With their eyes on debates in SIBOS, a client recently asked me if I believed that global custody had met its nemesis with the advent of Blockchain and other disruptive new technologies. My response was simple. I started with the known or the assumptions that appear logical.
Blockchain style technologies will change the industry’s approach to record keeping. It may also revolutionise trading. Robotics will enable automation of more query handling. Information flows will become more digitalised and standardisation will extend its reach across message flows. Technology change will reduce IT platform life expectancy and, by necessity, change fundamentally the IT architecture of the market place. But Global Custody is a misnomer for a much broader industry and the hurdles to global adoption of new technologies are immense; there will be parallel running for decades irrespective of the regulatory hurdles so often cited as barriers to progress.
There are numerous open issues and, to help the layman understand the potential reach of those new so-called disruptive technologies, the experts need to discuss them with market practitioners across the value chain in far more open environments.
Let us look at the cycle from the perspective of issuance. Distribution of new instruments is a logical step for single ledger technology and, if that technology were, in that segment, as open to access as bitcoin, would allow issuance to move from institutional block allocation down to retail clients. Primary markets are easier to accommodate than secondary, as the totality of a new issue starts in one location with the issuer. In secondary markets, we no longer have the concept of a single location for trading although we may have dominant venues for price formation. In a secondary market trading venue, is Blockchain an added venue, a substitute for a leading venue or could it be a concentrator for multiple venues? And what is the scope of trading? Is it simply an exchange of value or does it encompass asset maintenance and service? And is it realistic to assume that single issues, especially those held globally, would align themselves with a unique platform unless it passed four core tests. Is it cheaper? Is it as safe? Is it acceptable to regulators in all impacted jurisdictions? And what connectivity is needed?
Progressing to the post trade arena, it is worth considering the meaning of post trade operations, assuming our industry footprint starts at the trade confirmation or allocation process and covers all subsequent stages of each security and portfolio life cycle. A recent McKinsey study suggested that distributed ledgers would cut $16 billion from the £54 billion annual post trade wallet. The critical issue is whether this is likely in their five year timeframe and what costs could be eliminated to ensure that the profit impact is minimised.
There is logic in a single record of ownership but the question is how is that constituted and who has access or right of transaction over it? And will it really lead to a seamless link between issuer and investor?And there is logic in several mooted advances in process design, which still looks too like an electronic mirror of the old manual processing environment, but that will require common sense to prevail in market segments that have not been enthusiastic about it or change. Looking at markets post trade we see multiple flaws. Issuance is still heavily paper based with the legal profession generally antagonistic towards electronic communication, other than of documentation, and issuers failing to act as the key investor population does not really focus on improvements in the administration space. The obvious flaw in asset maintenance is the multiplicity and lack of coherence in different records.
What is the true record? Is it at CSD in omnibus form, at custodian and fund in perhaps diverse designated states or at the traded or settled level? The reality is that a holding means different things to different parties in the securities life cycle. And, unless Blockchain is developed to encompass portfolio level information, is multiple Blockchain the solution or just a step towards the solution? We also need to consider asset servicing, from corporate actions that are hybrids of the primary and secondary markets through to income collection, tax reclamation, regulatory reporting or complex M&A activity. How will these be handled for currently they are not driven necessarily from a single holding perspective? Is it not unlikely that Blockchain could accommodate market needs without complex linkages into client and market information?
At fund level, we have the issue of understanding, at instrument level per fund, some of the dynamics of the market place and the fund investment criteria to allow a trade to progress. And we have the need for valuation, taking into consideration issues such as hedges, transactions in flow and special conditions that may be attached to a single holding or subset of the holding. Some of these would disappear with instant settlement but, given the stress at investor level to accommodate T+2 in markets such as the US, I suspect this is not going to be a norm for markets for some years to come.
And Blockchain and other developments will change IT architectures. Most IT architectures are now modular. That creates connectivity challenges but allows for component by component change in infrastructure. But what technologies can co-exist and how should the market approach an age of fast disposable applications? Is this the age of the cloud, or its successor, to enable shared applications and rapid renewal as the pace of change progresses?
And at a business level, many of the current drivers for developments are too technology focused and not business enough. There are serious issues to be resolved around cyber security, especially at gateways, and there are major agreements needed in terms of technical standards. And all this, if the technology is to be global and not niche, at a universal level and across the different market constituencies. And the technical standards are needed at both messaging and process levels.
Blockchain is incredible. It has changed thinking and made the market look at shared ledgers. Blockchain is revolutionary. It could eliminate billions of cost and revenue across the post trade space. But it will need to prove its worth in small universes. Paradoxically, although they do not appear to feature strongly in this space, alternative investment funds with their close investor, administrator and issuer relationship across a limited number of parties, appear to be logical testing grounds for the process before it moves to global issuance and the complexity of the post trade space. Is there a volunteer?