Financial product standardisation is no magic wand

In “The End of Finance, As We Know It“, the Psy-Fi blogger argues that a common language for financial products will disrupt the industry.

Tim Berners-Lee was a lucky guy

First, on a point of detail, I think the HTML-made-the-web meme is well overdone. It’s very probable that the web and the Internet were doomed to happen once the enabling technologies — hypertext, client computers powerful enough for graphical user interfaces, networking fast and cheap enough for networked hypertext for the median computer user — were available. Indeed, it happened almost as soon as these technologies had developed to be close enough to be practical. Then sooner or later an implementation of the networked hypertext paradigm that hit a sweet point between usability and technical practicality was going to appear, and then catch on and through network effects and become dominant. Some of the qualities of the HTML solution, like openness, are probably only very marginally relevant. It’s something that techies appreciate, but most of the world don’t care about such things. Video happened on the web via Flash, which is the antithesis of HTML: a closed proprietary technology, which in the days that mattered was tightly controlled by a rent-seeking commercial operator.

The focus on HTML as a semantic language also seems overdone, at it’s core it’s just an hypertext protocol, that plays a similar role as over technologies in the stack, such as operating system APIs that support browser software, or the encodings used at the fiber level on operator level data-links. Had it been named a hypertext “protocol” instead of a “language”, which would probably be more accurate description of what it is in essence, there would probably be very little talk about the web being enabled by a common language in a semantically relevant way. Contemporary HTML, known as HTML5, has evolved more towards a platform, which includes Javascript, a programming language, but it’s a technical artefact that doesn’t really change the argument that it’s not really a “language” in the common sense of the word that made the web possible.

Product standardisation without disruption

The main point behind the post, HTML irrelevance’s notwithstanding, remains though valid: having machine-tractable product descriptions enable more efficient markets in the underlying products in the presence of the Internet. The argument is then that the development of standardised descriptions of financial products will revolutionise finance, and displace the incumbent operators.

This might be true for some narrow niches, e.g. treasurers of midsize companies looking for OTC derivatives to hedge their real world business would benefit if they could compare rival investement bank’s proposals from computer-processable term sheets sent to a comparison service or software. There are already advanced initiatives in that field. It may be true of other niches as well.

But what about retail: in the most advanced markets the core useful products of retail finance: current and savings account, electronic payment methods, mortgages, index funds, all are pretty much standardised, and can often be approximately but close enough summarised in more or less one number (APR, interest rates, TER, etc). Some of this has been driven by regulation, and to a large extend it is one domain where it has been successful; even too much perhaps, in the sense that there’s little space for non-standard products due to the difficulty of making them fit in the regulated standardised framework. This is all common “language” that’s needed.

More exotic products may be less standardised but are are of dubious utility to most people, and for those people who misuse them the solution is not to standardise them but to stop using them. In a similar vain, making a peer review platform for churches or religions, however thoroughly, won’t make God exist, and there’s no interesting benefits to be gained in making efficient markets in fundamentally pointless things.

So we really do have readily comparable financial products, and indeed comparison platforms for all of them are widely available. You can use the Internet to find more or less painlessly the best mortgage or savings account. There’s some rough edges, some tangential contract conditions may escape the normalisation, but overall it’s good enough for purpose, and this has been the case for a number of years. So we have the precondition for disruption, and yet nearly everyone is still getting loans, mortgages and current accounts, from the same old banks. Why is this so?

What doesn’t kill you make you stronger (sometimes)

A possibly salient angle may be to look how the Internet disrupted other industries. There are definitely several industries, from recorded music to travel agents, where incumbents have been marginalised by the internet, being either made irrelevant or replaced by new Internet-era companies taking over their traditional business.

But there are yet other industries where incumbents have successfully taken on the Internet, and improved or re-centred their product successfully. Telecommunication operators are a prime example. When home Internet access became possible, all Internet service providers were startups. The incumbent telcos were into providing voice telephone, and data infrastructure only to businesses, including the ISP startups, and were totally uninterested in doing something else. The ISP scene bloomed, some better operators emerged and became market leaders. Nevertheless, in a short few years the incumbent telco operators got their act together, used their size advantage and the fact that they were anyway operating the underlying infrastructure, and killed, through acquisition or attrition, the startup ISP scene, which are now as niche and retro as vinyl records.

You can observe a similar trend in airlines: there are no “Internet airlines” to speak of, they just all adapted. The last wave of business model innovation in the airline industry was low-cost, which started in the telephone sales era — remember planes with phone numbers on them? — and just adapted successfully to moving onto doing the same on websites.

Any hope?

Whatever the reason that made banking be more like telcos than music labels, so far, what I think is pretty likely is that if the industry does in the end get disrupted beyond recognition, it will not be through (retail) product standardisation. It would probably be unwise to care too much about something that is essentially, unusually for finance, a solved problem.

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