards, are youmore loyal to Netflix or your ISP?

Telcos have largely been powerless to stop OTTsdelivering innovative products, services and customerexperiences at their expense. Some ISPs have done dealswith OTTs because they know customers want thecontent. However, they do so at the risk of cannibalisingtheir own products and driving network data growth3 thatthey will eventually have to pay for4. As a result, returnson their own networks are declining over time – makingtelcos look more like utilities – while returns to OTTs areincreasing.

In financial services, we can already see some FinTechstartups operating as Financial-Over-The-Top (FOTT)players by sitting over the top of the existing financialservices network. These organisations use innovativedisruptions to re-appropriate value from underlyingbanking capabilities and reshape industry boundaries.

FinTech though the FOTT lens

Because many incumbents are partnering and integratingwith FinTech startups, their influence is often consideredto be benign. However, this view may change onceincumbents recognise FOTT behaviour in FinTechs. Forexample, when a customer signs up for a PayPal accountusing their existing bank account, PayPal communicatesdirectly with the banks customer by sitting on top of theunderlying the bank service. FOTTs such as PayPal canappropriate a significant amount of the value from thesenew customer relationships without the same legacy andcompliance issues faced by incumbents5.

As FOTT market power grows, it may not necessarilycreate “winners” and “losers” straight away, but it couldinsidiously leach value from the roles played byincumbents. In telecommunications, OTT disruptorsbecame an issue for:

► Incumbents – who didn’t see themselves becominga “dumb pipe” and had already spent millions ofdollars trying to create differentiated consumerservices.

► Regulators – who didn’t have copyright and creativecommons legislation ready for new media channelsand major players.

Although it is hard to imagine the current financialservices organisations becoming commoditised, currentprice sensitivity from customers could be an early

3 ATKearney: A Future Policy Framework for Growth, 20134 itNews: Telstra to roll out 135 rural 4G base stations, 20165 EY & HMT: UK FinTech on the Cutting Edge, 2016

indicator. While banks are turning to FinTech to attractcustomers and lower costs, this could also drivecannibalisation and dilute their customer relationships –an effect compounded by consumers’ growing interest inadopting FinTech6.

Models of FOTT disruption

We are seeing FOTTs using three different types ofdisruption:

1. Disintermediating financial institutions - treatingthem as the financial equivalent of thetelecommunications “dumb pipe”. In this model,incumbents are separated from their coretransaction and information, with the intelligencecreated, and captured, by FOTT players such ascloud-based payment processers and wallets.

2. Facilitating peer-to-peer (P2P) market making -aggregating the bids or prices at which individualmarket participants are prepared to transact,deposit or borrow money and bringing these partiestogether for a fee. This is used by some internationalcurrency providers and most lending providers.

3. Encouraging participants to bypass the formalfinancial system - encouraging the “banked” tobecome unbanked or use other mediums as financialdeposit holding instruments.

These types of disruptions can be pursued simultaneouslyor separately, depending on the new entrant’s businessmodel and objectives. In particular, whether they areattacking an existing segment and whether or not theyare relying on leveraging the existing underlying bankingsystem.

Figure 1: Models of FOTT disruption

Leve

rage

ofun

derly

ing

bank

ing

syst

em

No

Yes

Existing Market New Market Making

Market Opportunity Focus

6 EY: FinTech Adoption Index, 2016

By-pass formal bankingSystem

e.g. Deposits,Investments

Disintermediate existingfinancial institution

relationshipse.g. Local Payments,

Remittances, CustomerRelationships, Wallets,

Insurtech

Make new markets viainnovative peer-to-peer

offeringse.g. Peer-to-peer, Lending

Banking on (top of) the future | 3

Emerging battlegrounds

At present, we are seeing FinTech disrupt the financial services sector in six “battlegrounds” (Figure 2), spanning bothconsumer and business segments. Lucrative opportunities also exist for those who can capitalise on large global micro SMEmarkets, particularly in emerging economies, and on scalable solutions for the commercial sector.

The model below is illustrative only. It is difficult to draw clean distinctions across FinTech as, in practice, innovations areblurring existing boundaries. For example, payment capabilities span both local and international payments. Similarly, somepayment applications also morph into digital wallets; some crowdsourcing funding models also work as peer-to-peer depositand investment takers.

Figure 2: Six emerging "battlegrounds"

1. LocalPayments 2. Remittances 3. Peer-to-peer

& Lending4. Deposits &

Investments

5. CustomerRelationships& Wallets

6. Insurtech

Consumer

e.g. PinPayments,PayPal, numbrs

e.g.Transferwise,HomeSend,CurrencyFair ,azimo, venmo,worldremit

e.g.DirectMoney,LendingClub,Moneyplace,Harmony,Ratesetter,SocietyOne

e.g. Sigfig,Syndicate Room,nutmeg,Orchard,Squirrel

e.g. PayPal,Yoyo wallet,Mondo, Pockit,Moven

e.g.friendsurance,TrueMotion,Oscar, cuvva,Guevara,

SME

e.g. tappr,Satago, PayPal,Lemon, Square,Pin Payments,Braintree

e.g.Transferwise,HomeSend,CurrencyFair ,venmo,worldremit

e.g. Moula,LendingClub,Moneyplace,Timelio,GetCapital,Funding Circle,Kreditech,Ratesetter,iwoca

e.g. mint,Orchard, Sigfig,Syndicate Room,nutmeg, EssentiaAnalytics

e.g. Moven ,PayPal, Yoyowallet

e.g. Bizguard,Insly, insureon

Commercial

e.g. PayPal,Lemon,Braintree, PinPayments,

e.g. HomeSend,currency cloud,clearXchange,CurrencyFair

e.g. GetCapital,Kreditech,Marketlend

e.g. Orchard,Sigfig, EssentiaAnalytics,Squirrel,Fundapps

e.g. PayPal,Lemon, Squirrel

e.g.Quantemplate,Analyze Re,Insuritas,360Global

Will financial services incumbents “see it coming”?

“Objects in the mirror are closer than they appear.”

Disruptive innovation research shows that executives inincumbents are often fantastically optimistic andintransigent when faced with apparently distant threats.The list of famous last words of celebrated CEOs who“didn’t see it coming” within their industry is soberingand growing7. How will financial services leaders andregulators avoid the same fate?

Being able to react to a changing situation, starts withseeing the change, understanding what it means and howit is significant, and then contemplating how the currentmodel needs to change. It also means convincing theremaining doubters in the organisation that resourcesneed to be marshalled in a new direction.

The starting point for this is to recognise the collective“mental model” that management has of the industry ingeneral and their organisation in particular. When people

7 Australian Financial Review: Don't dismiss disruption like theexecutives who ignored these 11 tech threats, 2016

work in an industry for a long time, they develop aparticular view of how the world works: what customerswant, how costs behave, what’s important to get right,how to make money and even who is the competition.They use these mental models as convenient short handfor framing complex industry knowledge and using this tomake decisions. The problem is that, the industrychanges, managers rarely revisit the assumptionscontained in their mental models. They are captive totheir old thinking.

Old thinking prevents management from see beyond theirimmediate business model – even if they believe thefuture will be different. For example, Kodak’s leadersunderstood that digital photography would eventuallydominate their industry, but their old thinking preventedthem from seeing how to make money out of it. At thetime, their “razor-blade” business model depended onselling high-margin film on the back of cheap cameras.Kodak held back on investing in digital camera innovation

Banking on (top of) the future | 4

because management feared the negative impact on filmsales. When Sony launched a filmless digital camera, itwas too late for Kodak to catch up.

Currently, many incumbents are thinking about FinTech inthe context of old industry models. What innovations arethey failing to invest in because the result would threatentoday’s margins?

Potential mid-term possibilities:understanding the macro scenarios

Unless we know the full extent of change and its velocity,setting the direction for the future becomes challenging.However, we can speculate on likely scenarios based ondifferent demand and supply factors.

On the supply side the main uncertainty revolves aroundto what extent the market will be fragmented orconsolidated. Will global FOTT players be successful inachieving scale, or will smaller FOTTs and local incumbentbanks dominate?

On the demand side, the main uncertainty is the extent towhich consumers and business customers accept thesenew FOTT players.

Figure 3: Short-term scenarios

2. Co-Existence

(Fragmented Supply,Mainstream Demand)

Acceptance of FOTTs is highand there is a large group ofentrants and wide variety ofbusiness models servicingbattlefields, with both localand larger global playerscompeting

4. Dumb Pipe BankingUtility

(Consolidated Supply,Mainstream Demand)

Larger global FOTT playershave consolidated eachbattlefield area and demandis mainstream

1. Status Quo

(Fragmented Supply, NicheDemand)

The current state wherethere is a plethora of newFOTT attackers, but demandis nascent

3. Armageddon Avoided

(Consolidated Supply, NicheDemand)

Larger global FOTT playershave consolidated, formingallegiances and/or rolling upthe smaller FOTTs, howeverdemand is niche and theservices don’t ever seriouslyrival mainstream banking

Macro Scenarios

1. “Status Quo” (Fragmented Supply, Niche Demand)– the current state with a plethora of new FOTTattackers, however nascent and niche demand. Thetraditional banking model continues to dominateand bank profitability is high.

2. “Co-Existence” (Fragmented Supply, MainstreamDemand) - acceptance of new attackers is high, witha large group of entrants and wide variety ofbusiness models servicing different battlefields.FOTT players have partnered or formed allianceswith incumbents and battlefield profit pools arehotly contested; banks win a share but overallprofits are down.

3. “Armageddon Avoided” (Consolidated Supply,Niche Demand) – FOTT players have consolidated,now dominating each battlefield area. Despite this,demand for services now seriously rivals themainstream banking system and local incumbentbanks have managed to avert a significant threat totheir profitability.

4. “Dumb Pipe Banking Utility” (Consolidated Supply,Mainstream Demand) - larger global FOTT players ineach battlefield, crowding out local incumbents ineach area, with large numbers of consumers andbusiness customers using these services. Bankshave now become utility providers, with thecustomer relationship owned by the FOTT.Battlefield profit pools are contested by large FOTTsresulting in utility-like returns in these areas forbanks.

Using micro scenarios to ask “whatif?”

To avoid miscalculating the scale of change, financialservices incumbents must consider “what if” scenarios tothink about how a “whole new world” could unfold. Newplayers may not simply “plug in” to the existing world.Ideas that once sounded preposterous, are becominghighly possible. A recent monitor of Australian consumersrevealed that “42% would consider opening a bankaccount with Paypal”8 while an increasing number of“digitally active” consumers are being lured towardsFinTech offerings9.

The following scenarios consider the major shifts thatcould occur if consumer demand takes a substantial turnand if regulators, investors and other market playerschange their stance towards FinTech.

8 EY & EY Sweeney: Digital State of the Nation: 2015-16, 20169 EY: FinTech Adoption Index, 2016

FOTT Demand Goes Mainstream

Indu

stry

Envi

ronm

ent

isFr

agm

ente

d

IndustryEnvironm

entis

Consolidated

FOTT Demand Remains Niche

Banking on (top of) the future | 5

Micro Scenario One – “What ifconsumers take up paymenttechnologies such as Android PayTM

en masse?”

The “stickiness” that consumers have demonstratedtowards smart devices carries large ramifications. Twoovertly dominant players in the smart device market havethe capability to tailor offerings to us and targetadvertising at us in more innovative ways. However,previously, these system providers did not have fullaccess to the pivotal information of when and how wespend our money. Now with Android PayTM and othersrolling out to more markets globally, the power of thesetwo giants to see all that we do, and communicate with usthroughout the day, is immense.

In a new world, these providers may know: where we live,where we work, who we’re friends with, how often wecontact them, where we drive, how much we earn, howmuch we pay on our mortgages, how healthy we are andwhat we buy. In this alternate world, what will banks,insurers and wealth managers know about us that willmake us still use their service?

Micro Scenario Two – “What if Xerooffered peer-to-peer lending basedon data analytics?”

Thousands of SMEs globally have adopted Xero’saccounting platform. The Software as a Service startuphas matured as an enterprise and forged multiplepartnerships to bring customers a wider net of integratedbusiness solutions. The Xero platform collects multipledata points on SMEs’ day-to-day business activities,generating an intimate knowledge of their clients’financial management history, financial position, creditterms, margins, debtors, creditors and cash flow.

Imagine if, in a future world, Xero put this knowledge touse in its own peer-to-peer lending solution. Xero wouldknow which clients have surplus funds to invest and,

conversely, which clients need credit – and theirrepayment capability. This could become even moregame-changing if Xero innocuously offered peer-to-peerlending for invoice payments as a line of credit oroptional short-term accumulation service. In this world,why would SMEs approach banks and existing lendingservices, if they have access to intuitive financing andasset management solutions?

Longer-term possibilities: impactsto banking business models

As the impacts of change become more visible, banks willneed to adjust their business models and strategies. Wedon’t know what the actual future will be, but we canpredict how potential changes could be handled. Banksmay look incredibly solid, but they are finely balancedand highly sensitive to changes in critical parts of theircapital structures and revenue lines. Fundamentally, bankprofitability is driven by a tight nexus between a:

► Healthy balance sheet – comprising cheap fundingsuch as deposits and “good” risk loans

► Healthy P&L – comprising fee income from accountrevenues and loan spreads.

Any erosion of either will reduce profitability overallsignificantly, particularly on the balance sheet side.

In the post-GFC era, banks must hold more regulatorycapital to withstand potential future shocks. Now, FOTTplayers are putting additional pressure on bank balancesheets by eroding their value. These impacts could gaintraction if adoption becomes more mainstream. What willhappen, for example, if superannuation or mutual fundsdeploy even 0.5% of their funds into FOTT or otherfintech models?

Already, the viability of the current large, financialdepartment store model is in question. The delicatebalance is under threat as FOTTs attack each element ofa traditional banking model (see Figure 4).

Bank Customer RelationshipsCustomer relationships drive loyalty, product sales and furtherreferrals

Bank Balance Sheet Bank Profit & LossCustomers provide deposit offunding which banks use askey source of capital to makeloans

Banks earn fees on accounts,transactions and advisoryservices. Customers earninterest on deposits and payinterest loans

Simplified Bank Model

Disintermediatedrelationships andlowerdifferentiationmake cross/upselling moredifficult

Fee incomereduced throughlower costattackers

Interest incomereduced throughmore competitivedeposits and loans

FOTTsdisintermediateexistingrelationshipsreducing customerswitching costs,and loyalty

Higher competitionfor deposits and“good risk” loansfromcrowdsourcing andP2P weakensbalance sheet

Figure 4: Simplified bank model

Banking on (top of) the future | 6

Staking out a position in the future

Disruptive transformation is not likely to happen overnight. It may be more than a decade before we see a glimpse of thefinal industry landscape taking shape. However, the future is already writing itself and new FOTT players are jockeying intoposition. Some look set to become a permanent fixture in the industry.

To calculate the coming change and respond to it appropriately, incumbents must begin the complex process of strategicand business model renewal.

This starts with asking the better questions:

► Do we see what is on the horizon? Can you sense what it might mean?

► Do we know how to explore and act? Will we know how to act quickly with shrewd judgment?

► If we don’t perceive FOTT as creating a fundamental shift – why not?

► Are we influenced by facts, empirical lessons, fears or not understanding what we don’t know?

AuthorsLead AuthorMaurice Violani, Partner,Transaction Advisory Services, AustraliaMaurice.violani@au.ey.com

Co-AuthorSonia Miles-Khan, IT Advisory, FinancialServices, AustraliaSonia.miles-khan@au.ey.com

Co-AuthorMeredith Angwin, Partner,IT Advisory , Financial Services, AustraliaMeredith.angwin@au.ey.com

References

► The Age, 2016, ‘Australian banks report lowest profitabilitysince 2009’, 11 May, Accessed athttp://www.abc.net.au/news/2016-05-11/australian-banks-lowest-profitability-since-2009/7404898.

► ATKearney, 2013, ‘A Future Policy Framework for Growth: Areport for the European Telecommunications NetworkOperators' Association (ETNO)’, Accessed athttps://www.atkearney.com/communications-media-technology/featured-article/-/asset_publisher/8RuTMUxXJpxX/content/a-future-policy-framework-for-growth/10192.

► Australian Financial Review, ‘Don't dismiss disruption like theexecutives who ignored these 11 tech threats’, June 13,Accessed at http://www.afr.com/brand/boss/dont-be-like-these-executives-who-dismissed-disruption-when-it-hit-20160610-gpg7c7.

► Becerra, J, Evans, P, 2015, ‘Navigating a world of digitaldisruption’, Latin Trade, vol. 23, issue 6 p 12

► Bernhoff, J, 2013, ‘Are You Ready for Digital Disruption?’,Marketing News, vol. 41, issue 1, pp. 24-25

► EY, 2015, ‘Emerging technology trends: the road to the bank ofthe future’, Ernst & Young, Australia, Accessed athttp://www.ey.com/Publication/vwLUAssets/EY_-_Emerging_technology_trends/$FILE/EY-emerging-technology-trends.pdf

► EY, 2016, ‘EY FinTech Adoption Index’, Ernst & Young (Global),Accessed at http://www.ey.com/GL/en/Industries/Financial-Services/ey-fintech-adoption-index

► EY & EY Sweeney, 2016, ‘Digital Australia: State of the Nation2015–16’, Ernst & Young, Australia, Accessed athttps://digitalaustralia.ey.com/.

► EY UK & HM Treasury, 2016, ‘UK FinTech On the cutting edge:an evaluation of the international FinTech sector’, Ernst &Young, United Kingdom, Accessed athttp://www.ey.com/Publication/vwLUAssets/EY-UK-FinTech-On-the-cutting-edge/$FILE/EY-UK-FinTech-On-the-cutting-edge.pdf

► itNews, 2015, ‘iiNet is 'over the hump' of Netflix slowdowns’, 6July, Accessed at http://www.itnews.com.au/news/iinet-is-over-the-hump-of-netflix-slowdowns-406025

► itNews, 2016, ‘Telstra to roll out 135 rural 4G base stations’,July 19, Accessed at http://www.itnews.com.au/news/telstra-to-roll-out-135-rural-4g-base-stations-420979

► Sandvine, 2015, ‘Global Internet Phenomena – Asia Pacific &Europe’, Accessed athttps://www.sandvine.com/downloads/general/global-internet-phenomena/2015/global-internet-phenomena-report-apac-and-europe.pdf

► Levy, N, 2011, ‘Digital Disruption Drives Change’, PR NewswireEurope Including UK Disclose, 23 March, PR Newswire

EY | Assurance | Tax | Transactions | Advisory

About EY

EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We developoutstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited byguarantee, does not provide services to clients. For more information about our organization, please visit ey.com.

© 2016 Ernst & Young, Australia.

All Rights Reserved

APAC no. : AU00002694

This communication provides general information which is current at the time of production. The information contained in this communication does not constitute advice and should not be relied on as such. Professionaladvice should be sought prior to any action being taken in reliance on any of the information. Ernst & Young disclaims all responsibility and liability (including, without limitation, for any direct or indirect or consequentialcosts, loss or damage or loss of profits) arising from anything done or omitted to be done by any party in reliance, whether wholly or partially, on any of the information. Any party that relies on the information does so at itsown risk. Liability limited by a scheme approved under Professional Standards Legislation.

ey.com/au