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Blockchain – a new tool to cut costs

The traditional dominance of active asset managers in the maintenance of the portfolios of both institutional and retail investors is under heavy pressure. When both nominal and real interest rates were higher and when regulation was less arduous and costly it was significantly easier to deliver satisfactory net returns.

Operating in a low interest rate environment is challenging enough for fixed income investors who are acquiring sovereign debt at significant risk and despite it’s frequently generating negative returns before costs.

Regulatory compliance and fund administration services must then be accounted for and these alone can suck away whole percentage points of income. On top of that, the managers need to be left with sufficient excess revenue in order to cover their own costs and to leave a profit for their shareholders.

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Blockchain in Trade Finance

Adding intermediaries into an equation or chain rarely translates into efficiency, but leads to costs, complexities and increases the risk of errors and missteps. The vast transactional chains in the financial industry serve the livelihoods of many providers across the entire ecosystem, yet it does not always benefit the end users and their commercials.

Core Challenges in Trade Finance

Trade finance is a notoriously cumbersome process dominated by intermediaries and it is an area of financial services which has made little progress in terms of automation. Settlement can take weeks depending on the jurisdictions involved in the supply chain, and the process is notoriously opaque. Instructions for remittances and verifications and approvals are often authorised with limited visibility into the transactional chain, which can lead to oversights and duplications.

It is often contingent on unique rules and mechanics across different countries, at conflicting levels of development. Many of these processes involve a host of intermediaries including entities which lie outside of financial services such as customs agents, health and safety inspectors, and transport groups.

Analysis by the Organisation of Economic Co-operation and Development (OECD) estimated 15% of the overall value of traded goods comprised of hidden costs, much of it a result of manual processes. The OECD added this translated into losses of $100 billion per year. At a time when revenues are under significant pressure, this is a huge sum.

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Blockchain in Insurance and Reinsurance

The reinsurance market is ripe for disintermediation and it is no surprise that it is one of the many sectors exploring how Blockchain technology can help enable efficiencies in what can often be a fragmented operating model. The insurance market is widely seen to be lagging behind banking in terms of technological innovation and adoption.

The insurance market as a whole is reliant on data supplied from multiple sources including the end client, broker, reinsurer and various service providers such as administrators and custodians. Analysis by PricewaterhouseCoopers (PwC) calculated Blockchain adoption in the reinsurance market, for example, would result in cost savings of up to $5 billion.

The PwC data highlighted that between 5% and 10% of premiums are derived from reinsurance expense ratios. The PwC study added Blockchain solutions could remove between 15% and 25% of expenses in the reinsurance industry. Integration of Blockchain could reduce the operational workload around data processing, by streamlining processing times and costs of placement.

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FCA Investment Management Review

The active asset management community was dealt a shock by the UK’s Financial Conduct Authority (FCA) on 18 November. The FCA’s Asset Manager Market Study castigated the active management industry for collecting high fees and delivering unsatisfactory performance. The FCA found active managers charged on average a management fee of 0.9% whereas a passive provider typically incurred costs of 0.15%, although the latter had generated superior returns.

The FCA’s paper made a series of recommendations around active managers’ cost structuring, including the possibility of “an all-in-fee model”. This approach would force firms to cover all of their costs in a single fee including transaction charges. The FCA’s objective is that it wants investors to understand what they are paying for. As such, this is likely to result in active managers being forced to reduce their fees.

This poses a problem for managers as their compliance costs have been steadily growing. A 2015 survey by Alpha FMC of asset managers running a total of £6 trillion in Assets under Management (AuM) found 78% of respondents expected to spend more on regulatory compliance over 2016, while 89% said they would devote greater time to dealing with regulatory matters. A paper by Citi in 2015 said small hedge funds, for example, were struggling to pay for their operating costs through their management fees alone, estimating a manager required at least $310 million in AuM to breakeven. Active managers, particularly boutiques, are facing huge cost challenges.

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How Can Blockchain Help Streamline Syndicated Loans?

Market participants often complain about the longevity of equity trade settlement, particularly in emerging markets where trade life-cycles can be as long as T+5 or more.

The internationally accepted T+2 settlement time-frame for equities is becoming more commonplace, particularly with the US transitioning from T+3 to T+2 for equities, corporate and muni bonds and unit investment trusts in September 2017.

Spare a thought then for market participants transacting in syndicated loans, and its associated trade settlement process…….

A typical syndicated loan will settle on T+19 or T+20. Syndicated loans are a critical source of funding to the real economy, with beneficiaries including major governments, large corporates or small-to-mid-sized enterprises (SMEs). There is also a sizeable secondary market with various financial institutions trading these loans.

Enabling syndicated loans to settle immediately in a Blockchain framework would bring about huge benefits. Blockchain – by facilitating real-time settlement and providing an immutable database of transactions – would bring an unparalleled level of automation and transparency to the asset class in both its primary and secondary markets.

Transparency is crucial, particularly because the syndicated loan debt is often shared between multiple underwriters. The volume of documentation – given the number of participants involved in the syndicated loan trade cycle – is significant, even by the standards of today’s post-trade environment.

So how could Blockchain boost transparency in this market? Blockchain could enable – through permissioned access – for market participants to pull syndicated loan transaction data from the ledger in real-time.

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