By Mike Wilkins, Head of Industry Solutions, R3
“The digital transformation for the buying side” has been a topic of conversation at countless conferences (and most recently webinars) over the past 10 years. Wealth managers, large and small, have been looking for ways to achieve high returns while eliminating the frictions associated with transactions.
But what does this actually mean? Let’s take a quick look at three practical and tangible ways digital assets and blockchain are driving this change at an increasing pace.
EXPAND THE UNIVERSE OF INVESTABLE ASSETS
While the volatility associated with cryptocurrencies such as bitcoin makes headlines, the reality is that the advent of digital assets has expanded the set of products available to wealth managers. In a 2021 Fidelity survey, 70% of institutional wealth managers surveyed planned to invest in digital assets in the future, with 90% of them planning to allocate those assets over the next five years. Unsurprisingly, investment managers and exchanges are expanding their product offerings in response to attract interest on the buying side.
For investors looking to profit from cryptocurrency swings without the complexities of portfolios or worries about the trading and clearing process, a number of providers have launched crypto ETFs. These instruments are usually composed of a basket of short-term cryptocurrency futures (such as BTC or ETH contracts listed on CME) that need to be rolled over as they approach maturity. While not an exact match for holding the cryptocurrency itself, asset managers with a long-term view can chart the overall direction.
Another option now available to institutions is a digital currency trust. In August 2022, BlackRock announced the launch of a private trust that will offer institutional investors direct access to cryptocurrencies, starting with bitcoin.
While both ETFs and trusts make exposure to digital currencies more accessible and reduce the risk and administrative burden associated with digital currency, there is plenty of room for further process improvements. BlackRock’s launch announcement of their digital trust product said they intend to leverage both licensed blockchain and tokenization as a means to enhance their digital currency offering.
This demonstrates a commitment to innovation not only in the products they provide, but also in the way they deliver them through forward-looking ways.
Streamline reconciliation and settlement processes
Even if a wealth manager doesn’t choose to dive headfirst into incorporating digital assets into their portfolio, they can still leverage the benefits of underlying technology and processes to operate faster and cheaper.
One of the biggest burdens an asset manager faces is business reconciliation. The bigger they are, the more likely they are to trade on multiple brokers who will then reward themselves across multiple companies. The volume of data associated with these operations grows rapidly, and much of the reconciliation process is still handled through a semi-automatic and disjoint combination of email, spreadsheet and FIX messages. Recent technological changes have made the process much more based on exceptions, but resolving those exceptions still requires time and human intervention.
Using blockchain to support trade reconciliation simplifies the process. Instead of individual ledgers managed by each asset manager, broker and clearer, all counterparties move their business to a single authorized and immutable ledger. With all the data of every transaction in one place, the need to go back and forth disappears because a single ledger means there is nothing to reconcile. Eliminating the need for reconciliation reduces both the financial risk and human capital costs associated with manual processes.
In addition to virtually eliminating the need for trade reconciliation, an authorized blockchain also supports faster trade settlement. A shared and synchronized digital record between all parties involved means participants can dictate their own settlement times, whether it’s compressing from T + 2 to T + 1, switching to multiple scheduled settlement intervals per day or even to adjust in real time.
The first step towards faster settlement involves tokenization, the process of converting both the asset and the payment associated with the asset into individual digital tokens. The asset and payment tokens are then combined into a smart contract that contains the asset’s characteristics and payment details. This smart contract is then simultaneously distributed to all parties on the blockchain for validation. Once validated, the asset token is released to the buyer and the payment is released to the seller.
Accelerating the settlement process not only reduces risk across the spectrum but also creates a more open market where smaller players have lower barriers to entry and markets can support continuous trading, clearing and settlement.
SIMPLIFY THE TASKS ASSOCIATED WITH THE ADMINISTRATION OF THE FUNDS
As if post-trade reconciliation and settlement workflows weren’t enough for wealth managers, there is also a whole host of administrative workflows they need to deal with, including onboarding, compliance and reporting. of investors. These workflows have become more complex in recent years with alternative assets such as real estate and private equity commitments becoming more popular as components of investment portfolios. While increasingly popular, many of these investments are illiquid and more difficult to value.
Valuation data can often become outdated and isolated, causing discrepancies.
However, by storing alternative investment valuation data on a blockchain, multiple parties, including fund managers, investors and accountants, can access a “single source of truth” containing up-to-date information for much more accurate valuation.
Additionally, the tokenization concepts discussed above can also support numerous aspects of fund administration workflows. Alternative investments can be converted into tokens which can represent fractional shares of a commercial real estate development or a multi-year venture capital commitment. Investors can tokenize their investable capital, giving them the flexibility to enter and exit different funds when market conditions require it. Having all this data centralized on a ledger means that regulators and auditors have a single source of information from which they can request data on request, shortening the request process.
As we continue to see more and more adoption by purchasing digital assets, we will also continue to see the industry looking for ways to leverage associated technologies to function more efficiently. Transaction efficiency will reduce the time buy-side market participants have to spend on administrative tasks, allowing them to spend more time innovating their offerings and posting better returns.
This article was first published in the Q3 2022 issue of GlobalTrading.