The future of financial services will be defined by ESG, AI and regulation

The financial services industry is undergoing a significant transformation driven by three key forces: the rise of Environmental, Social, and Governance (ESG) considerations, the disruptive influence of artificial intelligence (AI) and fintech, and a continuously evolving regulatory environment. These interconnected trends will reshape the industry in the years to come, impacting everything from product delivery to workforce patterns.

Forward-thinking institutions can leverage these trends for competitive advantage. Early adoption of ESG practices attracts socially conscious investors, customers, and talent. AI streamlines operations, enhances risk management, and personalises customer experiences, while development of technology or strategic acquisitions and partnerships with fintech companies unlock new markets and services.

ESG Integration: a business necessity

Companies need to integrate ESG considerations across recruitment, operations, business models, and investment products. This attracts a younger generation seeking both financial returns and positive social and environmental impact, but authenticity is critical. They are also vigilant against ‘greenwashing’ (where investors are misled by exaggerated or false claims of environmental stewardship) and demand alignment between corporate words and actions. To build trust, institutions must demonstrate genuine commitment to, and delivery upon, ESG principles through transparent reporting, robust due diligence, and active stakeholder engagement.

Mergers and acquisitions (M&A) are a potential route to accelerating the transition towards hitting ESG milestones. Mergers allow the combined entity to combine ESG resources and expertise while positioning to win greater market share and open up new markets. For example, the 2017 merger of Aberdeen and Standard Life (now Abrdn) combined ESG resources and expertise to win market share. Similarly, Schroders Capital’s acquisition of Greencoat Capital in 2022 expanded its investment capabilities in the high-demand renewable infrastructure market. In January 2022, M&G acquired a majority stake in responsAbility Investments, an emerging market private debt and private equity impact investor. The ESG-focused M&A deal strengthened M&G’s sustainable investment capabilities and boosted its international presence.

AI-powered financial services will bifurcate the industry

AI and related technologies like machine learning are driving a seismic shift in the financial services industry. These powerful tools automate tasks, enhance risk management, and personalise financial products and customer experiences. A recent Cambridge Centre for Alternative Finance survey predicts that by 2025, nearly two-thirds (64%) of financial institutions will leverage AI to generate new revenue streams. This transformation is already taking shape across various sectors. In asset management, AI is seen as a tool to optimise investment returns by analysing alternative datasets (e.g. social media trends, payment provider data and geolocation information). In finance, lenders anticipate improved credit analysis through AI, while payment providers expect to revolutionise customer service and risk management. AI’s potential extends further, with possibilities like personalised portfolio allocation based on individual goals, intelligent chatbots for enhanced customer experience, and machine learning algorithms to streamline operational efficiencies.

However, AI adoption presents challenges. Widespread job displacement is a concern, with the same survey predicting a 24% workforce reduction in investment management within a decade. Additionally, potential biases in AI algorithms and data security breaches pose risks. Access to data, talent and evolving regulations further complicate widespread adoption.

Financial institutions face a critical decision: embrace AI and become early adopters, or risk falling behind. Traditional institutions often focus on AI-powered improvements to existing products. In contrast, nimble fintech companies typically explore entirely new frontiers. This disparity invites strategic acquisitions and alliances between former competitors. Looking ahead, robust cybersecurity measures will be paramount as the financial landscape becomes increasingly reliant on technology. Ethical considerations regarding data privacy and algorithmic bias need careful navigation. Open banking presents both risks and opportunities. By leveraging data responsibly, institutions can develop innovative products and services that cater to evolving customer needs, including personalised experiences, convenient digital access, and tools for independent financial planning. Ultimately, attracting and retaining top talent with the necessary skills will be crucial, while ensuring business models remain aligned with ever-evolving regulations.

Regulation: where change is the only constant

The interplay between regulation and innovation is particularly evident within capital markets. For instance, new regulations like the Designated Reporter regime and UK EMIR refit for derivatives reporting aim to ensure accurate and timely reporting in the derivatives market, enhancing transparency and mitigating systemic risk. Similarly, ongoing discussions on accelerated settlement, involving regulators, clearing houses, and market participants, reflect a focus on modernising infrastructure and minimising counterparty risk. While these initiatives hold significant promise, navigating the associated operational changes across the market will be crucial. The impact on a wide range of stakeholders, coupled with potential cost increases and temporary liquidity volatility, requires careful consideration.

Sustainability is equally a powerful driver of financial regulation, with the UK government planning to implement green finance strategies, including a UK Green Taxonomy and sustainability disclosures. ESG adoption is leading to a rapid increase in the demand for ESG ratings and data products, calling for closer scrutiny of respective providers. As a result, the International Capital Market Association (IMCA) has developed a code of conduct to improve trust in these products, as they relate to the financial services sector, to guide investors in allocating their money and alleviate the risk of greenwashing.

Elsewhere, risk management remains a top priority, with Basel capital standards being implemented in the banking sector and increased attention on non-bank financial intermediaries. The regulatory focus extends to asset management, retail investment, insurance, and digital finance. Also in the digital finance industry, the UK is venturing into regulating digital assets, with frameworks in development.

Conclusion

The ever-changing financial landscape requires a clear vision and a trusted partner by your side. BTG Advisory can be your guide. We offer a comprehensive suite of services to help financial institutions of all sizes capitalise on opportunities. Whether you are a leader looking to accelerate growth or a firm needing to adapt to changing trends, our team of experts can develop a customised strategy for success.

We provide a full spectrum of services, including identifying and executing strategic M&A opportunities, conducting due diligence, and securing new finance. For institutions seeking to catch up with market trends, we offer independent business reviews to identify areas for improvement and, if necessary, restructuring advice. Contact BTG Advisory today to discuss your specific goals without delay.