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Today New City Initiative is comprised of 51 leading independent asset management firms from the UK and the Continent, managing approximately £400 billion and employing several thousand people.

Displaying articles for 2018

Reflections on NCI’s Blockchain Event of 28 March 2018

Reflections on NCI’s Blockchain Event of 28 March 2018

On 28 March 2018, New City Initiative (NCI) held a discussion and panel event on the topic of how Distributed Ledger Technology (DLT) and other technologies would likely affect the boutique asset management industry. In some of NCI’s recent policy papers we have explored the unique culture within small and medium-sized boutique asset managers: that culture promotes innovation and use of DLT is likely a trend that will advance rapidly in the industry.

The evening was structured as follows. Firstly, I gave a brief introductory presentation on DLT, including some usage cases across industries such as banking, insurance, music and public services. The common perception of DLT is its usage in Bitcoin, yet that is merely one usage case and moreover presupposes that public blockchains will dominate. The transformative effect runs more deeply and is likely not yet fully perceived, just as early use-cases of the internet in the late 1990s were not necessarily those that thrived: companies such as Amazon have used the internet as an enabler to drive changes in real-world businesses and, in my opinion, that is how the effect of DLT will ultimately be seen. This was followed by a panel discussion featuring three expert panellists: Liliana Reasor, who is CEO of SupraFin; Richard Maton, Partner at Aperio Strategy and Founder of the Financial Institution Innovation Network, and; Nick Bone, Founder and CEO of EquiChain.

Liliana talked about how the traditional IPO market can be disrupted by the processes used in Initial Coin Offerings (ICOs), transforming the operation of capital markets and empowering individual investors: SupraFin is a leader in this space. Nick commented on how DLT can be used to automate middle and back-office functions, but how there should be an awareness of vested interest in resisting change. Rather, investors may ultimately access securities and the custody chain directly, a usage case that EquiChain is developing. Richard commented on the need for changes in organizational culture and collaboration models to create and develop solutions that incorporate DLT and other technologies such as Artificial Intelligence (AI) and the capacity to be self-critical: by way of example, Kodak, Xerox and the like could not adapt, and perhaps actively avoided change; the result is self-evident.

Another interesting topic discussed was how DLT, and the security it can give, could allow emerging economies to leapfrog legacy economies, a process assisted by demographic change and a modern dependence on the state in Western countries. I walked away feeling excited about the future yet thinking that the asset management space, and financial services generally, will change rapidly in the face of technology: DLT intersects with AI and the increased data processing capabilities often called Big Data.

Panels such as these are a good opportunity to consider major changes in our industry and make us rethink certain assumptions. For instance, it may not be Brexit or regulation that turns out to be the biggest threat and opportunity to asset managers, but instead the adoption of disruptive technologies such as DLT and AI, amongst others.

Furthermore, the insightful questions from the industry audience put paid to the view that asset management is conservative and resistant to change; instead they demonstrated an appetite for innovation.

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Brexit - Still far from settled

Brexit - Still far from settled

To say the timing of AIMA’s (Alternative Investment Management Association) Global and Regulatory Policy Conference in Dublin was fortuitous is an understatement, happening less than one day after the UK and EU announced a conditional agreement for a transition or implementation period, potentially giving businesses an additional 21 months to finalise their Brexit planning. The word conditional here is very important because the transitional arrangement will only be formalised if the withdrawal treaty is fully agreed.

To summarise one AIMA attendee, "it is an agreement conditional on an agreement." Any number of issues could wreck UK-EU negotiations over the next 12 months including the future status of the Northern Ireland border; Spanish disagreement over Gibraltar; or even insistence from nationalistic Greeks that a Brexit transition be somehow linked to the immediate return of the Elgin Marbles (sadly not a joke).

If no withdrawal agreement is ratified, a Hard Brexit in March 2019 beckons. Despite all of the vainglorious media reports over the last 48 hours, it is very difficult to see what has actually changed. EU regulators – conscious of this misplaced optimism - have been at pains to stress that the risk of a no-deal is not a remote possibility, but something which organisations should still be actively provisioning for.

As such, fund managers must not over-analyse this relative thawing of Brexit negotiations, but should continue making preparations to ensure EU access – assuming they still want it – is still available to them following the UK’s departure. With delegation and reverse solicitation’s future both looking increasingly precarious in the AIFMD review, now is the time for firms to consider whether they create subsidiaries in the EU-27.

On the basis that there is unlikely to be any certainty around Brexit until early next year, the decision to relocate will have to be made blindly.  However, regulators at the AIMA event warned UK fund managers and banks that establishing shell companies inside the EU to game market access will not be tolerated post-Brexit. A number of EU regulators have also told managers that authorisations could take time if submissions all occur concurrently, and are recommending that firms send over their applications by mid-2018.

The other big risk for asset managers is fragmentation. Recent statements from EU regulators have been revealing. While fragmentation is not ideal, many EU regulators seem resigned to the fact it will happen, and have urged firms to plan for it.  For boutiques, this risks adding more costs to their operations if they are marketing into the UK and EU. Managers should start factoring these potential costs into their businesses, and build buffers accordingly.

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liquidity - avoiding a mismatch

liquidity - avoiding a mismatch

Liquidity – when markets are volatile – is a priceless commodity for fund managers to have, which is why UCITS’ products – for example - have seen strong, regularised inflows from investors globally.

However, some NCI members are warning that certain daily dealing products are at risk of facing a liquidity mismatch, causing significant damage to their reputations. UCITS’ brand strength is attributable to several factors, not least of which is the daily liquidity these funds provide clients. Nonetheless, there have been warnings that macroeconomic conditions – most notably in the fixed income market – could present liquidity challenges for UCITS managers running bond funds.

In 2016, Fitch issued a statement warning that 90% of UCITS running fixed income strategies were at risk of suffering a liquidity mismatch amid volatility in bond prices. While not a UCITS, a high-yield mutual fund in the US shuttered in 2016 after it failed to satisfy client redemption requests during the bond market volatility. Similar outcomes for UCITS cannot be ruled out if fixed income trading conditions take a turn for the worst.

The growth of alternative UCITS operated by hedge fund managers typically replicating their flagship products albeit under more regulated conditions is also a worry for some NCI members, mainly because they believe unsuitable or illiquid strategies are at risk of being distributed under the UCITS banner. If markets were to seize up, and redemptions grounded by one of these firms, the UCITS brand could be seriously undermined.

However, it is important to note that most hedge funds running UCITS will do so within the confines of the rules, while regulators are very proactive at flagging strategies down which they believe are unsuitable for the brand. Equally, esoteric or complex strategies should not be misinterpreted as being illiquid in nature. 

NCI members also expressed misgivings about the proliferation of daily dealing open-ended property funds. It was well documented that a handful of such funds were forced to temporarily suspend redemptions following the shock Brexit vote, and its immediate hit on UK property prices. Despite these funds having large cash reserves to satisfy redemptions in ordinary market conditions, these holdings are not always sufficient during periods of high volatility.

In extremis, firms could be forced to unwind property in fire-sales at uneconomic prices causing widespread losses for end clients. Even if a property fund was able to sell its underlying investments, it would be very difficult not to suspend redemptions as it is physically impossible to offload a building in a single day to a buyer. In response, some NCI members feel regulators should scrutinise the liquidity terms offered by daily dealing property funds.

NCI will produce a white paper exploring whether or not some fund types including alternative UCITS, daily dealing open-ended property funds and certain ETFs are at risk of facing a liquidity mismatch, a scenario which if played out would undoubtedly result in serious damage to the industry and its standing among investors. NCI will be consulting with its membership on this paper shortly.

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Blockchain and Boutiques

Blockchain and Boutiques

Having begun its life as a fairly unimposing piece of technological infrastructure supporting the then peripheral and arguably mysterious world of cryptocurrencies, Blockchain is now seen as being one of the biggest potential enablers of cost reduction and efficiency in financial services, including fund management.  

Blockchain or shared, immutable distributed ledger technology (DLT) is forecast to save the financial services industry approximately $110 billion in costs over the next three years, according to McKinsey, with cross-border B2B payments, trade finance, P2P payments, repo transactions, derivatives settlement, AML and KYC likely to be the areas targeted for streamlining and disintermediation.

Fund managers – at least in the short term – are likely to find Blockchain technology being increasingly used in client and regulatory reporting, corporate actions, proxy voting and automation of transactional processes in the distribution cycle. Over time, the use cases will expand with the technology – which can process transactions in real-time -  potentially disrupting clearing and settlement. The elimination of intermediary costs – certainly in the custody chain – will bring cost savings for managers which can be passed on to customers.

Boutique asset managers will not be omitted from the Blockchain revolution. Admittedly, most boutiques will not develop proprietary Blockchain solutions, mainly due to the initial costs of the R&D being too high, but also because service providers should do it for them, providing industry-wide solutions and infrastructure. As fiduciaries, however, fund managers have a responsibility to investors to mitigate operational risk, and this applies to how they use Blockchain.  

Interoperability: Getting it Right

System upgrades and transformations rarely go ahead without some form of inconvenience or impediment to the end client. The legacy technology supporting the fund management industry and their service providers can be antiquated, making it very difficult to introduce new systems without causing massive disruption. If Blockchain is to work, it must be able to operate with legacy infrastructure, which can be decades old.

This may require service providers to maintain their existing technology simultaneously to rolling out a Blockchain solution in parallel. A dual infrastructure should help avoid IT meltdowns as and when Blockchain becomes more customary in financial services, but the cost of running two systems may result in the industry and its customers being saddled with higher fees during that interim or transition period.  

Making a Complex Ecosystem More Unnavigable

Given the gravity around unwanted disclosure of confidential information and cyber-crime, most fund managers do not support the idea of a public Blockchain despite the efficiencies it will bring. As such, most service providers are developing private Blockchain solutions.

This has scope to exacerbate complexity in an already convoluted and crowded financial ecosystem, particularly if different Blockchain solutions cannot interoperate, or were fund managers to find themselves working across dozens of distinctive and arbitraging DLT interfaces. Rather than saving costs, this could potentially add to them. 

No Standards

Market-wide standards are essential as they help create uniformity across capital markets. SWIFT, for example, has played a vital role in setting the standards for payments and securities transactions across multiple geographies. Nothing of this sort exists for Blockchain although this is symptomatic of any technology’s early stage development and a reluctance among industry participants to impose prescriptive requirements at the expense of innovation.

Regulation of Blockchain is limited for similar reasons. Without some standardisation or regulation, Blockchain’s development is likely to be slightly staggered and uneven across markets, something which will make it harder for the fund management industry to fully embrace.

Secure or Not?

Cyber-security was found wanting in 2017 as a number of multinational organisations fell victim to sophisticated hacks. Information contained on a Blockchain is protected through encryption and cryptography, barriers which make it materially harder for hackers to breach, or so the theory goes.

Advances in technology have cast doubt as to whether Blockchain encryption is sufficiently capable of protecting client information against future threats such as those posed by quantum computers.  Quantum computing is an extraordinarily powerful, theoretical form of computational strength which could decipher or crack even the most sophisticated Blockchain encryptions and cryptography.  

If Blockchain providers do not take note of this potential risk, the technology may only be usable for a decade or less. It is critical for managers to pause before they consider Blockchain, and ensure the technology is future-proofed, otherwise they could end up spending significant sums on a short-lived concept vulnerable to new, unexplored risks.

Blockchain Bubble?

The highly speculative Bitcoin and Initial Coin Offering (ICO) mania which has swept the world over has alarmed some Blockchain providers. For several years, they have worked assiduously to disassociate themselves from Bitcoin, and the big fear now is that any sudden price rationalisation in cryptocurrencies could hurt a number of investors which in turn may sour (unfairly) the reputation of DLT.

Conversely, there is a Blockchain bubble in itself, namely an oversupply of providers, many of whom are hoping to capitalise on the technology’s popularity in financial services. Most Blockchain providers will fail and it is important managers work with established or credible organisations when implementing a DLT strategy to avoid any business disruption.  

The Best Approach

Blockchain will have a positive impact on asset management, but firms still have time to make a decision on how to apply it to their businesses. It is probable the larger asset managers that will embrace the technology initially, before it trickles down to the boutiques unless they collaborate. NCI is hosting a Blockchain seminar later this year for its members. Venue and details will be published shortly.  

 

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