Blockchain — the transaction database technology underpinning the bitcoin currency — is being used by hundreds of investment companies and wealth managers around the world, as more businesses see its potential to transform financial services. For financial services groups, blockchain is attractive as it means there is no intermediary to pay for certain transactions— offering scope to cut costs.
The potential impact of blockchain
Some analysts believe the impact of blockchain will be limited to the back office and other behind-the-scenes processes. And early efficiency benefits do accrue most obviously to the middle- and back-office through data standardization, reduced trade breakage and simplified infrastructure.
However, when real world assets — represented digitally through tokens or smart contracts — are able to settle between owners at the speed of execution if desired, an innovation tipping point will occur. Settlement flexibility will enable new pricing models and service offerings. Beyond better data management, the ability to verify assets held on-ledger as truly unique is an innovation not offered by traditional databases.
For example, digital assets could reduce risk in collateral management; real-time calculation of underlying asset risk could enable more accurate pricing of asset-backed securities. Centralized solutions have sought to solve these same problems in the past, but decentralized trust may be the elusive key for market adoption. Blockchain’s impact may eventually reshape market structure, product capabilities and the client experience, ultimately having a lasting influence on the global economic system.
The opportunity for asset managers
Asset managers face challenges and pressures on their traditional business model, and growth in revenues and assets under management (AUM) has slowed considerably. Regulatory burdens and concerns over access to liquidity are rising. To meet the new challenges and improve earnings and AUM, asset managers are focusing on a range of levers:
• Upgrading their operating model and improving data management.
• Looking to provide solutions, rather than products, to clients.
• Providing continuing service value to clients in a rapidly changing competitive landscape. Blockchain technology has the potential to support asset managers on each of these fronts. FinTech vendors and market infrastructure providers will offer new blockchain solutions to these challenges. In time, asset managers will also develop their own blockchain applications.
Potential asset management use cases
- Accelerated document processing for origination and trading settlement– Blockchain used for sharing and validating loans, IPO documentation among a trusted network. Incentivizes standardization of contractual terms, Accelerates processing cycle and Aids liquidity
- Shared reference data sources (e.g., KYC, trade repositories). Common reference data for market participants held and updated on a blockchain as a central utility. Avoids duplication of work across participants Reduces anti-money laundering (AML) risks, potential for fines
- Data environment to support workflow and analytics. Transaction-level data stored in cryptographically secured smart contracts, which users enrich and use through their workflow; data accessed via nodes. Can become a golden source for multiple sets of reference data Removes need for reconciliation Enables more powerful analysis
- Tracking collateral assets across sources and uses. Status and location of pledged assets tracked via blockchain, used to flag eligibility, rehypothecation rights and excess collateral. Bridges multiple margin accounts Real-time status With smart contracts, can support optimization logic
- Seamless transfer agency Fund. – Unit transfers and ownership tracking carried out on a distributed ledger between funds and investors. Automation of subscription and redemption processes Enhanced investment cycles
- Near-T+0 settlement of trades. Faster clearing and settlement systems via asset and cash ledgers, with both sides of the transaction executed simultaneously Significant reduction in settlement liquidity risk More efficient deployment of capital
- Peer-to-peer custody and settlement networks. – Builds on peer OTC trading networks referenced above, but digitizes assets such that ownership can be transferred and recorded via the ledger. Eliminates need for agents and intermediaries Significantly speeds up settlement processes
While the obvious business case will be around cost reduction, the deployment of blockchain can also lead to revenue opportunities. First, improved data sources can enhance value-added client services such as analytics and real-time reporting. Second, trading strategies can benefit from access to new liquidity or by lowering the risk profile of complex products, such as syndicated loans. Third, blockchain can enable new product structures or vehicles, such as tradable, digitized fund units. On the investment side, active managers will have more to gain than passive managers. For example, loan-based strategies may become more economic. Nonetheless, the majority of revenue benefits are on a slower track due to the greater complexity of deployments and higher contingency on wide adoption.