In most industries technological disruption (such as blockchain) has resulted in more choice and less cost to the end user. Not so in a large chunk of financial services. One of my favourite pieces of research examining this dismal state of affairs comes from French academic Thomas Philippon, who teaches at New York University. In Finance v Wal-Mart: Why are Financial Services so Expensive?, Mr Philippon crunches the numbers on costs for consumers. The results aren’t pretty, with increased intermediation just one of the smoking guns. According to Mr Philippon: “The cost of intermediation per dollar of assets created has increased over the past 130 years.”
He suggests that the “unit cost of intermediation has been somewhere between 1.3 per cent and 2.3 per cent of assets. However, this unit cost has been trending upward since 1970 and is now significantly higher.” I can’t help but think that one of the biggest smoking guns is the web of fund administration functions in funds settlement and management, which helps keep the professionals in places such as Luxembourg in Audis. Let’s chart the chain of agents involved in a fund value transaction: transfer agents, fund accounting, global custody services, depository services, fund distribution solutions as well as index firms if we’re using exchange traded funds.
Processes vary but we can note down calculations of net asset value, know-your-customer and anti-money laundering controls, plus a longer list of even more boring, repetitive but necessary tasks. The net effect is a decline in efficiency (with settlement of trades taking two or three days) plus the inevitable extra costs to fund manager and end investor. Perhaps technology can provide a solution? At this point I gently, hesitantly, fearfully even, introduce the dread words — crypto and blockchain. For the record I remain to be convinced of many claims made about this impossibly boosterish world of nerds. What I would be willing to place a small bet on, say a lunch, is that the disruptive technology behind distributed ledgers (DLT) could result in many job losses in Luxembourg and beyond. I’m not alone.
A Deloitte report concluded: “Blockchain technology has the potential to wipe Luxembourg oﬀ the map of the fund distribution and administration market.” Bad news I’d suggest for those Audi dealers. More to the point I am beginning to run into outfits of varying size — such as Calastone, FundsDLT and Amun — that are beginning to figure out how to apply smart contracts and DLTs to the fund admin chain. Swiss-based Amun for instance has been quietly building a full-stack fund admin structure that could be used with outside firms — it was forced to build these multiple functions so as to launch its own physically-backed crypt tracker.
FundsDLT has also worked with Amundi, the €1.47tn European asset manager. In effect, these early-stage companies have worked out that this long chain of fund admin functions is just a value chain of paper-based commands that need recording somewhere accessible and verifiable. Smart contracts, where technology implements actions based on conditions, can be built into permission-based ledgers and blockchains. Along the way we could see costs reduced and efficiency vastly increased with T+0 (same-day trade settlement) theoretically possible. There are already businesses building DLT-based architecture.
Challenges remain: regulators will need to get behind these ideas, but the way in which central banks have begun to seriously consider digital ledgers — for emoney versions of fiat money — suggests that their bureaucratic minds may be open to the possibilities of blockchain. It is also true that the technology is not user-friendly and is vulnerable to tech-savvy manipulation.
Open access to the transaction and settlement blocks scares many while even more insiders worry about scalability — my guess is that leviathans such as State Street or BNY are not quaking just yet. Looking even farther out, another vista appears: the tokenisation of most fungible assets. I would be a rich man now if I had received £1 for every opportunity spun to me about tokenising an office building (or expensive violin or bottle of precious French wine). A few projects have emerged in the US, in the property space for instance, but it is clear that the back-office settlement systems on which these projects rely are far from complete.
If fund admin is blockchained, that could change; even better if the smart contracts sitting under the bonnet help cut costs (especially magic-circle legal costs) and result in access to new alternatives. This brings me to my last contrarian thought. Could a progressive regulator mandate a wholesale move to blockchain?
Source: Financial Times