The Innovation for Financial Services Summit was held in Luxembourg on 21-23 September 2011. Organized by the Public Research Centre Henri Tudor in partnership with ISPIM (International Society for Professional Innovation Management), it brought together innovation management professionals from research, industry, and intermediary organizations with a shared interest in the financial services sector. The format included themed sessions for academic and practitioner presentations, together with discussion panels, leading keynote speakers and workshops.
Talking about innovation requires starting to define what innovation means, especially in the financial services sector. A common definition to which most panel speakers agreed is to define an innovation as something new and useful. Most innovation in the financial services sector so far was either centered around technology (e-banking, mobile payments, etc.) and investment products (structured notes, CDOs, MBS, etc.). In addition, the introduction of the UCITS framework some 25 years ago was seen as a major driver for the fund management industry in Luxembourg.
Innovation areas in the financial services industry
The plenary session presentations and the panel discussions where mainly focused around identifying the drivers of innovation in the financial service sector. Taking a high level view, there exist three main dimensions of innovation, that is,
- transfer of risk between market participants,
- enhancement of liquidity, and
- generation of funding through managing the cost of credit.
The focus in innovation is, according to one speaker, always around the three areas of
- revenue generation,
- cost reduction and management, and
- business or operating model development.
The most common inhibitors for innovation are i) not invented here and ii) not sold here. But also the perceived complexity, especially of new investment products is perceived as a drainer for innovation. This has become especially true after the recent crises where innovation in investment banking has been considered devilish. Unfortunately, complexity does not say anything about the merit or the worthiness of an innovation.
The current sentiment tends to move back to basics, which has as a consequence to dry up innovation. According to the panelists, we need to move from a yes but mentality to a yes and one.
Another perceived drainer for innovation discussed was the trend towards outsourcing. Indeed outsourcing is focusing on cost reduction and as such makes it more difficult for improving internal productivity.
A final drainer that came up multiple dimes during the discussions was that innovation takes time, usually multiple years, but the modern society, and especially the financial services industry is primarily focusing on short term results.
Financial services innovation in Luxembourg
Luxembourg aims at being considered at the forefront of innovation in the financial services industry around five pillars:
- Wealth management.
- Asset management and fund distribution.
- International loans.
- Structure finance.
UCITS as an innovation driver
The idea of the UCITS directive was war born about 25 years ago. Its goal was i) to protect consumers of financial services products by providing an airbag, and ii) create an open market for investment products in the European union. Luxembourg has seen this directive as a framework to stimulate innovation. It was the first to implement the directive into legislation. Since then UCITS has become a reference framework worldwide. For example, more than 50% of the funds sold in Hong Kong are UCITS funds.
During the 2008 financial crisis, the UCITS framework was resistance tested for the first time. Different issues came to light and many of them were subsequently addressed in the current UCITS IV and upcoming UCITS V directives.
But for some market participants the open question whether innovation around UCITS investment vehicles has gone too far is on the table. Indeed the UCITS framework was conceived to protect retail investors, but it has evolved into a highly sophisticated framework including hedge funds. In addition, there still exist divergences in national implementations of the UCITS framework, mainly with respect to depository banks and their role.
A key topic in innovation management theory as well as practice is open innovation. Open innovation is the use of purposive inflows and outflows of knowledge to accelerate internal innovation and expand the markets for external use of innovation. This paradigm assumes that firms can and should use external as well as internal ideas, and internal and external paths to market, as they look to advance their technology. The main advantages of open innovation are
- resources available,
- knowledge sharing,
- cost reduction through sharing,
- access to new markets, and
- reduced time to market.
But open innovation remains still unexplored in the financial services sector.
Client centric approach
Another hot topic discussed during different sessions of the summit was the use and implementation of client centric approaches. Figure 1 shows five key dimensions of a client centric approach.
According to one summit participant, the two main drivers for becoming client centric are
- adjusting the client segmentation, moving from a product or demographics oriented segmentation to a behavioral segmentation, and
- focusing on distribution channels.
When aligning the client segmentation, the associated pricing models should be adjusted too. More granular pricing models focus on client needs will help win new clients. Bundling services and especially combining self-service products will help improve profitability. The distribution channels should be such that they provide satisfaction to the client rather than only focusing on internal efficiency. Branch offices will be revived. Call centers on the other hand will lose importance as they do not favor the client experience which plays an important role in a client centric business model. The role of social media remains a disputed subject as to whether it will be beneficial, neutral, or even devastating to build the client experience.
In addition to the two main drivers of segmentation and distribution channels, reducing complexity and optimizing risk are important factors to address in a client-centric business model.
According to banks, there exist four main areas which can be monetized when implementing a client-centric business model.
- Unbiased advice combined with client service excellence.
- Reputation integrity.
Numerous researchers have addressed the process aspects of innovation and product development. There exists a key difference between consumer goods and industrial products when compared to financial services. Financial services do not go through thorough testing before being launched. The testing phase is in general combined with the launch. For example, new funds are launched without dedicated research on the actual client needs. If the expected need materializes, the fund will grow in size, otherwise it will be closed again after a short period of time. This way of approaching product innovation is considered cost efficient and best protects intellectual properties and the associated competitive advantage. In financial services the components of innovation are i) product development, ii) distribution, and iii) adoption by the clients. The process implemented to come up with innovations is
- looking at historical data,
- transforming that data into information, and
- gaining insight which is transformed into products or solutions.
The first Innovation for Financial Services Summit provided an intellectual platform to exchange ideas around innovation in financial services with a special focus in the Luxembourg industry. It was very welcome by most participants although, by the nature of innovation, some participants found the content not hands-on enough.