The M&A route to diversification is increasing as London’s Alternative Investment Market fixes its tarnished image and buyouts of small firms are up. FX firms can now diversify their product ranges and invest in London-based FinTech for much cheaper than before, just watch out for the patent trolls!
London is a bastion of quality and integrity as far as electronic trading giants, both on the institutional and retail side are concerned.
Many firms in the world’s financial, electronic markets and FinTech capital are long established, with economies of scale, and are often publicly listed entities with capitalization that runs into hundreds of millions of pounds.
One of FinanceFeeds predictions for the year ahead is that mergers and acquisitions will be back on the agenda for many FX companies, whether in the brokerage, prime brokerage or technology sector, and as the year gets underway, there is now marked evidence by way of research that demonstrates that London is the place for growth, expansion and synergy via mergers and acquisitions, especially among companies listed on the London Stock Exchange’s Alternative Investment Market (AIM).
Just two years ago, the number of smaller companies entering the publicly listed arena on London’s AIM had fallen by over 50% from the previous year largely due to what was at the time being cited as political instability and corporate scandals, resulting in only £4.9 billion having been raised, compared to over £7.5 billion the year before.
During 2015, the AIM’s reputation had suffered as a result of incidents such as that which surrounded legal processing and technology group Quindell, fuelling concerns about its vetting procedures and rules.
Founder Rob Terry and former Quindell managers faced an investigation at the time by the Financial Conduct Authority over whether they misled the stock market, resulting in the shares in the company having been suspended in May.
Other incidents included the collapse in share price of prolific and highly efficient electronic trading company Plus500 which listed on the AIM in 2013, raising $75 million and rising up to become a benchmark standard in automated client acquisition, with a market capitalization of $1 billion just one year later.
Unfortunately, at the same time as the Quindell incident, Plus500 UK invoked an account freeze which applied to all of its customers, preventing trading, deposit or withdrawal until certain regulatory parameters stipulated by the FCA had been carried out. This action caused Plus500 Ltd (LON:PLUS) shares to drop by 28% overnight, and resulted in a long, drawn out period in which Plus500 had to report publicly on the status, generating lack of confidence among investors.
The question at the time asked by FinanceFeeds was, why did the FCA do this? The FCA usually does not impose any such measure on any firm, instead using a very passive methodology whereby a complaint is filed, to which the FCA responds by sending a letter to the company in question, stating that there has been an allegation of some form, and that the firm has an option to pay a fine with a 30% discount and settle it without any investigations, or to go to court.
British law firm Freshfields last year concluded that 97% of all of all complaints raised in the three year period between 2010 and 2013 were settled by payment without any investigation, regulatory action or court appearances.
So why the draconian action toward Plus500 UK?
FinanceFeeds researched this in detail and has discovered that some rival firms do not relish the thought of overseas competitors setting up shop on their territory, and have implemented methods by which to cause such companies commercial harm.
According to a number of sources close to the matter, Plus500 UK’s restriction was initiated by a series of competing companies having close relationships with FCA officials, and in some cases recruiting former FCA officials to work in departments dedicated to researching what could be deemed as malpractice by competitors in order that they can use their channels and connections to converse with officials in order to put a metaphorical spanner in their works.
Unlike the United States, where the domestic regulatory authority – the National Futures Association – requires that all firms submit daily electronic reports and if there are irregularities, or if a complaint is made, the compliance officer of the company concerned will be subjected to three months with an NFA official sitting next to him going through every record, the FCA resembles a ‘boys club’ which takes its subscription revenue and settlement revenue quietly, often without conducting any investigation at all.
The basis for the FCA’s instruction to Plus500 UK was that the regulator had concerns about the company’s checks when onboarding new clients, especially relating to Anti-Money Laundering (AML) procedures.
Plus500 does check the identity of all clients before opening account.
The company stated at the time:
“We use companies such as Experian and GB Group which are authorized by regulators to provide automatic online ID verification and are also used by our peers. We additionally do sanction list monitoring with World-Checks (a Thompson Reuters company) – all of these are done following sign up.”
By mid-June, following this action, Plus500’s valuation had declined to £459.6 million, almost half of the firm’s value just two weeks prior, rousing the interest of Teddy Sagi’s Playtech PLC (LON:PTEC) which entered into discussions with Plus500 with regard to acquisition.
CMC Markets, which floated 31% of its stock on the London Stock Exchange in 2015, took a very astute route by listing on the main market, rather than the AIM, elevating it from the ranks of newcomers and fast-exit start ups and positioning itself among the large, established blue chip entities.
During the course of that year, interest in listing had dwindled within electronic trading firms and retail FX companies, and was a shadow of the former massive activity that had come about in 2013 when many retail FX firms and their associated support industries which included payment processors and software firms, were eager to list on the AIM.
A year of organic growth ensued, but M&A is now most certainly back in focus, and London’s AIM is flourishing, giving rise to an opportunity for large, established firms to acquire small, niche firms that have recently listed for cheaper than they would otherwise, and also giving overseas entities a chance to invest in forward thinking London firms, thus making London even more of a massive epicenter for this industry than it already is.
Data produced this week by accountancy firm UHY Hacker Young has demonstrated that acquisitions of companies listed on London’s AIM rose by a fifth in 2016, with the fall of the pound making it an attractive market for bringing in investors from overseas.
Massive increase in acquisitions of AIM listed firms
During the course of 2016, 34 companies on the AIM were purchased with 70% of the fourth-quarter bids having been from overseas, suggesting the falling value of sterling may have played a part.
The number of companies on AIM fell below 1,000 to 993 in 2016, representing a decline from a peak of 1,694 in 2007.
While there was an increase in the number of floats on AIM last year – 44, up from 39 in 2015 – the number of companies leaving Aim was also up, from 98 to 105.
“The continued shrinkage of AIM is not great, and if this continues at the present rate then the future of the market may be in doubt. There does need to be a lot more of an effort to market Aim to UK and international companies” said UHY Hacker Young Managing Partner Laurence Sacker.
Restrictions in credit extension to OTC derivatives firms by Tier 1 banks, the in ability for smaller OTC firms to maintain significant capital bases to satisfy the increasing requirements by prime brokerage divisions of banks, the new proposals on CFDs by the FCA and the forays into diversified multi-product trading environments that are being pioneered by many good quality electronic trading firms are all aspects that may well lead to M&A activity.
This time those wishing to acquire other firms will have nothing to do with maintaining regulatory precision or ability to access new markets, and everything to do with gaining enough capital to maintain existing prime brokerage relationships with banks and, if at all possible, establish new ones, and to diversify their product ranges.
Buy into FinTech – mind out for the patent trolls though!
Many newly listed firms on the AIM market are FinTech entities, which could be purchased easily by FX firms in order to expand their product range.
In the UK, these issues are only going to become more pronounced as the industry becomes more reliant on the free flow of data.
In August 2016, for example, the Competition and Markets Authority told the largest retail banks in the UK that they must develop and adopt an open application programming interface (API) banking standard in order to enable customers to share their data with third-party app developers and competitors within the next two years in order to help customers find better deals.
Striking a balance between the need to be more open with data and the need to keep data secure is likely to be a major challenge in the fintech sector for the foreseeable future. Data protection is only likely to become more serious. The General Data Protection Regulation (GDPR) enters into full force on 25 May 2018 and brings with it maximum fines of up to €20 million or 4 per cent of worldwide turnover—whichever is greater.
Evaluating the risks associated with fintech assets and the values of such assets is a major concern. Fintech companies rely heavily on intangible assets such as software, databases, data, know-how and business methods. More than half of respondents (54 per cent) feel that doing due diligence on such assets is one of the top three biggest challenges to fintech deals (Figure 20).
Working out who owns the intellectual property rights or other rights in such assets is, for instance, usually complex and often requires rather extensive fact-finding exercises. It can also be difficult to assess the risks related to such assets, including potential open-source software issues, the danger that the rights in such assets will be infringed by third parties, or the risk that their use infringes third-party rights.
In addition, because fintech companies are so reliant on technology, it is likely that patent trolls will increasingly target them with the aim of extracting money through forced licensing arrangements by threatening to enforce patents primarily obtained for that aim. Establishing the value of intangible assets—which typically represent a large portion of the overall value of a fintech company—is another big challenge. For example, accurately vetting the growth potential of fintech startups that may not even be profitable at the time of acquisition can seem like a shot in the dark.