By Adv. Roy Keidar, Special Counsel, Yigal Arnon & Co
Israel is globally known as the ‘startup nation’, a small country that has developed a rich ecosystem in which thousands of startup companies are creating new and innovative technologies. What it is less known for is its financial system. Israel's small size and distance from global financial markets, and financial centres such as NY, London, or Zurich, are significant barriers to further growing such a financial market.
Over the past few years, however, a growing presence of Israeli ventures has been evident in major business deals, investments, conferences, as well as global media coverage. Considering that the Israeli financial system has yet to show outstanding activity (2015 was a good fiscal year, but not exceptional), the key to such advancements may be the vibrant, creative and fast-growing Fintech industry, driving technological solutions to one of the most conservative and highly-regulated industries in the world.
Since 2009, the Israeli Fintech industry has experienced a meteoric rise. Starting with 90 startups, the industry has grown tremendously to become a global leader over a six-year period, quintupling its size, reaching 430 companies, 60 of these having raised about US$370 million in 2014. During this period, a stellar number of 14 R&D centres were established by global companies, joined by bottom-up efforts by local entrepreneurs, lawyers and other professionals. This thrust forward has been felt at every meet-up, cocktail event and conversation. Even more surprising than its sheer size, the local Fintech industry is diverse, with startups operating in almost every financial sector, including payments, trading, lending, anti-fraud, and insurance. On all fronts, startups offer relatively simple solutions to complex financial problems. eToro, for instance, maintains its position as a highly successful trading platform, while in the payments sector, companies such as Paybox are providing novel ways to circumvent the traditional bank payments system.
Within this vibrant financial ecosystem, one technology in particular stands out in its disruptive potential: the Blockchain technology, best known as the technology behind Bitcoin. A recent report, authored by the global consulting Company, Deloitte describes 38 Israeli startups currently working on various applications of the Blockchain technology, ranging across the entire spectrum of services: security, hardware, new currency, payments, P2P, online commerce and social platforms. Israeli expertise in cryptography and big data gained in the world of security and defence is now proving itself useful in the financial world, allowing for better, safer and more efficient ways to perform trusted transactions without intermediaries.
Taking a close look at the structure of the Israeli market reveals a relatively small, local financial market with Traditional Financial Institutions (TFIs), which are comprised of a small number of players such as the major Israeli banks, insurance companies and institutional investors. These are often perceived by the public as slow-moving and conservative. Rigid regulatory constraints add insult to injury, providing TFIs with little wiggle-room. In contrast, but also in tandem, Israel is rich with highly experienced and gifted human capital, which has resulted in Israel taking shape as a hi-tech superpower, and continuing to lead the world in cybersecurity and nascent fields, such as big data and machine learning.
There is little room for doubt that the global impact of Fintech on TFIs is substantial, and it emerges at troubling times for the incumbents: TFIs are heavily regulated worldwide, while simultaneously the trust level in TFIs in a post-2008 world is dropping. On the consumer front, TFIs appear slow and unattractive in comparison to the agility and glamour of Silicon Valley startups, while tech giants, such as Facebook, Amazon and Google, are much more adept at tailoring services and products, financial or otherwise, although doing so by leveraging personal information of their customers. These giants prefer to brand themselves as innovative and inspiring, leaving the bureaucracy to TFIs. As Richard Summerfield argues, the rise of the Millennials only exacerbates the mistrust in TFIs, increasingly perceived as unnecessary middlemen. We have, after all, become accustomed to eliminating the middlemen with Uber and Airbnb. Why not do so in banking?
These global trends, for better or worse, seem to play out differently in Israel. First, there is no place to hide: there is constant friction between risk-taking and disruptive startups on the one hand, and TFIs and regulators on the other. The Israeli ecosystem is full of networking-events, accelerators, incubators, hubs, conferences and symposiums, providing ample opportunities for VCs, startups and TFI executives to meet and develop relationships. While the heightened interest in Fintech is new, the type of process that is taking place is not. We have seen it before in cybersecurity. The Israeli ecosystem is merely perfecting yet another child prodigy.
There is another - some may say surprising - catalyst present: Lawyers and accountants are bridging the gap between conservative TFIs and agile startups, whether it is by navigating through the regulatory requirements or helping innovative technology to penetrate the market, and often providing valuable opportunities and solving problems.
Equally novel is the support and enthusiasm coming from local and international banks: From Bank Leumi's 'Elevator' to Bank Ha'Poalim's cooperation with Microsoft Ventures, these TFIs provide support to promising candidates in the form of funding, access, connections and guidance. This may seem counterintuitive. It is easier to imagine banks lobbying against those who challenge their quintessential business model. However, with increasing pressure from clients to cross the Digital Divide on the one hand, and faced with regulatory headache on the other, Israeli TFIs understand that they have much more to gain from working with Fintech ventures than by working against them.
What about the Israeli regulator? Although present at the table, through funding and support provided by the Office of the Chief Scientist and the Ministry of Treasury, regulation remains a significant barrier to entry. Israeli banks have been under close scrutiny by the regulator to ensure the stability of the financial institutions, even in times of global crisis (the relatively mild effects of the 2008 financial crisis on the Israeli market is a prominent example). However, requirements such as holding minimal capital and licensing requirements makes it harder on new small platforms to enter the market, throwing them into the (open) arms of the TFIs. With that in mind, finding the correct approach to the growing Fintech industry remains one of the big dilemmas faced by the regulator, which is often slow and conservative, especially with respect to banking. But, the pressure to adapt to these technologies within the existing regulatory environment is there, and is felt on all fronts, as evidenced by the unlikely alliance between the regulator, TFIs and the startup ecosystem.
Looking ahead at the future of the Israeli Fintech industry it seems that there is still work to be done. Many of today's startups are only in the initial stages of proof of concept, while TFI-startup integration is still in its infancy. Although TFIs may have promising technology at their disposal, they will still have to find their way forward. While doing so, they will struggle to find the right balance between maintaining their attractiveness to tech-loving millennials and the need to work with conservative and risk-averse, financial institutions. The inevitable outcome may be a hybrid - the brainchild of experienced yet conservative executives and innovative entrepreneurs - that will pave the road for a technologically-agile, user-friendly yet regulated financial system.
Adv. Roy Keidar is Special Counsel at Yigal Arnon & Co. Law Firm, specialising in the fields of international law, security and emerging technologies.