Blockchain is the Lifeline for Asset Managers

Blockchain is the Lifeline for Asset Managers

Blockchain is more than just bitcoin. For asset managers and wealth managers, the technology offers many opportunities. Blockchain seems to have come at exactly the right time for the investment industry.Asset managers are under increasing pressure to reduce their fees due to the rise of passive investing and robo-advisors. According to research by the American Investment Company Institute (ICI), the average expense ratio of an active U.S. equity fund fell from 1.08% in 1996 to 0.82% in 2016.Declining fees lead to declining profit margins, so asset managers must look for ways to lower their costs. For people's businesses, however, that is easier said than done. What remains is to cut compliance, administration and transaction costs. Blockchain technology can help with that.

Know your customer

Let’s start from the beginning: when it comes to compliance, blockchain may well have a revolutionary impact. Now, for example, banks and asset managers must perform a whole range of administrative actions to take on a new client.Roughly half of the potential new clients from an asset manager drop out during this so-called onboarding process.In the context of know your client (KYC), banks in Spain must in any case have a DNI number, name and address details and the date of birth of a (potential) client. After that, all kinds of checks are made, for example with the credit registration agency to check how creditworthy a customer is. Not only does this take a lot of time, because each agency has its own administration system, but companies also must store this data somewhere safely.And individual customer data, such as investable assets and investment preferences, can all be put in the blockchain as well, so they are easily accessible. The knife cuts both ways because the customer also benefits.  After all, with blockchain they can regain ownership of their data. For example, they can take away or add information themselves. In addition, there are an awful lot of different agencies and companies that all have information about customers, but a customer has hardly any insight into this. In a blockchain, a customer will soon be able to give his own permission to share his data, and all the data in the blockchain will remain there. Now it is still stored on all kinds of different databases.

Easier exotic investing

The applications of blockchain for investment purposes seem limited, but they are present, nonetheless. For example, the technology can be used to make certain asset classes more accessible to investors. This includes not only cryptocurrency, but also asset classes that individual investors currently have difficulty accessing.Blockchain makes transactions cheaper, and it gives absolute certainty about property rights. Investors can theoretically buy even a tiny piece of land through a blockchain-based system, which is impossible now because those markets are now difficult to access and illiquid.

Custodial banks are no longer needed

Still, the biggest advantages of blockchain lie more on the process side. For example, blockchain theoretically makes it possible to cut out intermediaries altogether. The depository and custodian banks, which a mutual fund currently has to appoint by default to monitor transactions and keep the assets in the fund, will no longer be needed with the advent of blockchain.A transparent blockchain can make custodial banks and other intermediaries obsolete. Blockchain gives you, the buyer, absolute certainty about who owns an asset and what it is worth at any given time.Once information has been recorded in a blockchain, it cannot be altered surreptitiously. This is done via so-called smart contracts: agreements between two anonymous parties that are entered into the blockchain in the form of codes. In such a smart contract, a transaction can be arranged by means of an encrypted code, such as the purchase or sale of investments, a dividend payment or the lending of shares or bonds. A smart contract can even be used to determine what a computer should vote on at a shareholders' meeting. At the moment, these kinds of actions are still approved and carried out by custodian banks, but blockchain can, in principle, take over that role.

No standard yet

Blockchain will drastically change the world of custodians, yet it’s not sure they will be the losers of blockchain technology. In ten to twenty years, their role will look very different, because it has happened before. Less than twenty years ago, custodian banks had to write a check by hand for every time a coupon for a bond or dividend on a stock had to be paid, which then had to be mailed.Before blockchain can be deployed on a large scale, it is also important to have a standard blockchain technology so that the various players can communicate with each other. And we are a long way from that. There are currently more than 100 different initiatives in that area worldwide. Eventually, though, we need to move toward a single standard. But that will be difficult with so many different players. That's why it is expected that it will take at least another five to ten years before blockchain can be applied on a large scale within asset management.But fragmentation need not be a problem at all. All asset managers and banks use different databases now anyway. You can make a business case for blockchain with fewer participants than you might think.

Convenient asset managers

So why are asset managers so slow to adopt blockchain? The main reason seems to be that they are just still doing too well. Profit margins of asset managers still average 35%. So why should they have to change anything? Even if their margins go down to 25% due to competition from passive funds, there's still little to worry about.Asset managers' focus on the short term also plays a role. Asset managers are generally tactical organizations that do little long-term investing. They often don't look beyond the next quarter. And often they also don't understand exactly what blockchain is and what they can gain from it.Perhaps it also has to do with the fact that many investment professionals adopt a first-see-then-believe attitude. Just as most professional investors don't get into a fund until it has a three-year track record, they will also first want to see that blockchain works in practice. And so it may be some time before it does.