The risks and opportunities of blockchain for asset servicers

Attending FundForum International 2018 this year and listening to EY’s Dr. Anthony Kirby discuss how investment firms can use blockchain for business and regulatory opportunities, it was clear that asset managers and their servicers are revisiting their operating models and applying new technologies such as blockchain to enhance organizational efficiency, create new sources of value and manage increasing levels of regulatory compliance.

When asset servicers make the decision to utilize blockchain technology, we believe they will benefit from a three pronged approach:

1. the ability to capture high quality, accurate data
2. apply data management to correct the errors of mismanagement
3. deploy technology as a tool to disrupt the entire data chain.

Blockchain opportunities

One of the most promising opportunities is the distributed ledger’s ability to significantly curtail errors from mismanaged data. Errors include data that is not collected properly from the source, such as trade details which with blockchain would need to be substantiated by two parties before being applied to the ledger. Another area where data management qualities can apply and errors can be reduced is when securities are issued and facts about the security and how it needs to be mastered throughout its lifetime are made available on the distributed ledger.

Moreover, asset servicers are also looking at product-focused use cases, such as digitizing and streamlining document-heavy fund distribution, syndicated loan or other contract markets. Shared ledgers could facilitate straight-through-processing (STP), replacing manual processes such as email and fax, supporting easier tracking of fees, assets and liabilities, as well as freeing up large amounts of collateral and capital (which can be used to improve the velocity of trading elsewhere). The benefits of automatic “track and trace” approaches are causing most firms to discuss collaboration, including how to involve government authorities and tax authorities in the know your customer (KYC) process.

Blockchain risks

As with any new technology, there are risks, both technical and operational, associated with adoption, and organizations are right to consider these during their evaluations.

1. Technology limitations: Being a young, still-evolving technology, there are certain aspects of the technology that may require further development or modification to reach its anticipated potential. For example, the same mechanism that provides trust to a public blockchain also introduces latency to the network. Transaction verification requires consensus: consensus requires some amount of computation, and computation takes time. As a result, transaction processing is not instantaneous and can often take several minutes.
2. Regulatory uncertainty: Technological innovations are subject to regulatory requirements and expectations that apply to asset servicer operations more generally (safety and soundness, risk governance and risk management, cybersecurity, data security and privacy, vendor/third-party risks, compliance, BSA/AML, etc.). The need for any specific regulatory response concerning blockchain applications and the distribution of digital assets across multiple environments remains uncertain.
3. Security: New IT systems introduce new cybersecurity risks, particularly a distributed IT architecture across multiple business functions or organizations. The type and amount of data stored on the blockchain will affect the risk profile, as will the permission mechanisms used. And with the exception of bitcoin, which has been in “production” for more than seven years, most blockchains have not had the benefit of production-level testing or the pressures that accompany a live environment (real transaction volumes, system penetration attempts, system interoperability, etc.).

This is one of the reasons why EY recently announced the pilot of the EY Blockchain Analyzer, a suite of blockchain audit technologies that enhances the ability to perform an in-depth review of cryptocurrency business transactions. The proprietary technology is designed to support EY audit teams as they perform audits for companies using cryptocurrencies and will lay the foundation for testing of blockchain assets, liabilities, equity and smart contracts as companies adopt blockchain technologies.

The technology has been designed to support testing of multiple cryptocurrencies including BitCoin, Ethereum, BitCoin Cash, LiteCoin, and a number of other crypto-assets managed or traded by exchanges or asset management firms. You can find out more about blockchain audit technology here, or contact Anthony Kirby, our blockchain FundForum speaker and London-based Ernst & Young LLP wealth and asset management Associate Partner who focuses on regulation and technologies such as digital, AI and blockchain as enablers and disruptors.

The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.