Although asset managers initially explored Bitcoin as a new investment opportunity, it is digital securities settlement infrastructure inspired by Bitcoin’s underlying technology, blockchain, that may have a greater impact on buy-side firms.
Blockchain technology could deliver settlement at will and enable greater degrees of straight through processing. As a result, buy-side firms could decrease operational costs and improve counterparty and liquidity risk management. These cost-savings and added efficiencies would enable them to become leaner and more focused. Asset managers — and consequently investors — have good reason to be excited about this new technology.
Indirect Savings: Efficient Ecosystem
Blockchain technology has the ability to reduce costs in the overall securities settlement ecosystem, creating numerous indirect benefits for the buy side. First, blockchain technology’s real time settlement capabilities could significantly reduce counterparty risk. As a result, clearing fund contributions to central counterparties could be virtually eliminated, lowering the cost of settlement for market participants. Second, blockchain technology could reduce the role of allocation and matching services, reducing costs for custodians and broker dealers.
Due to the competitive, cost driven nature of securities settlement, ecosystem cost savings would eventually be passed onto the buy side through reduced fees and commissions. This commoditization of settlement could even alter the negotiating power between asset managers and their service providers, like broker dealers and custodians.
Direct Savings: Lean, Focused Operations
Buy side middle and back office operational efficiency could directly benefit from blockchain technology. According to Broadridge Financial Solutions, 60%-70% of employees at asset management firms do not generate alpha or raise capital. Blockchain technology’s ability to create a single source of truth and fully track asset ownership on a shared record could slash reconciliation costs. In another example, instantaneous, T+0 settlement enabled by blockchain technology can eliminate the need to address settlement issues, such as failed trades and the potential mismatch between trade date and settlement date accounting.
Middle and back offices would also become leaner in a blockchain environment, enabling asset managers to operate with a more singular focus on generating higher returns for investors.
Increased Stability: Enhanced Risk Management
Beyond the aforementioned direct and indirect cost savings, blockchain technology could also improve the way that asset managers manage risk. First, the reduction in counterparty risk created by instantaneous settlement could improve overall stability for asset managers. Second, real time settlement may help asset managers meet redemption requests more easily, reducing liquidity risk and lowering the amount of cash that must be held to meet potential redemption spikes. Together, reducing counterparty and liquidity risk allows asset managers to exclusively pursue risks correlated with higher returns.
Securities Settlement as a Utility
Despite their intertwined histories, blockchain technology and Bitcoin are distinct opportunities for asset managers. Blockchain technology has the potential to deliver transformative infrastructure improvements that provide buy side firms with greater control, transparency and efficiency. From an asset manager perspective, blockchain technology is far more than an incremental improvement on the status quo. It is a chance for the buy side to fundamentally change its relationship with the securities settlement ecosystem as an end consumer.
In the future, blockchain technology will enable asset managers to view securities settlement as an on-demand utility instead of a source of risk and costs.
This article first appeared in FundForum Live.