When a group of retail traders on the social network website Reddit created a trading frenzy in shares issued by US videogame retailer Gamestop, the ensuing volatility – which saw some retail brokers suspend trading in the shares – reignited a debate about the time it takes for trades to settle.

In the wake of the Gamestop furor, the US Depository Trust & Clearing Corporation (DTCC) outlined plans to shorten settlement times to one day after a trade is executed instead of the current two days, or T+2. The shift to T+1, it said, is to mitigate counterparty risk and reduce margin requirements, potentially making it cheaper to trade.

The DTCC stopped short of advocating for an entirely real-time settlement system, in part because of a process known as ‘multilateral netting’ – essentially a way to limit the amount of money and securities that need to change hands throughout the day, which the DTCC says would otherwise create “massive market and capital inefficiencies,” as well as increase credit and operational risks.

Opportunity knocks

The potential for blockchain use in the asset management industry might make such discussions moot as the technology opens up the possibility for trades to settle instantly without the technical impediments of conventional market infrastructure.

“Instead of waiting two or three days for trades to settle, you can confirm settlement and payment across the blockchain almost instantly,” says Amarjit Singh, Blockchain Assurance Leader at EY.

“At the moment, T+2 means you have credit risk and settlement risk over that time period. All of that effectively disappears by using blockchain technology, potentially eliminating the danger of cash going missing.”

For that to happen, however, the industry would need to undergo a radical overhaul – so far, traditional asset managers have been slow to embrace new technology, says Matthew Le Merle, managing partner of venture capital fund Blockchain Coinvestors and author of the book Blockchain Competitive Advantage.

“The asset management industry is an industry built on the notion that they help investors to access assets and they help issuers to issue assets, and most of that is all still paper-based,” he says.

“Asset managers are now going through the process of asking themselves: should they be offering new products, should they create a blockchain ETF, should they put their funds on a digital platform.”

Matthew Le Merle, managing partner, Blockchain Coinvestors

“Even if the assets are not paper-based, the processes of the industry are still based on legacy activities and approaches that resulted from a paper-based world. We digitized public equities in the 1980s, and we’re going to get round to digitizing all the other assets at some point – the industry knows it’s going to happen, but the reality is they have been slow to act.”

The emergence of cryptocurrencies and other digital assets based on blockchain technology has given rise to a new wave of fintech companies offering crypto assets such as Bitcoin, leaving the asset management industry caught somewhat off-guard, says Le Merle.

“Asset managers are now going through the process of asking themselves: should they be offering new products, should they create a blockchain ETF, should they put their funds on a digital platform,” he says.

“They have to act fast because, by the time you see a lot happening, you’ve already got a problem because that means the adoption curve is about to go through its steepening point.”

But it is not just about selling digital assets; there are also several other potential use cases for blockchain technology in the asset management industry – not least how it can support the middle to back-office functions, which often involve tasks built around inefficient, manual processes.

Compliance checks

Take onboarding new customers. Typically, the know-your-customer (KYC) and anti-money-laundering (AML) compliance checks are paper-based and not usually joined up. So, if a customer signs up to a different service in a business of which they are already a client, the onboarding process often needs to be repeated.

“That customer experience is horrible,” says Le Merle. “Digital identity based on blockchain technology has the potential to change this – it’s portable, secure, immutable, and reusable – and the reason why it has so much potential is because, where we are today, every asset management firm relies on unsecure, unreliable, and non-reusable versions of identity. They’re very costly, they take a long time to process, and bad actors are really good at spoofing paper-based KYC and AML situations.”

The technology could also be used for regulatory and compliance purposes.

“When people talk about blockchain, it is often in a very one-dimensional sense in that you can just use it to store data,” says Haydn Jones, Senior Blockchain Market Specialist at PwC.

“But there is another dimension where you can add conditionality to the data. That can allow you to configure it in such a way that it becomes a regulatory perimeter that says, for example, if you have exceeded a certain threshold, then the following sanction applies.”

In addition, companies can apply the technology to internal governance controls where certain outcomes are triggered if particular thresholds or conditions have been met, he says.

“Central banks will create a secure payments layer that settles instantaneously, so when we start to see these central bank digital currencies coming through, that will trigger a whole slew of digital assets that will function like classic debt or equity instruments but will be issued on the blockchain.”

Haydn Jones, Senior Blockchain Market Specialist, PwC

That same conditionality feature is being used by distributed ledger technology-based (DLT) corporate bond trading search and execution platform LedgerEdge. CEO and co-founder David Nicol says the idea for his business came about because the corporate bond market is relatively illiquid – when traders place orders to buy or sell bonds, that information often causes prices to move against them.

“When you do want to get a large or complex trade done, you’ve got two bad options,” says Nicol. “Either push to the whole market and hope you can get the trade done very quickly, or spend valuable time on the phone trying to find the right pockets of liquidity without giving up too much information. We think there’s a better way.”

Using LedgerEdge’s DLT ecosystem enables traders or portfolio managers to control who can see their data and under what circumstances. For instance, they could set conditions where orders are only revealed to another order over a certain price or above a certain size.

“This helps trades happen more quickly, more easily, and with less friction so that you can make the assets work more for you,” he says.

While these examples underscore the massive potential for the technology, Jones says the big turning point for blockchain use in the asset management industry will be the introduction of central bank digital currencies.

“Central banks will create a secure payments layer that settles instantaneously, so when we start to see these central bank digital currencies coming through, that will trigger a whole slew of digital assets that will function like classic debt or equity instruments but will be issued on the blockchain,” says Jones.

“That will completely transform the settlement process because the value leg of the transaction and the security leg are synchronized – at the moment, the value leg is separate to the security leg, so while you could potentially use blockchain to settle traditional securities now, you still need to move fiat currency in and out through a traditional payments system, which introduces lots of risk and faffing around when trades or payments have failed.” 

Industry buy-in

Adoption of this technology, however, will require buy-in across the industry.

“Something like this only works with the network effect – you need the big providers sitting in the middle, processing trades to move their infrastructure onto the blockchain, and then you need market participants plugging into these systems – only then will you start to get the benefits of the technology,” says Singh.

Another potential adoption challenge is that some firms are just reluctant to embrace change even if they acknowledge the direction of travel. Some firms are unwilling to cannibalize their legacy profits, others hide behind regulatory uncertainty, and some are just complacent, according to Le Merle.

“There is a knowing-doing gap,” he says. “When you talk to most asset managers about how they’re doing with digital natives, one issue is they are not getting their fair share of new account openings from people under 40, and secondly the churn for under 40s is much higher – they have experienced platforms like Robinhood or Revolut or Binance, and they prefer that to the traditional experience, which is not convenient and involves too much paper.”

The manifestation of that, he said, is that clients slowly pull their assets away. It might start as a trickle, but it can soon become a torrent.

“These are the cracks, the little glimmers that the dam is going to break,” he said. “You can pretend it’s just a hairline fracture and it could be easily plastered over, but, when the dam breaks, it’s too late to do anything about it, and that’s sort of what’s happening here. It’s very easy for firms to say this technology isn’t relevant to me, but what’s going on is you are losing your future – your future is bleeding away today and you don’t even appreciate it yet.”