By Mike Wilkins, Head of Industry Solutions, R3

“Buyer Side Digital Transformation” has been a topic of conversation at countless conferences (and more recently, webinars) over the past 10 years. Asset managers both large and small have been looking for ways to post strong returns while removing the friction associated with trading.

But what does this really mean? Let’s take a quick look at three practical and tangible ways that digital assets and blockchain are driving this change at an ever-increasing rate.

EXPANDING THE UNIVERSE OF INVESTMENT ASSETS

While the volatility associated with cryptocurrencies like bitcoin grabs the headlines, the reality is that the advent of digital assets has expanded the suite of products available to asset managers. In a 2021 Fidelity survey, 70% of institutional asset managers surveyed expected to invest in digital assets in the future, and 90% of them planned to allocate those assets in the next five years. Not surprisingly, in response, investment managers and exchanges are expanding their product offerings to attract buyer interest.

For investors looking to benefit from cryptocurrency exchanges without the complexities of wallets or concerns related to the trading and clearing process, several providers have launched cryptocurrency ETFs. These instruments are typically made up of a basket of short-term crypto futures (such as BTC or ETH contracts listed on CME) that must be rolled over as expiration approaches. While not an exact match to hold crypto itself, asset managers with a longer-term view can trace the general 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 mitigate the risk and administrative burdens associated with digital currency, there is plenty of room to further improve processes. BlackRock’s launch announcement of its digital trust product mentioned that they intend to leverage both permissioned blockchain and tokenization as a means of enhancing their digital currency offering.

This demonstrates a commitment to innovation not only in the products they offer, but also in how they deliver them through innovative ways.

STREAMLINES CONCILIATION AND SETTLEMENT PROCESSES

Even if an asset manager does not choose to dive headfirst into incorporating digital assets into their portfolio, they can still reap the benefits of the underlying technology and processes to trade faster and cheaper.

One of the most onerous burdens facing an asset manager is business reconciliation. The larger they are, the more likely they are to execute trades through multiple brokers that are then settled through multiple companies. The volume of data associated with these exchanges adds up quickly, and much of the reconciliation process is still handled through a semi-automated and disjointed mix of emails, spreadsheets, and FIX messages. Recent technological changes have made the process much more exception-based, but resolving those exceptions still takes time and requires human intervention.

Using blockchain to support trade reconciliation streamlines the process. Instead of individual ledgers maintained by each asset manager, broker and clearer, all counterparties move their business to a single, immutable, authoritative ledger. With all the data for every transaction in one place, the need to go back and forth disappears because a single ledger means there’s 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, a permissioned blockchain also supports faster trade settlement. A digital ledger that is shared and synchronized between all parties involved means that participants can dictate their own settlement times, whether that be compressing from T+2 to T+1, moving to multiple scheduled settlement intervals per day, or even settling in real time. .

The first step toward 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 delivered to the buyer and the payment is delivered to the seller.

Speeding up 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 ongoing trading, clearing and settlement. .

SIMPLIFIES TASKS ASSOCIATED WITH FUNDS MANAGEMENT

As if post-trade reconciliation and settlement workflows weren’t enough for asset managers to tackle, there’s also a whole suite of management workflows they need to take care of, including investor onboarding, compliance and the generation of reports. These workflows have become more complex in recent years with alternative assets such as real estate and private equity commitments becoming more popular as a component of investment portfolios. Although increasingly popular, many of these investments are illiquid and more difficult to value.

Valuation data can often become outdated and isolated, leading to 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” that contains up-to-date information for a much more accurate valuation.

Additionally, the tokenization concepts discussed above can also support numerous aspects of fund management workflows. Alternative investments can be converted into tokens that 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 move in and out of different funds when market conditions warrant. Having all this data centralized in one ledger means that regulators and auditors have a single source of information from which they can request data on demand, shortening the query process.

CONCLUSION

As we continue to see more and more buyer adoption of digital assets, we will also continue to see the industry look for ways to leverage associated technologies to function more efficiently. Operational efficiencies will reduce the time buy-side market participants need to spend on administrative tasks, allowing them to spend more time innovating their offerings and earning better returns.

This article was first published in the Q3 2022 issue of world trade.

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