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Fund distribution DLT pilots struggle to get airborne

Vendors attempting to move funds distribution processing to blockchain can’t reach escape velocity.



After several years of pilot tests, technology vendors say they are ready to get asset managers and bank distributors to work together on blockchain to reinvent the processing around mutual funds.

They can point to pilot tests that appear successful. None has reached the point of being a product with multiple users paying commercial rates. Vendors say 2022 is the year this will change.

Calastone has announced an alliance with Microsoft to transform its blockchain-based admin idea into a product called DMI Fund Services. In Spain, Allfunds has completed the first orders of a tokenized Spanish fund. And in Luxembourg, DLTFunds recently completed a pilot with UBS Asset Management.

Adam Belding, chief technology officer at Calastone in London, says the technology is ready, and that the company will sign its first users in the coming months.

The challenge isn’t the technology, however. “Tech is the easy part,” one vendor executive told DigFin. “Adoption is tough.”

Why blockchain for funds?

The case for blockchain is compelling. Asset managers in Europe and Asia rely on distributors, usually commercial and private banks, to sell mutual funds to investors. Between the fund houses and the banks is a messy patchwork of regulations and processes.

This includes onboarding end investors, maintaining a registry of who is buying or redeeming funds, processing orders among participants (including the custodian banks that safekeep the fund assets), and keeping track of fees and retrocessions (the rebates that fund managers pay distributors).

It also means reporting to a mishmash of regulators, across jurisdictions and across industry verticals: central banks oversee distributors while securities agencies supervise asset managers. It’s a lot of complexity.

On top of this, banks and asset managers have their own systems. Some of them still even insist on using fax machines to send orders. These inefficiencies have been wonderful for tech vendors who can provide services that essentially translate among systems and ease some of the regulatory and reporting idiosyncrasies.

The advantage of blockchain is that it allows many types of organizations share information in a trusted manner, with an audit trail visible to all, permissions to ensure data is only viewed by the relevant parties, and quick settlement.

This should mean that asset managers, banks, brokers, and custodians in different markets could communicate fund information across a standardized network in a secure, private, and immediate way. No more faxing, calling, or emailing counterparties one by one.

To the victor go the spoils

Therefore, if a tech company can eliminate much of the headache and cost of processing mutual funds, the reward will be big. As of June 2021, regulated open-ended fund assets reached $64.6 trillion, according to the International Investment Funds Association.

Of that, $56 trillion consists of long-term funds (equities, bonds, balanced, and other asset classes), while $8.5 trillion was in money-market funds and $8.2 trillion in exchange-traded funds.

And the industry is growing: in 2021, in 2021, fund inflows reached $150.5 billion across all asset classes, according to Calastone.

Race against DeFi

Become the DLT king or queen, a vendor will enjoy plenty of spoils. But that’s also a market at risk of slipping through their fingers should financial institutions adopt decentralized finance (DeFi).

Many asset managers and banks may not know it, but they are part of a race for the future of their industry: via semi-centralized, permissioned DLT operated by a trusted vendor, or the new world of DeFi in which today’s bilateral relations are translated into a far more efficient open network of tokenized funds.

DeFi may seem a little wild for most institutions, so vendors have a window of opportunity to sign up enough users now. So far, however, the complexity of processing funds makes it difficult to commercialize a blockchain solution.

Stuck on the runway

Companies have tried different approaches but all remain stuck as proofs of concept.

DLTFunds is looking to disrupt the Luxembourg fund administration industry, with a single (if large) partner in UBS Asset Management. It hopes its parent companies, which include Clearstream, will jostle more players into signing up.

Allfunds, which is headquartered in Spain, is launching its product in the confines of the local regulatory sandbox. It’s offer is the most innovative, but it will struggle to scale this beyond one country.

Calastone, with 2,700 asset managers and distributors using its services, is trying to be cross-border and universal from the get-go, but is betting on mass adoption by notoriously slow-moving institutions.

Try a new destination

Instead of trying to convince established players to move to DLT, the vendors could focus their efforts on new, fast-growing niches: digital banks looking to become wealth managers, robo-advisory companies looking to expand into new products or asset classes, or asset managers that want to wean themselves off banks and sell directly to consumers.

Because the vendors are based in Europe, they have also been piloting schemes there. But the need for solutions is greater in Asia, where cross-border efficiency is notoriously rare.

At least in the European Union, there are shared standards around eligible funds, and no foreign-exchange complications within the eurozone. Asia is even more complicated – and becoming more so, as more locales seek to boost funds domiciled domestically.

For example, the advent of Hong Kong’s WealthConnect program with mainland China applies only to funds domiciled in Hong Kong. In 2020, Singapore launched its variable capital company (VCC) scheme to make local domicile more attractive versus other offshore centers such as Cayman Islands.

These are supporting huge growth in the region’s assets under management. Hong Kong and Singapore regulators put their asset and wealth-management size at around $3.5 trillion each, with year-on-year growth of 17 percent (Singapore) to 19 percent (Hong Kong) – compared to 3.2 percent AUM growth for European asset managers.

That top-line growth, however, is coming at an increasing cost of operations. Perhaps the industry’s technology vendors should consider a pivot.

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