To Boldly Go… Financial Innovation And Progress

Evolution is nonlinear.

In the natural world, progress inherently depends on risk. Consequently, failure is inevitable. But it does lead to progress.

The same is true of innovation in finance and technology.

As per Schumpeter’s theory of Creative Destruction, in order for progress to be made we must accept that economic innovation and creativity – driven by free markets and economic liberalism – will lead to failure. But, we must also accept that from this state of failure, progress is made.

Schumpeter believed failure and renewal to be the oil that greases the wheels of capitalism. Entrepreneurial innovation leads to new technologies, skills and ideas being built to replace old, moribund methods and practises. The old is destroyed at the moment the new is born. This leads to economic development and global progress.

Financial innovation is a double-edged sword – we can use it to forge new paths, but it has the potential to damage our prosperity and lead to systemic crises. Whether this risk is worth the reward is subjective and hard to measure.

One thing we can measure is results. Over the last fifty years, innovation and appetite for risk in capital markets have led to the birth of options, swaps and futures, money market funds, indexed mutual funds and ETFs, securitization, venture capital, private equity, crowd finance… the list goes on. These products and solutions only exist because individuals and institutions were willing to take risk and invest in innovation.

However, due to an over acceleration of financial innovation, global economic development and progress came to a shuddering halt. Like a high performance car taking a corner too fast, in 2007/08 we lost control and spun out of control. The financial crash was undoubtedly linked to the complexity of the financial system, tools (e.g. derivatives and leverage) and products (e.g. CDOs, SIVs, CDSs) that banks, customers, regulators and policy makers didn’t fully understand.

Inevitably, the ensuing slowdown has led to increased scrutiny of financial services. In many respects, this has stunted governmental and institutional appetite for risk and development. Following a great crisis, the danger is that aggressive oversight leads to wariness and caution towards innovation. In the long term, this approach inhibits economic development even further.

But the worst thing you can be in times of crisis is afraid. In fact, the net effect of resisting innovation and creativity is more damaging than the initial risks.

The recent IT troubles to befall the NHS in the UK and British Airways are stark examples. The NHS’s inability to invest in modern operating systems and keep them updated over the long term led to a cyber attack that preyed upon an out-dated, vulnerable and dysfunctional IT network. Whilst the causes aren’t totally clear, British Airways’ failure to properly maintain and test its database functionality led to 24 hours of chaos throughout its global network that will lead to years of reputational damage. This damage is potentially irreversible.

As these examples show, the very worst thing we can be is afraid of innovation and development. If we choose to stand still we stagnate and, like the NHS and BA have done for too long with their IT infrastructure, the effects could be catastrophic.

We believe in a progressive and creative approach to innovation. Finance, especially the debt markets, is a traditional environment that sometimes seems reluctant to push into new technologies. We believe that this fear will lead to wider systemic problems, rather than less.

Without doubt, innovation is not risk free. But there are huge rewards, and our industry – which includes all market participants, from customers to business owners to regulators – is good at calculating risk. If the financial services industry is to survive and thrive, we must be prepared to boldly push on and try new things. Failure is an option. Fear is not.

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This article was created in association with Origin Markets, directly connecting dealers and issuers in the primary marketplace for the first time. 

Edward Playfair