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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.

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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.