Blockchain could replace post-trade intermediaries, says expert

Asset managers could be eyeing up blockchain for post-trade

Asset managers could soon be using Blockchain as a way to stop relying on intermediaries in clearing and settlement, according to an industry expert.

The shared sequential transaction database could act as a way for the buy-side to lower their transaction costs in the post-trade space, said Alexandre Rochegude, partner at KPMG in Luxembourg, speaking at the Association of the Luxembourg Fund Industry’s (ALFI) Alternative Investment Funds Conference.

“The main impact of Blockchain will be felt by managers as they disintermediate intermediaries in the post-trade space,” he said. “A lot of fund managers are seriously considering how Blockchain can help their businesses and they sense an opportunity. I suspect the real impact of Blockchain will be felt in the transfer agency and clearing space.”

Blockchain, the digitised distributed ledger, which underpins the Bitcoin, has generated immense traction in the post-trade and settlement landscape. Some optimists believe this disruptive technology could obviate the need for fund managers to rely on transfer agents, which are renowned for adopting highly manual processes. It could also streamline clearing and settlement, and by-pass the requirement to clear over-the-counter (OTC) derivative transactions through central counterparty clearing houses (CCPs). In terms of trade settlement, Blockchain could enable transactions to settle in real-time as opposed to the industry norm which is towards T+2 or T+3.

The centralised ledger technology could also provide a simpler mechanism by which to report details of trades or information about their businesses, as is required under the plethora of regulatory reporting obligations. Utilising Blockchain could render exchange traded derivative (ETD) and OTC derivative reporting to trade repositories or US swap data repositories obsolete if the information were shared via Blockchain.

Market infrastructures are exploring the Blockchain concept. The Australia Securities Exchange (ASC) is upgrading its existing clearing and settlement system – the Clearing House Electronic Sub-register System (“CHESS”) and according to reports has selected Digital Asset Holdings, a Blockchain start-up established by a former J.P. Morgan executive. ASX has said Blockchain could reduce costs and clerical errors. It is believed Digital Asset Holdings will assist ASX with clearing and settlement in the cash equity market. 

Financial technology provider R3 is fronting a consortium of global banks evaluating Blockchain, and seeking to develop standards around the concept. It was announced in December 2015 that global banks including Nomura, Santander, Northern Trust, Sumitomo, US Bancorp and Scotiabank were joining the R3 consortium bringing the total number of banks involved in the initiative to 42. Other major banks involved in the consortium include HSBC, Morgan Stanley, Citi, BNY Mellon, Bank of America Merrill Lynch and Societe Generale. Quite how long it will take to attain consensus on Blockchain is probably the biggest challenge facing its development. 

Despite regulators such as the Securities and Exchange Commission (SEC) issuing promising feedback around Blockchain, citing its ability to give national competent authorities better oversight of systemic risk, there are concerns. The Commodity Futures Trading Commission (CFTC) is to discuss Blockchain among other issues this month. The biggest concern surrounds accountability. Blockchain is a shared technology and should there be malpractice, regulators would need to point the finger. 

Others express concern that Blockchain could be vulnerable to cyber-breaches, a growing area of concern for regulators worldwide. “Cyber-security is a major challenge for every participant in financial services today. But Blockchain is highly secure and because it is open source, it would be far harder to breach,” commented Rochegude. 

It is not just evolution in operational processes. The growth of robo-advisers, which provide cost-effective computer-driven investment advice, is another major trend. While some fund managers fret this could threaten their livelihoods, Rochegude believes the opposite. “Fund managers need to understand that robo-advisers are an opportunity set and not a direct threat. Financial services and investors are evolving and end clients ultimately want accessible, cheap and app-friendly investment services. Most robo-advisers are based on exchange traded funds (ETFs), which are flexible and simple to understand for the end-users, who are becoming increasingly younger and tech-savvy,” he added.

Technology giants are also entering the fray. Snapchat, the disappearing photo-sharing tool, is reported to be exploring robo-advisory services, while Yu E Bao, a division of Alibaba, has amassed almost $90 billion in Assets under Management (AuM) in two years, a point made by Rochegude. In 2014, Google hinted it could launch an asset management service, having already developed a successful venture capital division. 

This alarmed a number of active managers, and several have gone public warning the industry not to be complacent about the threats posed by new disruptive entrants. Indeed, a study by State Street in 2015 confirmed 79% of asset managers feared a technology giant could upset their core investment management businesses. Nonetheless, most believe that technology players would be better suited to assist with distribution rather than competing with traditional fund managers.

“Perhaps one of the biggest challenges therein lies with the regulators. Regulators need to constantly update and adapt the rules to newcomers, whether it be a technology giant or online equity crowdfunding schemes. Regulators are having to work very hard to rewrite the rules to cater for the new models and players, and to help ensure investor protection,” commented Rochegude. 

This was evident during a speech to private equity industry leaders in London in December 2015 by Sven Gentner, acting head of unit for asset management, DG FISMA at the European Commission (EC). Gentner said the EC was reviewing cross-border marketing and was cognizant that the modus operandi around distribution has changed markedly, particularly in regards to online distribution. As such, he said regulators would have to be mindful of technological advances in future policy-making.