Why are banks, wealth managers and family offices putting their own capital into new fintech businesses instead, in some cases, of making the innovations directly themselves? FWR takes a look at the rationale.
As banks, wealth managers and other financial players try to surf
AI and other technology waves, a question that arises is whether
it is easier to finance R&D in-house or fund an external
venture instead.
The topic arose again in early September this year when Luminary,
which calls itself an “AI-native wealth transfer and
administration platform,” raised $22 million in Series A funding
that drew participation from the likes of BNY, the FinTech Innovation Fund
of Rockefeller
Capital Management, Focus
Financial Partners, family offices, and others. That funding
round was led by Ten Coves Capital.
Luminary says it turns estate documents into structured,
source-verified data powering workflows for financial advisors,
trust companies, law firms and accounting firms. This might be
the kind of business that established firms could have built
themselves, but as the example shows, it might make more sense to
leave this role to a new firm and try to profit if it succeeds
and take a controlled hit if it doesn”t.
“For a wealthy family, there’s no more important task than
planning for their future. That goes well beyond distributing
assets. It reaches charitable giving and what the next generation
cares about. Luminary gives families and their advisors a
powerful way to do that work together. That’s why I invested,”
Rudy Adolf, founder and former CEO of Focus Financial Partners,
told Family Wealth Report. Adolf has invested in
Luminary at Focus, and individually through his family office.
“People say general-purpose agents will commoditize application
software. But Luminary is different because it isn’t built on an
LLM [large language model]. It’s built on proprietary, structured
data that captures every entity, asset, relationship,
distribution term and fiduciary power in an estate, audited for
completeness and tied back to the source documents. A smarter
model can’t copy that,” he said.
A clear trend
There appears to be a clear trend of startups being where the
action is for fintech innovation, rather than from established
players, Arvind Purushotham, head of Citi Ventures, told
FWR.
“There’s little R&D in financial services that goes on in
large financial services. A lot of that innovation is in the
startup world,” he said in a call. “This [investing in firms]
gives us on-the-ground intel that can be very helpful. We have
got insights that we would otherwise not have.”
Purushotham’s own career is testament to the durability of this
approach. He has been at Citi Ventures for more than 15 years and
was part of the founding team. With a background in the US and
Silicon Valley venture capital sector, technology is a big part
of his background. Purushotham has worked in the technology
sector as a semi-conductor engineer. Before Citi Ventures, he
worked at VC firm Menlo Ventures.
Today, Citi Ventures has more than 100 businesses in its
portfolio. One segment of this is fintech businesses. It
recently sold an anti-fraud tech business to VISA, for
example.
In fact, Purushotham and his colleagues meet hundreds of startups
a year that are looking for capital.
Taking this approach is useful both for seeding potential fintech
“winners” but it also keeps banks at the leading edge of
innovation and in touch with what their peers are up to.
“We understand business models even better and see what our peers
are doing…we become partners in these businesses,” he said.
Importantly, investee companies don’t need to be clients of Citi,
he said.
FWR asked BNY about this approach to “outsourcing
innovation.”
“We are focused on identifying emerging technologies that can
help address real challenges across financial services,” Marianna
Lopert-Schaye, global head of strategic partnerships, investments
and innovation at BNY, said. Asked about the specific Luminary
business, she said it “brings a distinctive approach to wealth
transfer and estate planning, an area of wealth tech where
modern infrastructure can help advisors better serve high net
worth clients.”
If you can’t beat ‘em, join ‘em
It may be that part of the reason for investing into external
firms is a defensive one. Fintechs pose a competitive challenge
to incumbent banks, particularly as the latter labor under legacy
technology and costs. Seeding fintechs that can also be later
absorbed or used by the investing bank looks like a smart move.
A paper presented to the FDIC Bank Research Conference 2024, by
academics from Duke University and University of Connecticut,
entitled From Competitors To Partners: Banks’ Venture
Investments In Fintech, found that the percentage of
banks investing in fintech surged from around 20 per cent in 2001
to more than 70 per cent in 2022; five banks made such investment
before 2011, and 24 banks did so in 2022. Fintech deals involving
banks reached 66 in 2022, rising from only five before
2014.
Readers will recall the flurry of interest around “robo advisors”
more than a decade ago, and the AI trend in some ways continues
in this vein. For example, Goldman Sachs and JP Morgan were
co-investors in Motif, an early robo-advisor. As that example
showed, however, these ventures don’t necessarily work out as
predicted: Motif closed in the spring of 2020. (Charles Schwab
later acquired Motif’s intellectual property, including its
technology platform, algorithms, and source code.)
Turning to another bank, in 2020 UBS set aside “hundreds of
millions of dollars” of its own money (Forbes, May 26,
2020) for a corporate venture fund. In Japan, Mizuho put money
into a local robo advisor, WealthNavi. Just over a decade ago,
UBS Wealth Management Americas and tech company SigFig formed a
“strategic alliance” to develop digital technology for UBS WMA,
its financial advisors and their clients.
Prove, a North American tech company, said in a January 31, 2022
article on its website that the amounts that banks and fellow
financial firms are putting into fintechs has continued to
grow.
“Most leading banks with vast AuM have realized that investing in
fintech is the future, another reason why fintech startup
valuations are so high,” it said. “Investors will gauge how well
these investments are received by incumbents, and this will lead
to more investments from venture funds or other banks that will
open their own venture funds. In contrast, older financial
institutions are developing labs and accelerators to leverage
emerging technologies in order to foster innovation. By
partnering with fintechs, they gain expertise in fields outside
of their areas of specialization.”
Among examples of more recent deals, Capitolis, a fintech that
says it unlocks balance sheet constraints and cuts capital market
risks, said in October that it had completed $220 million of
financing. The round was led by Citi. Bank of America, Nomura and
Tradeweb Markets came in as new strategic investors. Barclays,
BNP Paribas, JP Morgan, State Street and UBS also took part. In
another case, Quantifind, a US regtech providing AI-powered
risk intelligence for financial crime and national security work,
raised a $200 million growth investment led by Summit Partners.
Existing backers Citi Ventures, S&P Global, Deloitte and
Stephens Group also took part.
Possible downsides?
There is some suggestion that banks’ investment in fintech firms
might dent returns over time, even though bank executives will
nevertheless think the expense is worthwhile if they
gain intellectual property and other benefits.
According to a March 2022 research paper (source: Science
Direct), “Bank equity investments in fintech firms generate
statistically significant negative abnormal stock market returns
(CARs ranging from -0.21 per cent to -1.05 per cent), driven by
integration costs, technological redundancies, and higher
risk-taking,” it said. (“CAR” is “cumulative abnormal
return.)
Whatever the figures say, the focus on AI and the large amounts
of capital required to drive it will likely continue to encourage
some banks to finance fintech startups.
At Citi Ventures, Purushotham said there have not been many exits
from its wealthtech portfolio because many of the relevant
companies are among its more recent investments.
“Some of our current portfolio companies operating within that
are relevant to wealth management and private banking are
Wealth.com, Jump, Conquest Financial, and iCapital, to name a
few,” he said.
Innovation role
Purushotham said he thinks of Citi Ventures’ innovation approach
includes three areas: to invest in firms that are developing
differentiated solutions and introduce them to business leaders
inside the bank for possible commercial use; second, convening
meetings between founders and Citi leaders to discuss trends, and
third, to educate Citi employees about opportunities and
advancements that new technology gives rise to.
Clearly, AI is ever present in today’s discussions.
“Generally speaking, nearly every startup we speak to has an
element of AI integrated into their product, in a lot of
ways. AI nativity is becoming “table stakes” for companies
really seeking to drive innovation, particularly in financial
services,” Purushotham said. “There are so many areas of
financial services that can be augmented by AI, from automating
meeting notes and actioning follow-up items between advisors and
their clients through agentic workflows, or KYC processes that
can be streamlined in a safe, compliant way with AI. Given our
position investing on behalf of Citi, we’ll continue to look at
those startups that are developing the future of finance, which
in many cases may involve an element of AI workflows,” he added.
In certain cases, a fintech is steered at an established trend
such as intergenerational wealth transfer, for example via the
Luminary venture.
“Scaling wealth transfer services starts with data that can serve
as a single source of truth for advisors and the families they
serve. We’re proud to back Luminary as it delivers a platform
that helps advisors bring a new standard of care to their
clients,” Steve Piaker, founder and managing partner of Ten Coves
Capital, said.
Luminary’s platform supports client assets totaling more than
$500 billion; clients include Caprock, IEQ Capital and Wealth
Enhancement Group, as well as tax advisory practices, AM Law 100
legal practices and trust companies.