The ambition to digitalise financial assets is broadening and deepening. A major shift to distributed ledger technology – or blockchain – has long been predicted but adoption outside the cryptocurrency world has been patchy. Gartner, the research firm, uses its ‘hype cycle’ to demonstrate the rising expectations followed by a trough of disillusionment. Now the graph is pointing back up as ‘enlightenment’ heads towards ‘productivity’. Increasingly, the technology underpinning bitcoin and other cryptocurrencies is going mainstream.
This has big implications for banks, particularly those managing a firm’s balance sheet such as treasurers. The pace of innovation is accelerating and adoption of distributed ledger technologies (DLT) is spreading fast as many firms forge partnerships that blend the old and the new. But that is unlikely to be enough without a wholesale reworking of existing processes. In addition, isolate islands of blockchain or DLT systems fails to deliver on the broad networks needed to truly mutualise financial services infrastructure.
Automation technologies that digitalise existing processes and new emerging technologies that reinvent the way things are done both offer huge potential for bank treasurers to automate and transform the way they and their clients access markets. Off the peg, proven solutions are readily accessible and easily create new ways of working, while DLT solutions have the power to revolutionise transactional finance, opening the door to digitalised issuance, tokenisation and new, cutting-edge products and structures. Understanding the implications is vital.
Moving beyond the here and now
The liquidity fund market is a good example of this. Investors have long sought simpler ways to trade and settle short-term assets by replacing the faxes, emails and phone calls with an automated end-to-end investment process – from order routing and reporting to settlement, with direct access to any of the fund providers and portals they was to invest with.
Today, it is possible for treasurers to invest into money market funds from any system using a completely digital process and without having to invest in new systems. They can see their trade data and monitor settlements in real time, providing complete control and oversight. Automation lifts efficiency and cuts processing time.
Automation can enable banks to transform market access for their clients, giving them more direct routes to both term markets and short-term liquidity products. The next step for the liquidity market will be to learn from other areas of the funds market, and from developments in transactional finance, and move to new technologies solutions, such as DLT and cloud.
For banks and corporates, DLT holds out the promise of a unified digital environment where they can launch and place their issues. This is now reality. In April this year, the European Investment Bank launched the first blockchain-registered bond issue involving a syndicate of banks including Goldman Sachs, Santander and Société Générale. Among the gains cited by the EIB were a reduction in the number of intermediaries, lower fixed costs, increased ability to see trading flows and identify the asset owners – and much faster settlement.
A number of investment banks have borrowed from the crypto world to develop ‘stablecoins’ – essentially tokens backed one-for-one by central bank currency. Examples include Tether, USD Coin and JPM Coin. They are acting as a bridge to bring the benefits of the digital asset world – shortened processing times, reduced cost and enhanced visibility – to mainstream finance.
In June 2021, Goldman Sachs completed its first repo trade using JP Morgan’s private blockchain network, swapping a tokenised version of a Treasury bond for JPM Coin. In February 2021, Dutch bank, Rabobank broke new ground when it completed the first Euro commercial paper transaction using DLT. The deal reportedly settled the same day as opposed to the usual T+2 timeframe. It said ‘blockchain technology can boost intraday liquidity for debt securities, meaning our clients can manage their portfolio and liquidity risks in a truly real-time manner’. It can also save a lot of costs over the lifetime of a deal.
Towards greater automation of settlement
The technology and experience gleaned in the crypto world is increasingly spilling over into the mainstream markets. Investors have long wanted more efficient ways to manage their cash. Blockchain is beginning to bring them.
Real-time, instant settlement has long been seen as the holy grail for equity markets. Now it is coming closer. In the US, there have been a number of pilot transactions aimed at demonstrating that blockchain can both telescope settlement time and slash costs. In May, Credit Suisse teamed up with Instinet and Paxos to conduct US equity trades in both the morning and the afternoon that were settled on the same day.
The Hong Stock Exchange has an ambitious project, dubbed Synapse, using blockchain-based smart contracts to accelerate settlement on northbound Stock Connect transactions and meet the mainland markets’ tight T+0 settlement cycle. HKEX is partnering with DTCC to link HKEX Synapse to DTCC’s Institutional Trade Processing (ITP) services.
As more and more assets take the digital route, the need to build out the supporting infrastructure becomes more pressing. A survey undertaken by Citibank and the magazine Global Custodian found that lack of a secure market infrastructure was the main obstacle among broker dealers to participation in digital assets.
Two things are key here. One is a neutral facilitator with the capability to maintain a secure and distributed register. Neutrality may become increasingly important as banks seek to rely less on a competitor’s platform. The other is a global custody service offering everything required to navigate the hacker-infested waters of the digital world combined with the financial buoyancy of traditional providers.
To that end, many of the established custodians are working hard to establish their credentials as digital players. BNY Mellon, State Street, Citi, HSBC and BNP Paribas have all announced major investments in this area. According to analytics company Blockdata, Standard Chartered leads a list of 13 global banks who have invested the most into DLT and crypto.
Transforming cash … with CBDCs
Confronted with the proliferation of cryptocurrencies and stablecoins, numerous countries are developing their own central bank digital currency (CBDC), not least to maintain some control over monetary policy. China is well advanced with its plans for a digital Yuan. The US Federal Reserve and the Bank of England are both investigating the possibility of issuance.
The largest challenge today is to find ways DLT platforms can communicate with one another in a world of differing norms, processes and regulations. The Bank of Canada and the Monetary Authority of Singapore have shown it can be done. Combining their respective long-running projects to develop next-generation DLT networks for wholesale payments, the two central banks were able to interoperate, allowing cross-border tokenised payments to be settled on CBDCs.
Tokenisation ushers in new investment vehicles
Tokenisation – dividing the ownership of an asset into fractions, or digital tokens – has the potential to transform the collective investment market. Tokenised asset classes traded on a DLT platform have the power to collapse the distance between investors and the underlying assets while reducing many of the intermediary costs. The new vehicles give firms more ways to capture investor flows, not least through fractional ownership.
For banks and asset managers, they pave the way for niche, innovative products that leverage and package a wider range of asset classes. For instance, today, size is the key to viability for any bond issue. Tokenisation transforms the economics, making it possible to tailor a niche investment vehicle to a specific group of clients.
The investor experience is likely to be transformed over time. For a start, it takes automation to a new level with the possibility to trade 24/7/365 with real-time pricing. This would represent a huge advance for money fund investors who currently have to wait to find out the price at which they have dealt
In a survey conducted by Funds Europe in partnership with Calastone, crypto emerged as the number one future means of delivering investments to investors – picked by 91% of respondents and ahead of ETFs (picked by 61%).
Next steps: Enterprise level utopia?
Siloed information is the perennial bank treasurer challenge, it adds to cost and creates an efficiency drag. Technology that simplifies process and creates a safer, faster business environment cannot be overstated. From digitalising manual processes, such as money market fund trading; automation solutions, DLT and crypto can fuse the digital and physical worlds. They can centralise trading platforms and enhance liquidity and risk monitoring.
For the liquidity markets this could very well pave the evolution to a 24/7 industry. Such a system could create a more accessible industry. It could allow credits and debits to clear immediately, potentially reducing risk. It could even strip out unnecessary intermediary costs and reduce fees with the ability to borrow for only hours instead of days by reducing the inconvenient overnight credit facilities that delayed money market fund trades can bring.
In reality, the only thing holding treasurers back is the is their appreciation of the rate of change over the next five years.
Changing things for the better – what is Calastone doing?
At Calastone we believe in finding new ways to solve problems, from applying proven solutions in new ways or delivering new solutions to solve old problems. We have digitalised the liquidity investment process, giving bank treasurers a simpler and safer liquidity investment process that affords full trade and payment visibility and control, while enabling greater fund choice. This is underpinned by Calastone’s Distributed Market Infrastructure (DMI) which combines the connectivity of our global network with the very latest technologies, including distributed ledger technology (DLT).
Our well established DLT-based service for investment funds ensures a frictionless environment for the processing of fund transactions and is connected to the world’s largest community of funds and a worldwide distribution network. It is helping cut costs across the funds industry – and could provide the same platform for tokens.
As a founding member of the InterWork Alliance, we are working with the likes of Microsoft, Digital Asset, SDX, Accenture and UBS, promoting token-powered solutions in different areas and working towards the development of standards – turning the promise of the new technologies into reality.