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April 2024
AAM Magazine
April 2024
Back to June 2021

Disruption comes to custody

By Paul Mackintosh   
  • Asia
  • Global
Digital assets seen as a transformational force

The recent furore over bitcoin has again pushed financial technology into the news, but many of the most interesting applications of the underlying blockchain technology and other fintech developments are happening in more staid areas of financial services. 

One such area is custody. But custody itself is facing new challenges, both from the impact of technology, and evolving regulations around transparency, reporting, sustainability and compliance, among other things.

Custody is a key area of financial services with a sizeable volume of business exposed to potential technology-driven disruption. A recent report from The Business Research Company predicts the global custody service market will expand from US$24.42 billion last year to $26.79 billion in 2021, a compound annual growth rate of 9.7%, as companies recover from the coronavirus pandemic. By 2025, it forecasts the market to reach $36.75 billion, equivalent to a CAGR of 8%.

According to Mathew Kathayanat, director and head of product and strategy for Asia Pacific in asset servicing at BNY Mellon, data management, blockchain and open architecture are the areas of particular promise in fintech.

He says data management is witnessing the combination of non-traditional data with traditional data sources “as unstructured data becomes mainstream” while advances in physical and behavioural biometrics and cybersecurity technology are fostering advanced predictive models, enhancing user experience for end-clients. 

Meanwhile, blockchain is reaching a scale at which large financial institutions and regulators around the globe are now looking at the technology to eliminate unnecessary or duplicative processes, cut costs and increase efficiency, transparency and resilience. 

And open architecture is giving institutional investors flexibility to “choose best-in-class systems for their investment activities, and capture insights from a wide variety of fintechs”, Kathayanat says. BNY Mellon has committed to this open, ‘plug-and-play’ model, opening up a traditionally closed ecosystem in a transformational mindset, he adds.

Financial infrastructure is also an area exhibiting great promise, according to Arthur Shek, Hong Kong-based partner with McKinsey & Co. In his view, a lot of attention and funding over the past decade has gone to front-end innovations, especially in the business-to-consumer segment, with fintech companies offering new payments, lending, and wealth management solutions to customers. But that is changing. Shek says more recently, back-end areas such as core banking and insurance systems, automation, regtech and even open banking infrastructure “have really grown by leaps and bounds”.

Digital assets

Digital assets will be one of the most transformational forces affecting capital markets in the years to come, predicts Swen Werner, managing director for digital product development and innovation at State Street.

This new ecosystem will elicit innovations to solve reference data and pricing for crypto assets, key management solutions, and deployment of smart contracts irrespective of the underlying blockchain protocol. But Werner believes there are many other key themes of equal promise, such as artificial intelligence or “faster deployments and automation through so-called ‘no-code’ platforms”.

According to Angelina Ng, managing principal with Capco Hong Kong, digital assets are the top of the agenda for many asset managers and their service providers. She says custodians appear to have accepted that cryptocurrencies are here to stay, and they are moving to service and secure these assets. 

Werner sees the creation of “decentralised, and peer-to-peer market models” as one of the most potentially transformational innovations in terms of how custody services operate. 

“At present, there is a key focus on how digital assets can be held safely, without forgoing the opportunity to deploy them to revenue enhancing strategies such as staking,” he says. Such arrangements allow investors to earn additional yield by lending their crypto assets to so-called proof-of-stake blockchains. 

Kathayanat says BNY Mellon is taking the lead along with other partners in some significant projects in improving operational efficiency through artificial intelligence-based reconciliation and data control solutions, and enhancing multi-asset analytics. This is in response to institutional client demand for “sophisticated solutions that allow them to leverage their data to improve investment decisions while obtaining a single view across their multi-asset portfolio”. New platforms are allowing institutional clients to do this for themselves.

Werner also notes the rapid development of technology and services “to combine digital custody solutions with access to various markets and liquidity pools”. A typical example is the provision of administration services for a crypto-backed exchange-traded fund, with third-party external wallet solutions combined with established accounting and reporting platforms. 

“This is just the beginning”

It’s still an open question as to whether fintech has fulfilled its promise outside of the enthusiasm for cryptocurrencies, and whether further development is what’s needed to enable it to reach its full potential.

Shek is of the view that “fintech still has a significant way to go” as compared to the kind of impact that technology has had in sectors such as retail, media, and telecommunications. He believes the true signs of a transformation will be when fintech solutions become intuitive and second-nature to digital natives, are “‘smart’ like Google Maps, and when incumbent institutions and systems are fundamentally challenged”.

Werner says there is appetite among institutional investors to capitalise on innovative solutions that are compliant with regulatory requirements. Regulated banks are able to offer robust service models while leveraging new technology opportunities where they arise. “This is a continual area of development without an end date,” he says.

He says the key challenge facing many fintech providers is that certain solutions need to fit into a larger operating and service model, requiring deep insight into the operations of asset managers across the entire value chain. This necessitates understanding of front-to-back integration and compliance with local market regulations. 

According to Kathayanat, “this is just the beginning”, with huge opportunities to scale fintech solutions in the financial ecosystem. BNY Mellon is seeing particular success in accelerator programmes to foster the best fintech startups, and streamlined onboarding processes to bring emergent solutions into the broader financial services market more quickly and effectively. 

Asia Pacific an early adopter

The main financial centres and innovation hubs in Asia Pacific are pushing hard to make their own way in the competitive realm of fintech innovation, whether to produce localised solutions or fundamental innovations. 

Kathayanat says the region has been an early adopter in initiatives focused on digital transformation. He points to the success of the Symphony communication-powered networked market infrastructure platform in Asia Pacific, where real-time settlement information is provided using bots. This system has become “the largest community of financial counterparties and professionals, moving beyond core chat to incorporating bots, natural language processing and AI into their ecosystem”, he says.

Ng highlights the speed with which Asia Pacific regulators are establishing frameworks around digital assets, especially to reduce financial crime risks. She is looking to regulators in Hong Kong, Singapore and Thailand for interesting developments.

Werner says State Street is working with numerous fintech providers in the region, looking at various aspects of digital assets, “such as static data and automated business flows through the use of smart contracts”. Such solutions may originate in Asia Pacific but be rolled out in any region. 

The firm is also having many conversations with asset managers looking to launch innovative products in the digital asset space, who may need to leverage different fintech providers that would connect to a custodian. “There is a lot to come in this space over the next few years,” Werner predicts.