Financial innovation in emerging markets is profound it is reshaping the very foundations of financial markets. From the financing of large-scale projects to new dynamics between borrowers and savers, emerging markets are in a prime position to reap the benefits of new technology by adopting it faster and more comprehensively than more developed economies.
At the forefront is Dubai, which is investing heavily in new technologies such as blockchain. With platforms such as Dubai International Financial Centre (DIFC), the emirate has created a global financial centre that not only serves mainstream financial services, but also encourages innovation to thrive.
Let us first look at the infrastructure needs of emerging markets they are strong, structural and growing. The good news is that $60 trillion to $80 trillion has been committed globally to infrastructure over the next 10 years, with two-thirds of that in emerging markets. The bad news is that while demand remains strong, the industry is faced with a significant funding gap estimated to be somewhere between $500bn and $1.5 trillion. Emerging markets, in particular, need these major infrastructure projects to support economic development.
How did we end up with such a large shortfall? In the wake of the financial crisis, governments around the world have been forced to cut spending. Exacerbating the problem for the economies of the GCC and certain other countries is the fact that oil is selling for about 65 per cent less per barrel than at its peak of $140 in 2013.
The thing is, capital is not scarce. In fact, US consultancy McKinsey & Company estimates there is more than $120 trillion of capital sitting with institutional investors and banks. The challenge is how to channel this deep pool of private capital into public infrastructure projects.
Realistically, banks are unlikely to be the solution for the funding shortfall; they have notorious trouble matching their short-term deposits with long-term liabilities and they face a raft of capital restrictions associated with Basel III (and what is colloquially known as Basel IV). Instead, we expect the insurers, asset managers and public pension funds to take a more active role, fuelled by financial innovation.
Apart from a small group of specialist asset managers, institutional investors have rarely ventured into the world of infrastructure, deeming it too risky and inconsistent from a regulatory and international standardisation perspective. However, this is starting to change. On the back of financial innovation driving rapid improvements in computational power and data analytics, asset managers are able to generate more accurate analysis, make decisions faster and deploy capital quicker. The net result is that the velocity and quality of private capital going into emerging market infrastructure is increasing, picking up the shortfall left by the public sector.
The impact of innovation is pervasive and can be felt right across the financial services industry. It is continuing to disrupt the way capital is fundamentally intermediated. As more people have greater access to data, analytics and insight, the advantage institutional investors have over individual investors is narrowing. Peer-to-peer models in financial services are nascent but powerful. If individuals can cheaply deploy capital directly into public and private securities, then surely the role of banks and broker dealers must change.
This is not going to happen overnight, but the financial services community has to prepare for new dynamics. Rather than stick its head in the sand, it should support the development of new technologies. International financial centres (IFCs) such as DIFC have a key role to play in this.
The best IFCs are clusters of capital, knowledge and activity. They enhance the accumulation and intermediation of capital. Thriving IFCs attract the best financial services firms and talent, which provide both support and competition for one another. This in turn stimulates innovation and drives growth.
In emerging markets, where economies are less developed, this effect is even more pronounced. Just consider the fact that across the Arab world, more than 50 per cent of the population do not have bank accounts (World Bank Global Findex, 2014). The opportunity for innovation to promote financial inclusion is huge.
DIFC provides a platform for more than 1,600 institutions and 21,000 people to create markets and meet the financial needs of this rapidly growing region. Meanwhile, through initiatives such as FinTech (financial technology) Hive at DIFC, the regions first FinTech accelerator space, we are strategically cultivating innovation and connecting it into the heart of the regions financial community.
To the global financial community: watch out for emerging markets. Watch out for innovation. And watch out for financial centres. We will continue to do our part in disrupting and improving the way capital is allocated around the world.
Salmaan Jaffery, chief business development officer at the DIFC Authority
Salmaan Jaffery is chief business development officer at the DIFC Authority