Blockchain technology has the potential to be one of the most disruptive and transformative phenomena that the financial services sector has ever seen – but there is also scope for tremendous frustration.
Not because the idea of a distributed digital ledger isn’t practical or proven – it very much is – but because persuading people to switch to it in sufficient numbers at the same time is going to be very challenging.
Take the UK’s £1.5tn mutual fund sector, an industry that is built upon a remarkable patchwork of back office legacy IT systems that require huge amounts of manual intervention and generate high costs that must ultimately be borne by investors.
For all the talk about innovation and digital technology in financial services, take a trip to one of the vast processing centres run by the transfer agents that provide the administrative underpinning to mutual funds and you’ll be confronted by a scene that looks 30 years out of date: small armies of staff engaged in time-consuming paperwork with little or no automation.
The need for modernisation will only become more imperative as investors step up the demands they make of mutual fund managers – already, they want globalised portfolios and multi-asset investment strategies, and they want complete transparency about charging, performance and asset allocation.
Front-line investment managers may be equipped to deliver greater sophistication, but their back offices, including the third parties on which they rely, are very often unfit for the purpose of serving that demand.
Blockchain technologies could be the solution to so many of their problems.
The blockchain offers a secure and straightforward digital ledger on which many parties can log their transactions. Under the control of no single party and entirely decentralised, this ledger eliminates the need for any intermediary to sit between two parties in a transaction – whether to control the exchange of money, register the change of ownership or provide a permanent record of what has taken place.
In a mutual fund context, that means no more need for transfer agents, with their expensive exercises in paper-shuffling.
So why aren’t mutual fund managers falling over themselves to move to this technology?
One problem is they don’t know how to do so – recent PwC research found 57% of asset managers weren’t sure how to respond to the potential of blockchain technology.
The other problem is that this is a transformation that requires mutual funds to move together – it doesn’t work if only one asset management company makes the leap.
In an industry where mistrust rather than collaboration is so often the prevailing emotion, that’s a real challenge.
There is some reason to be optimistic.
The Financial Times reported in February that five mutual fund managers – Schroders, Aberdeen, Columbia Threadneedle, Aviva and Henderson – have begun working together to explore the possibilities. But for blockchain to move forward, we will need to expand this coalition of the willing.
Don’t expect the big push to come from the fund administrators, which have quite enough to cope with managing their legacy systems in the face of their more demanding customers (the switch to blockchain is, in any case, unlikely to be in their commercial interest).
Nor should we pin our hopes on startups, despite their remarkable success in other areas of FinTech. The capital required to launch the kind of operation required by the mutual fund industry is too much for even the most ambitious and well-connected of entrepreneurs.
In the end, we may even need some sort of regulatory intervention. The Financial Conduct Authority is rightly praised for its efforts to facilitate fintech innovation, with a number of initiatives that aim to ensure regulation doesn’t get in the way. Maybe the FCA needs to go one step further and take the lead in this area.
Mutual funds are, of course, only one area of financial services that stands to benefit from embracing blockchain technologies.
There’s no reason why, for example, these ledgers shouldn’t replace the exchanges where securities trading is currently taking place.
The technology has applications in everything from know-your-customer processes to trading and settlement. But until we find a way to encourage large numbers of market participants to work together, we aren’t going to capture the potential of these opportunities.
This blog was first featured of Tech City News