By Tom Strauss, Vice Chair, Cowen Inc.
Every industry lives and dies by innovation, and the financial industry is no exception. By offering new products and solutions, the financial industry helps companies access the capital they need to develop breakthrough technologies that create jobs and grow the economy. The ongoing innovation evolution in financing generates efficiencies and invariably lowers the cost of execution, benefitting all market participants.
All truly breakthrough innovation, however, takes time to be widely accepted. There is always initial resistance— the road to innovation is rarely linear. A newly introduced financing vehicle invariably goes through multiple iterations in response to the demands of market participants. This has certainly been true in financial services over the past 40 to 50 years and is especially the case with special purpose acquisition companies (SPACs), which have taken two decades to reach widespread acceptance.
Today, so many of what were once innovative products are part of the mainstream. Yet there was a time when these products were not only new, but also faced significant resistance. It’s an important perspective for ongoing product development; the new and different often meets skepticism rather than an instant embrace. Here are some examples:
Mortgage-Backed Securities — Today, mortgage-backed securities (MBSs) are widely accepted and provide critical liquidity in the massive mortgage market. But the road to institutional acceptance for MBSs, which were introduced in the early 1970s, was anything but linear. Initially, many investors were skeptical and repeatedly asked, “When do I get my money back and how quickly? And what happens when interest rates rise or fall?” Prepayment models had to be improved to answer these and other questions. As the MBS market expanded, a second type of security was developed: the collateralized mortgage obligation.
High-Yield Bonds — Below-investment-grade bonds grew in popularity in the 1970s and 1980s, particularly to finance leveraged buyouts. Although they were often disparagingly referred to as “junk bonds,” they provided an alternative to bank financing.
Derivatives — Over the years, numerous derivatives have been developed—so named because they derive their value from an underlying instrument. Examples include: currency swaps, first developed in the 1970s by large UK banks to help clients avoid paying premiums when obtaining dollar-denominated loans; interest rate swaps, first used in 1981, with a fixed rate on one side of the swap and a floating rate on the other; and treasury STRIPS (Separated Trading of Registered Interest and Principal of Securities), which were launched in 1985 to separate interest and principal and offer a specified payment on a future date.
ETFs — First introduced in 1993, exchange traded funds (ETFs) were created to allow individual investors to access passive indexed funds as an alternative to mutual funds. Since then, ETFs have exploded in popularity because of their relative low cost, tax efficiency, and ease of buying and selling.
Direct Lending — As a source of strategic capital from private sources, direct lending is an alternative to bank financing, accessed mostly by small and medium-size companies. Spurred by the financial crisis of 2008-2009, when banks reduced their loan portfolios, direct lending has grown in volume and popularity.
THE FUTURE OF INNOVATION
Each of these financial innovations developed for one critical reason: they filled a void in the capital markets which benefitted the end user. The success of an innovative product can be judged by the adoption of a broad number of market participants, well beyond the firm or firms that were first at the forefront of innovation.
This brings us to SPACs. Originally created more than 25 years ago by the Securities and Exchange Commission (SEC) for smaller companies, these transactions faced their share of skepticism and even disparagement. Today, SPACs are widely used as an alternative to traditional IPOs for accessing the public market. Structural improvements in SPACs have accounted for their broader adoption in recent years, and further development may well continue in the years ahead.
SPACs have enabled companies in critical growth industries to access the public markets more efficiently and at an earlier stage in their development, thus providing capital to expand their businesses. Access to capital also helps support employment growth in disruptive and strategic industries such as biotechnology and technology.
Importantly, the flow of capital enables technological advances that propel the environment, social, and governance (ESG) mission, leading to the development of a more sustainable economy. Capital formation via SPACs will also permit the U.S. to maintain its competitive position in the global economy, which is never assured. In addition, SPACs have permitted financial institutions that manage money for IRAs and other individual portfolios to invest in growth to a much greater degree than in the past.
Cowen is committed to doing quality SPAC transactions where such strategic combinations provide capital needed to satisfy each company’s growth objectives. In this way, we are positioning ourselves at the forefront of the latest chapter in a long history of innovation in financial instruments and, as an entrepreneurial firm, aligning ourselves closely with our clients across multiple industries such as biotechnology, alternative energy, mobility/transportation, robotics, edge computing/5G, and sustainability.
From new ways to manage risk and obtain capital to advancements in fintech, innovations will continue to be the lifeblood of the financial industry. As we have seen, even when there is skepticism initially, innovations that truly represent improvements will gain traction and acceptance. Over time, what was once breakthrough and novel will take its place in a growing array of capital market solutions. Whether in the financial services or another industry, innovation is ongoing and will never end.
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