With so many Canadian companies emerging to the forefront of the financial technology industry, a lot of fellow investors ask us “How did this happen?”
The secret to Canadian Fintech success lies in a single word “oligopoly”. And like many sudden trends, the roots of it came about a long time ago. Like 1930s long time ago.
As a response to the collapse of banking during the depression, countries acted together (Bretton Woods) and independently to strengthen the financial sector in an effort to protect depositors from structural weaknesses. In the United States, the Glass-Steagall Act of 1933, and the following Banking Act of 1935 were designed to maintain a decentralized system by such methods as banning interstate retail banking (strengthening the McFadden Act of 1927), and banning agglomeration of financial services (insurance, brokerage, etc…). The idea was to reduce exposure to financial crises by essentially firewalling depositors from potential global contagions at the state and local level. The outcome was that by 1988, there were 13,400 banks operating in the United States with 12,500 of those having less than $300M of assets. At the time, there was very little co-operation within the ecosystem, and with so many small local banks, balance sheets were not strong enough for a vast majority of the sector to invest in meaningful technical innovations.
In the meantime, the Canadian regulators took an opposite approach to the Americans and worked to promote merging of local and regional banks into increasingly larger deposit takers while discouraging new entries – especially foreign banks. As a result of this approach, only two regional Canadian banks have ever failed since 1923 and after a slew of mergers, the Canadian financial sector became dominated by “the big 6” oligopoly that we now recognize today.
With literally thousands of potential counterparties at the table, it was impossible for American banks to form a shared national interchange for debit transactions, so the debit revolution was missed by Americans, along with many other technical advances made by Canadian banks during the 1990s.
So how does this effect Canadian financial technology? Well, some very serious improvements in banking technology occurred because these large banks had balance sheets to invest in important innovations such as deposit systems and Automated Banking Machines (ABMs). For example, during the 1980s CIBC and Royal Bank were among IBMs largest mainframe customers (and an impetus behind the development of the massive IBM Research Centre in Markham Ontario). During the late 1980s and early 1990s these two banks were the largest global buyers of ABMs from NCR (which at the time was the largest ABM manufacturer in the world). It was also in the mid-1990s that a national automatic debit system was introduced along with the seminal shared electronic interchange called Interac. Interac could be considered an early ancestor of cloud computing and occurred because there were only six counterparties to its formation. All of this activity led to the development of a vibrant ecosystem of FinTech innovators that most Canadians haven’t heard of because they were either subsumed by their banking clients, or they were quickly acquired by global technology behemoths like IBM. Why did this happen? Why did companies like Janna Systems, Phoenix Technologies and so many others disappear before they were recognized?
By contrast, with literally thousands of potential counterparties at the table, it was impossible for American banks to form a shared national interchange for debit transactions, so the debit revolution was missed by Americans, along with many other technical advances made by Canadian banks during the 1990s. While Canadian bankers were already talking about “virtual banking”, and deploying some of the very first on-line banking services, a majority of undercapitalized American banks were struggling to buy used bank machines. This means that there was a pretty limited market available to successful Canadian FinTech vendors beyond the local Big 6 market – especially related to payment networks and back office technologies. Although the market did not scale well into the US for Canadian FinTech (despite blowing billions trying), the capabilities were born and remain for a second wave that the American financial sector is not only participating in, but now leading. How did this new wave of US demand suddenly emerge?
Canadian FinTech vendors, with a long pedigree of expertise, now have larger markets to sell into as blockchain technologies disrupt antiquated clearinghouses, as corporate income statements and consumer bank accounts become cloud enabled, and as payments become ever more mobile and flexible.
American bankers recognized, especially after the Savings & Loans Crisis in the 1980s, that regulations were hindering innovation and actually creating unintended risks. As such, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 introduced relaxed restrictions on interstate deposit-taking. Hundreds of local and regional mergers formed, creating a handful of “super-regional” banks like U.S. Bancorp, New York Mellon, and PNC Financial among others. This activity contributed to the repeal of the Glass-Steagall Act in 1999, allowing deposit-taking banks to merge with investment banks, and to allow further scaling. The result was another merger frenzy which greatly reduced the number of banks operating in the United States while expanding balance sheets. Now there are only about 6100 banks operating in the US with 1900 of those carrying balance sheets above $300M. As well, partly due to the Financial Crisis of 2008, the US now has its own national “Big 6” that represents over 55% of all American assets and some of the Super Regional banks rival the Canadian Big 6 in asset size.
Canadian FinTech vendors, with a long pedigree of expertise, now have larger markets to sell into as blockchain technologies disrupt antiquated clearinghouses, as corporate income statements and consumer bank accounts become cloud enabled, and as payments become ever more mobile and flexible. Davis & Henderson, Carta Worldwide, VersaPay, Wave Accounting, Freshbooks, Vogogo, Posera-HDX, Beverly Payments, PayFirma, IOU Financial and many more are all now positioned much better for global reach than those fintech firms of the 1990s because current global financial markets are more integrated and the United States is no longer a technology laggard in the sector.
With bigger complex markets comes more vigorous global competition. It will be interesting to see how well these companies can leverage their capabilities to carve out meaningful market niches and sustained cash flow. There will be more losers than winners, but we are convinced that, unlike in the 1990s, a couple of Canadian vendors could emerge as globally recognized FinTech brands.
We are watching the space closely and are investing in what we consider to be the best management teams among them.
About the Author, Ron Shuttleworth:
Mr. Shuttleworth joined Stableview Asset Management in May 2014. For the previous eight years, Ron was recognized as a leading equity analyst specializing in technology and special situations. Ron’s research garnered a loyal following and was well regarded both by clients and his peers. Ron’s research has consistently produced solid returns for the clients of this firms at which he worked. His research also help facilitate many of the capital market activities of the companies which were the subject of his reports.
Prior to his career in the capital markets, Mr. Shuttleworth spent over a decade in the software industry as a founder-CTO, CEO, and Venture Capital Executive-in-Residence. In 1997, Ron was a founding partner in a leading internet distributed enterprise software company that was acquired in 2000 by a Boston-based software company. In 2001, Mr. Shuttleworth returned to Toronto to become Executive-in-Residence for venture capital firm. It was during this time that Ron took on the role as Chief Executive Officer for an enterprise financial software company located in Kitchener Waterloo, where he helped the firm raise venture capital.
Ron began his career with a large Canadian bank helping to redesign its retail network, and then introducing electronic delivery systems into its retail mix as General Manager, Alternative Delivery Systems. Projects included debit cards, smart cards, interactive kiosks, and internet banking. Prior to founding the software company Mr. Shuttleworth spent three years at boutique advertising firm where he was Director of Interactive, which was responsible for some of the earliest web-based commercial transactions executed.