Investors are demanding lower fund fees. Returns have been relatively buoyant recently, but even so clients are seeking cheaper options. The fund distribution industry has to find a way to cut costs if it is to remain relevant. Asset managers understand the potential of digital transformation, but this is an industry that is traditionally wary of fast, dramatic change. Blockchain and distributed ledger technology offer an opportunity for Luxembourg fund distribution firms to make this transition.

While talk of digital disruption is a great way to generate venture capital investment, this language refrain with the asset management industry’s traditional safety-first approach. If you’re looking after people’s retirement savings, revolution is the last thing you need.

So maybe excitable talk of the fund distribution industry being blown away by FinTech start ups is obscuring the key message: cutting edge technology has to be harnessed to ensure the efficiency and products which match new customer demands.

What’s holding the industry back?

The good news is that substantial savings are there to be taken. A recent report by the consultants Deloitte* pointed to Europe’s crossborder fund industry spending about 1 billion per year more than it needs in areas such as cash management, errors and reconciliation, KYC, due diligence processes, and more. A lot of this waste is due to different players collecting, holding, and processing duplicate data internally. If this information could be held and managed differently, this would cut costs and open the way for innovation.

Legacy systems and concerns about untested new technology are the main brakes on innovation in the asset management industry, noted a study** by the consultancy Create Research.

They polled 458 asset and wealth managers, and found that it wasn’t so much the cost of innovation investment that put decision makers off (this was cited as a barrier by a third), but mostly the reluctance to tinker with tried and tested legacy systems (74%). There is also the “innovator’s dilemma”: a reluctance to invest when times are good, and a lack of funds during a downturn. This was mentioned by two-thirds.

Making the transition

Yet asset management industry decision makers know that change is needed. Asked what was driving the need for innovation, three quarters cited cost pressures, with half saying fees were becoming a major differentiator, reflected in the rise in popularity of passive funds. Over the next ten years, only 2% of asset managers predicted business as usual, with 18% seeing incremental change, 61% partial disruption, and 19% expecting full industry-wide disruption.

Blockchain is a case in point. It is a technology that could bring the “sharing economy” to fund distribution. Just as online peer-to-peer services put counterparties in touch directly, it could help fund businesses improve how they work together and communicate with clients. However, the survey found that only 6% of asset management firms are implementing blockchain projects, and most of these are subsidiaries of large banks. Indeed more than fourfifths of asset managers still say they are in the awareness-raising stage for blockchain. However, the reluctance to innovate is more than just resistance to each technology. The likes of big data and robo advice are only being implemented by less than a fifth of those surveyed.

Another challenge with blockchain is the need to ensure that a powerful monopoly does not emerge. The distributed ledger technology (DLT) which drives blockchain applications needs an ownership and governance structure that guarantees neutrality. A host of regulatory and legal issues also need to be worked through. Distributed ledger technology functions because all users can see and trust transactions taking place.

Blockchain in operation

A Luxembourg consortium are developing a solution which takes these diverse challenges into account. FundsDLT is a mutually owned, mutually-run transaction hub for fund distribution processes. It will also feature a range of applications to automatically process and enrich data.

The project is being led by Fundsquare (the Luxembourg-based user owned and governed investment fund order routing and information services specialist), InTech (an ICT solutions firm owned by Post), and the consultants KPMG Luxembourg. A range of fund distribution service providers are also participating, contributing to the test phase.

A prototype is already operational. Cash and fund shares were exchanged over FundsDLT in early July. Shares in a variety of Natixis funds were exchanged for cash following an order received from a mobile application. Work since then has been on making the system fully robust, while adding features to increase the power and flexibility. Central to this are the development of “smart contracts”, programs woven into blockchain that respond automatically to events that take place on the distributed ledger.

This would speed up and simplify everything from order routing, to counterparty clearing, to KYC, to reporting. A centralised hub would also facilitate greater standardisation of data, opening the way for streamlined interfaces. This in turn would open the way for third party IT firms to create innovative enriching tools. An industrialised FundsDLT is due for release next year.

Digital transformation will come to the fund industry, however this will be an evolution rather than a quick disruption. It will probably feature existing players adapting to the advent of new technology and the growing consumer pressure to cut costs and boost services. As the world’s leading cross-border domicile, Luxembourg has no choice by the take the lead.

* “Europe’s fund expenses at a crossroads: The benefits of mutualizing the cost of distribution”, Deloitte
** “Digitisation of asset and wealth management: promise and pitfalls”, Create Research

AGEFI Luxembourg, Octobre 2017

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