Funds Europe talks to Ken Tregidgo about the potential of the blockchain and Calastone’s plan to provide easy access.
The potential for distributed ledger technology (DLT) to transform the funds industry has been well documented and is increasingly recognised by market participants. The question has always been around how much work is needed for the current operating model to realise this potential and whether market participants will be willing to undergo the effort required.
DLT enables counterparties to create a single, immutable and non-repudiable version of the truth accessible to anyone with the relevant permissions. When combined with smart contracts and other consensus algorithms, DLT can create a digital distribution chain where all participants can agree on the data and the same outcome.
What is clear is that there are inefficiencies in today’s market that need to be addressed. Participants have their own interpretations of a transaction and communicate via different messaging systems and reference multiple copies. It is a chain full of friction, prone to error and in need of regular reconciliation.
It is also costly. A study by Deloitte into the Luxembourg fund market found that manual errors and reconciliations cost the industry more than €355 million every year. But with a common and distributed ledger, these costs can be significantly reduced.
“When we looked at this, we saw that there is a future state model that can address these inefficiencies,” says Ken Tregidgo, deputy CEO of Calastone. “But to get any advantage from this model, you have to address the complexity and scale of the market and provide a migration path to all. There is no point in having a shiny new white box if no one can connect to it.”
As easy as possible
Calastone’s approach to DLT is to address the market as a whole by implementing a new ‘distributed market infrastructure’ (DMI), and make it as easy as possible for its clients to connect to it. “We are able to populate our DMI with the entire Calastone universe, we process the full order life-cycle and we provide a choice of connectivity options so that clients can use the blockchain when they are able to and on a timescale that suits them.”
They can interact, with the entire marketplace, via their existing messaging infrastructure or through an API to get direct connectivity to the blockchain. “With the migration path that we provide, they can move over when they are ready. We do not need everyone to move over all at once. But we believe that the sooner they move over, the more advantage they can get.”
Tregidgo believes that a big part of Calastone’s success has been providing a simple way for market participants to use its service. It is the same approach it has taken to all of its offerings, he says. “For example, when we first looked at the use of the fax in fund orders, the only alternative for market participants was to implement totally new technology. We enabled the firms still using faxes to connect to our service and we would do the necessary integration and automation to connect to the TAs and custodians.”
Another possible impediment to the progress and adoption of DLT is the underlying technology itself. As Tregidgo acknowledges, it is a maturing technology but it is not yet mature. Furthermore, there are various different versions of DLT, from the blockchain to beyond. However, Calastone is providing a service rather than pure technology. “We worry about the underlying technology so that the client doesn’t have to, and instead can concentrate on managing their business, and developing new business models this technology enables.”
These changes will mostly centre on addressing the challenges facing the market in terms of distribution, disaggregation and demand for improved client experiences, says Tregidgo. “If we can reduce the frictional cost of trading and enable new business models, volumes will increase and all participants should benefit, including the end investor.”
There are other changes in the current market that will sizeably increase the volume of orders and
scale of transactions, from the move towards disaggregation and the trend towards client-centric digital distribution. Distribution models are changing with increasing channel competition, fund providers are developing direct-to-consumer (D2C) offerings, TAs are developing D2C and platforms, platforms are developing D2C and TA services.
Meanwhile the number of distribution channels is continually growing – from the traditional IFAs to execution-only IFAs to IFAs on-demand to robo-advice. Currently the most popular funds on the Calastone network can be accessed through more than 40 different channels and the market scale and complexity will likely only increase through fragmentation and disaggregation.
Data is also becoming more important in terms of understanding the client experience. And regulation, like MiFID II, is enhancing rules on product governance and ensuring that fund manufacturers know their distribution chain. “A distributed market model can help to address all of these issues and provide market participants with new business models and new revenue streams and new client experiences,” says Tregidgo.
Calastone’s experience with DLT started back in 2014 when they initiated an internal project to see how the technology could be scaled up and applied to the funds industry. It then publicised, in June, its vision to use blockchain to provide a market-wide distributed market infrastructure and is now embarking on the second stage of its proof of concept.
Enquiries from interested parties have followed, says Tregidgo. “We are currently engaging with clients and potential design partners, looking at proof of concepts in both the securities services and fund manufacturers/distributors space.”
The response has been positive, says Tregidgo. The market understands the concept and sees the opportunity and even if they are not ready to be in the first wave of adoption, they want to be first to be second.
“Different clients are at different stages, which is why it is important to have a migration path that offers clients a choice,” says Tregidgo. There are also a lot of blockchain initiatives covering all asset classes, including funds. “We advise clients to have a look and understand what’s going on and explore how they can develop new business models. The technology is not going away, so look to get involved.”
©2017 funds europe