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Friday, 29 January 2016

Need financial support? Don’t Bank on it…

"I sincerely believe... that banking establishments are more dangerous than standing armies" - Thomas Jefferson

The Banking Crisis supposedly ended six years ago. It probably doesn’t feel like that if you work in the remote gambling sector, however.

Back in the first heyday of remote gambling IPOs (2004 – 2005), banks were happy to lend, albeit on expensive terms and rapid rates of payback, and were more than happy to provide commercial services and process payments. The banks’ appetite for ‘risky’ remote gambling companies changed markedly in the summer of 2006, when UIGEA ended the party and put the banks in the spotlight, both for enforcement and past ‘misdeeds’ for supporting businesses facing the USA. The global Banking Crisis (2007-09) swiftly followed, highlighting some rather riskier banking activities and putting any form of even slightly controversial banking activity beyond the pale. These two events meant that the banks were firmly shut to many (most) remote gambling operators and largely have been since, an economic recovery and substantial remote growth notwithstanding.

But before we bash bankers too much, it is probably worth flagging that their Risk Committees had a point when it came to remote gambling. There are (or were) seven things typically found in remote gambling which give bankers pause – and it is the presence of all seven that made remote gambling particularly toxic (rather like the Titanic, bankers would probably have been more or less relaxed about the breech of any three of these risk-assessment bulkheads, but any more would be fatal).
First, and probably most importantly, the US government made its anti-remote gambling ire known to the financial services industry: every global bank has perforce extensive US interests - which are probably bigger than most countries’ gambling markets; it is not an unreasonable commercial decision that most banks fled from potentially upsetting the US government, whatever their own views were.

Second, back in 2006 the vast majority of remote gambling was regulated on a point of supply basis. Given that even many gambling executives use the shorthand of ‘unregulated’ for this activity (or even pointedly don’t put some revenue in a ‘Sustainable’ category when reporting), it is unsurprising that many banks regard ‘point of supply’ revenue as risky.

Third, and as a result of the second point, most remote gambling companies have their Headquarters in ‘exotic’ jurisdictions, typically associated with ‘tax optimisation’. With tongue firmly away from cheek, many bankers frown on these sort of structures, especially if…

… Fourth, most gambling companies are rather small by international corporate standards (eg, not one gambling company is in the FTSE 100, pending the Betfair – Paddy Power ‘mega merger’), meaning that the ‘return on risk’ on most remote gambling business simply doesn’t stack up for banks.

Fifth, the ‘entrepreneurial’ nature of many remote gambling companies meant that things like social responsibility and corporate governance were not early priorities. This not only plays badly in a corporate box-ticking environment, but also (far more importantly) increases the risks of negative regulatory change: especially where some mainstream press has an ‘anti-gambling’ stance. All of this naturally reduces a bank’s already low appetite for the sector still further.

Sixth, back in the .com world where most operators took money from most jurisdictions, providing a lot of trading access (or at least details) to a regulated entity with a fiduciary duty to block or report ‘dubious’ transactions was probably considered poor risk management from the gambling companies themselves: relying on ‘sector specialist’ financial services was much safer and more reliable.

Finally, many remote gambling companies are relatively young and, given the cash generative nature of such (more successful) businesses, have not hitherto needed much ‘vanilla’ financial services support. This has meant that there is no long-standing relationship or network of relationships within the financial services community to leverage: it is much easier to turn down a new business than turn off an established one.

Many of these ‘legacy’ issues are now being solved however. The US has been firmly shut for nearly a decade - levels of compliance have been comfortingly high and the US has even positively modified its regulatory stance (albeit in certain highly specific areas). Many remote gambling companies now generate most or all of their revenue from regulated markets, while UK Point of Consumption licensing has made many companies more visible and more accountable. Remote gambling is now big business, driven by a combination of organic growth and M&A: in the UK (the most liberal domestically regulated market), remote gambling is now the single largest commercial sector by official Gross Gambling Revenue stats, as well as one of the fastest growing.

Further, many companies have made the transition to well governed, socially responsible entities, through a combination of increasing scale, increasing regulatory scrutiny, and changes in management and/or ownership. Lastly, many remote gambling companies are now (at least) ‘medium sized’, well established businesses with a strong track record of sustainable (and audited) revenues and growth. 

Unfortunately, none of these positives have yet been accepted by mainstream financial services businesses, with appetite to deal with remote gambling companies (especially small and/or new ones) very low. This is important. In fact it is a lot more important than the remote gambling sector realises – I would point to five key reasons (Finance Director readers could probably add many more!).

The most obvious impact of having high volume ‘vanilla’ providers of financial services closed off as an option is that the cost of doing business increases - for commercial banking, processing or financing. This puts new and/or remote only businesses at a competitive disadvantage in terms of day-to-day activities (eg, payment processing as a cost represents c. 25% of typical remote profits).

Another impact of limited supplies of debt is that it materially impacts flexibility to grow. If substantially all of a company’s increased costs need to be organically funded by revenue or through equity investors, then growth is made both slow and expensive; reducing competition and innovation while favouring the larger incumbents.

The supply chain is probably the area where significantly reduced financial services options have the biggest and most problematic long-term impact. Platforms and content need R&D and infrastructure spend to grow. If this can only come from organic resources then the focus will be on short-term wins and tried-and-tested ideas. It will also keep small developers small unless they hit lucky with one very high return product or service or find a very generous equity backer. This not only polarises the supply chain into very few haves and very many have nots (materially reducing operator choice), it also stifles innovation. 

A potential regulatory risk issue for the sector is that forcing operators to use more exotic forms of financial services also puts them (perhaps unwittingly) into the ‘grey market’ supply chain. In a very narrow sense, this perpetuates the problem by providing life to the support structures of the industry that often cause greatest concern. In a wider sense, operators already plugged in to ‘regulatory flexible’ payment solutions or financing may become tempted to broaden their revenue base to riskier markets. This could be especially compelling when combined with the need to generate high margin revenue to support costs, given the paucity of attractive financing options.
Finally, by helping to keep large parts of the remote gambling sector small and ‘colourful’, the lack of mainstream financial services engagement helps to perpetuate the stigma that causes the sector so many problems, from inviting negative press and adverse political risk to making talent difficult to attract.
A further tangential risk worth flagging is that traditional land-based businesses are becoming increasingly remote (indeed need to); many of these companies also have material amounts of ‘vanilla’ debt. If the large banks maintain their anti-remote gambling position then increasingly ‘omni-channel’ businesses could see themselves growing their financing risk to dangerous levels; especially if land-based profits decline.

The lack of effective access to large-scale financial services therefore touches nearly every key aspect of the remote gambling industry. Moreover, as the industry matures, this lack of access is likely to be felt ever more acutely, causing deeper problems to perpetuate.

I would suggest that high-level stakeholder engagement, including regulators and equity holders, is key to resolving this impasse before the issue distorts the sector further and potentially also causes value destructive levels of risk. The sector should also be prepared to engage on more creative means of securing attractive financial services for the ‘regulated age’, without simply turning to expensive and high risk ‘.com’ solutions.

At the beginning of a year it is usually tempting to focus on which channel will see most growth, or M&A gossip, or some other form of crystal-ball gazing. But as the remote industry matures, it should spend less time pondering the ‘next big thing’ might be and more time focussing on resolving the very real issues that are retarding its ability to be taken as not only the most dynamic gambling sub-sector but also the most sustainable. As the remote sector challenges land-based sectors in terms of scale in many jurisdictions, the fate of the entire gambling industry might rest on making this transition successfully.

This article appears in the January/February edition of iGaming Business

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