When Calastone announced in June that it had completed a blockchain project for the mutual-funds industry, various news outlets emphasized the idea that this was going to cut processing costs.
Which is true: it’s what the press release said. But when DigFin sat down with the firm’s deputy CEO, Ken Tregidgo, to understand the project, he explained the vision behind the blockchain proof-of-concept went beyond an operational improvement.
London-based Calastone automates the connections between and among fund management companies, their distributors, and their asset service providers, in any format or protocol users prefer. It says it allows 12,000 links among its 1,200 customers across more than 30 markets, making it the world’s biggest router of mutual-fund subscription and redemption orders. Every year it processes hundreds of millions of fund instructions, including for reconciliation, settlement and delivery.
Two years ago, the company began investigating blockchain, which culminated in its PoC in June. Although this was expressed in terms of marrying its proprietary distributed ledger to cloud computing, resulting in much faster processing times and volumes, Tregidgo says the purpose was not just to improve speed.
“The mutual-funds industry faces many challenges,” Tregidgo said. These include the onslaught of cheap passive products, an ongoing uptick in regulatory requirements, and demographic challenges as the baby-boom generation begins to draw down its investments, while millennials remain wary of financial institutions in the wake of the 2008 crisis.
Meanwhile, digital distribution promises transparency and pulling apart old sales relationships, all of which suggest declining margins.
Simply focusing on the front end, with a nice mobile experience for retail customers, wasn’t going to solve the industry’s problems, Tregidgo says. The industry needs to revamp its value proposition in the face of higher costs and declining margins.
“How does the industry continue to add value?” he said. “Can blockchain be used to address the challenges to the industry as a whole?”
By shifting functions to a distributed ledger, via cloud computing, he argues Calastone can enhance resilience, reduce errors and cost, mitigate market fragmentation, support greater scale, and allow industry players to innovate more readily. “This will enable new business models to emerge,” he said.
The company is not merely trying to migrate an existing set of tasks to a faster means of processing: “Distributed ledgers mean we can move the system of record from the level of the firm, to the level of the market,” he said.
But what kind of DLT?
The nature of blockchain, as an immutable, shared and single truth of record, based on consensus among permissioned parties and executed through smart contracts, in effect will move all market participants onto a distributed computer.
Tregidgo deflected questions about the specifics of the blockchain Calastone has built. “We’re not disclosing the framework we’re using,” although he added, “We’re not in the business of developing DLT frameworks; we use them to address industry-level opportunities.”
The only hints he gave was that Calastone’s DLT is permissioned, and will use smart contracts, creating a consensus mechanism incorporating the market rather than unique protocols among individual firms.
The first phase of the PoC, announced in June, addressed technical issues of whether the blockchain can meet challenges of complexity, scale and a migration strategy. Tregidgo says the platform passed all three tests.
But isn’t blockchain meant to be slow? Even Ethereum’s founder has said it can only process four transactions per second, versus the far greater abilities of the traditional tech of DTCC, an Uber or an Alibaba.
Tregidgo said, “We have found a way to process volumes. We’ve done it for the entire Calastone universe at multiple times our normal speed. Now we are setting a migration path to let clients move to it as it suits them.” But he would not say how the company had achieved this.
What’s the endgame?
Is Calastone trying to create a DLT that would become the basis of all funds processing?
“When it comes to blockchain, there isn’t one ring to rule them all,” Tregidgo said, referencing Lord of the Rings. “The DLT industry is maturing – but it’s not yet mature.”
Similarly, he declined to outline some of the ideas the company is having with its clients in terms of new business models. He cited the case of Yue’bao, the Tianhong Asset Management money-market fund that zoomed to prominence on the back of Alibaba’s e-commerce platform. “That was about scaled distribution,” he said. “It’s the benchmark if the mutual-funds industry moves into digital distribution.”
For Calastone, that means the vendor will morph into something different. “This is a new business, creating the market infrastructure to support all activities throughout the value chain,” Tregidgo said. That might involve helping fund managers and distributors achieve omni-channel sales, and types of services that can differentiate them.
Calastone is now developing DLT for specific use cases with those clients that have been quickest to embrace the vendor’s project, he said; such projects have a two- to three-year horizon before they are likely to go into production.
“This isn’t about creeping incrementalism,” Tregidgo said. “Today we process hundreds of millions of transactions; we’re scaling to handle billions, and becoming a provider of market infrastructure.”