By: Alex Tarantino
Blockchain – also known as Distributed Ledger Technology (DLT) – is without a doubt a market disruptor and a regular topic on the agenda at Fund Forum International in Berlin. Blockchain is a database with cryptography so unique that it cannot be manipulated and is therefore unvarying. In other words, a financial institution reports information to the Blockchain and it cannot be changed.
In theory, this could have a major impact on numerous aspects of financial services including custody, clearing, settlement, collateral management, and investor and regulatory reporting. The latter resonates with fund managers. The volume of regulatory reports that must be supplied at a national and international level is significant. EU requirements such as the Alternative Investment Fund Managers Directive (AIFMD), the European Market Infrastructure Regulation (EMIR), Solvency II, the Markets in Financial Instruments Directive II (MIFID II) and the Securities Financing Transaction Regulation (SFTR) all oblige fund managers to supply information on their trades, counterparties, risk-profile, investors and operational processes to regulators.
The US – through Dodd-Frank – stipulates a Form PF be supplied to the Securities and Exchange Commission (SEC) by private funds (hedge funds, private equity). Disclosures of US accountholders must be made by financial institutions to the Internal Revenue Service (IRS) under the Foreign Account Tax Compliance Act (FATCA). Many of these EU and US rules bare a number of similarities but also differences. This can inevitably lead to arbitrage or investor confusion, particularly if clients note that different regulatory reports ask the same questions, but have contrasting answers. If all of this information was reported onto the Blockchain, there would be a single source of truth. The data could be obtained by regulators and clients and scrutinised potentially in real-time. A fund manager could therefore be compliant with their AIFMD or Form PF obligations simply by submitting the necessary information onto the Blockchain. It would also allow costs to be reined in, and operational efficiency to be improved. The SEC has said there could be advantages to using Blockchain.
Large asset managers have IT personnel that analyze the technology and assess how it can be applied to their businesses. Speeding up trades in illiquid assets could be one way, for example. However, barriers do exist. While the SEC may have expressed some enthusiasm for the technology, other agencies including the Commodity Futures Trading Commission (CFTC) want to understand Blockchain better.
Several international agencies including IOSCO, have warned DLT such as Blockchain could pose systemic risks. The lack of uniform regulations and industry-agreed standards around Blockchain is an issue and unfortunately not one that will be rectified hastily. A number of organisations must agree on the standards Blockchain must adhere to before it can be rolled out across markets. The problem is compounded as numerous organisations are developing private Blockchains, which may not interoperate. This includes asset managers and banks. Attaining agreement on regulatory harmonisation across thousands of market participants using their own bespoke Blockchains will not be straightforward.
Other problems that must be worked out include shifting Blockchain onto legacy systems; a process that will carry substantial costs and operational risks. There are fears that Blockchain may not have suitable scalability to work, in addition to justifiable concerns that it could be hacked by bad actors. All of these issues need to be solved before Blockchain becomes mainstream.
A number of banks are collaborating together on how to harmonise Blockchain and develop commercial applications for it through the R3 Consortium. For Blockchain’s success to be assured, it will require universal adoption and buy-in from market participants, which is a major ask.
Blockchain is a disruptor. The extent to which it will disrupt markets is open to debate, but it is already gaining some interest among asset managers who hope to deploy it and improve their middle and back office processes. As a leading provider of fund administration and middle office services to the institutional and alternative asset management industry, SS&C has a Blockchain working group which is closely monitoring developments to ensure we stay ahead of the market to best serve our clients. For more information, please contact email@example.com.