The winds of change for financial services have been a digital blessing

Friday, October 14, 2022 2:55 p.m.

The music industry has digitally transformed and now the asset management industry has too. Many industries have put digital wrap around their businesses, making themselves known online through their websites, emails, artificial intelligence, cloud computing, and more.

However, digital transformation is about business transformation and not just the ability to digitally interact with customers and suppliers. We have seen the digital transformation of the music industry and now we see the asset management industry following suit as more digitized/tokenized funds are created.

Crypto evangelists are keen to argue that digital assets will replace fiat currencies and the death of banks is near as people turn their backs on using cash. The reality is that although there are more 13,000 cryptos listedonly a handful of cryptos (including Bitcoin and Ethereum) account for over 52% of the crypto market capitalization, still dominating this relatively small asset class which is valued at less than $1 trillion.

However, the technology driving the crypto market is also being gradually adopted by existing traditional financial companies, in addition to newer companies, as people begin to realize that times are changing and technology is capable of transforming many existing regulated and unregulated companies. practices. As commerce becomes more and more digital, companies are looking to offer their goods and services online and, where possible, to automate processes, to be more efficient and to have a more direct link with their end customers.

In the past, we have seen a gradual increase in the number of intermediaries who have been created to, in theory at least, protect the interests of third parties. The problem is that these intermediaries (especially in the financial sector), coupled with an endless wave of regulation, have fostered a mentality of needing to check and double-check what regulated companies are actually doing.

This, in turn, has resulted in increased costs which impacts the return perceived by the end investor. Additionally, we have seen compliance drive business development in terms of declaring who is allowed to buy what and how, with a complex web of rules and regulations in various jurisdictions. Yes, we need compliance and strong risk controls to protect investors and maintain confidence in the financial markets, but unfortunately, to a large extent the paper-based systems and processes that were historically developed have now become electronic and do not are arguably more relevant to our modern society. financial services sector.

A very simple example of how the financial services industry has changed is that of an 87-year-old lady who visits one of the few remaining bank branches near her home because she wants to open a savings account. Once there, he is told that it is not possible to open a bank account at the bank as this process must be done online.

The bank (one of the four biggest in the UK) has really said goodbye to paperwork and quill pens and the need for a real signature, because the old lady is basically being told she has to “go digital”. But in reality, have banks actually gone digital, or are they like many businesses in thinking that all you need to do is have a website and ask people to fill out applications online?

So, for a business to be digitally transformed, it must actually change the whole way it conducts business and, in turn, redefine how and what it delivers to its customers. When a business comes up with new ways to create value for its customers or identifies a new target market for its products and services like it never has before, it has digitally transformed. This transformation concerns Company transformation, not just being able to interact digitally with customers and suppliers.

The music industry is a good example of an industry that has been digitized instead of just going digital. Historically, music was sold via physical disc and then via cassette tape, and it wasn’t until the 1990s that music was sold in a digital format – CDs, for example. This, in turn, led to Apple launching the iPhone and iPod where music could be purchased in a digital format, therefore not requiring a physical item such as a record, cassette or tape. CD.

However, the industry has not stood still. It arguably got even more digital when, in 2008, a new Swedish company that was just two years old launched Spotify and in doing so forced even the mighty Apple to go back to the drawing board and create Apple Music.

No doubt, the $100 trillion asset management industry – going digital with the use of email, as well as the cloud, and even deploying AI, Big Data and complex algorithms to actually manage funds – is just starting to digitally transform and offer products and digitized services. This process may well accelerate as the global economy falters and fund managers seek to target new clients and address old issues, such as the liquidity of some of the assets and funds they manage. .

Global Venture Capital Funding

Source: Crunchbase

After seeing record capital inflows into private equity (PE) and venture capital (VC) funds over the past two years, volumes have fallen – although they are estimated to exceed $1.8 trillion in available cash to invest in the next five years. One of the main challenges that investors must accept before investing in private equity or venture capital funds is that they will usually have to commit to not being able to access their funds for several years.

The lack of liquidity is largely due to the fact that the underlying investments that private equity and venture capital fund managers make are in private/unlisted companies. Furthermore, it may not be long before we see private stocks able to improve their liquidity in secondary trading since the Depository Trust and Clearing Corporation (DTCC), which is based in the United States and is the world’s largest bond and equity settlement organization, has been developing a digitized solution for years using blockchain technology. Whitney Project is just one of its projects to use blockchain technology to digitize private securities by offering tokenization using the Ethereum blockchain. It is hoped that once successfully implemented, this will help facilitate the trading of private shares and thus they will become more liquid.

Another driver for asset managers to embrace digitization will likely come from regulators and compliance officers, as they begin to understand that a digitized proposition can improve compliance infrastructure and reduce regulatory and business risk while providing near real-time access to information. Demonstration of digital transformation, private equity firm Kohlberg Kravis Roberts (KKR), which manages $479 billion in assets, announced that it will tokenize one of its private equity funds. This means that investors will have a secondary market where they can trade a KKR’s funds, and if popular, there is no doubt that KKR and other private equity firms will tokenize other private equity funds.

Thus, given that the private equity sector is valued at a value $7.2 billion so, if other private equity managers follow KKR’s lead and digitize/tokenize their funds, there could be huge demand for digital asset exchanges such as Archax, SDX, SIX, Tokeny, etc. , to trade these tokenized private equity funds. Meanwhile, other asset managers have already revealed that they too prepare for digitization some of their mutual funds with announcements from JP Morgan, Abrdn Franklin Templeton Asset Management and Alliance Bernstein. So how long will it be before we also see venture capital fund managers digitizing some of their funds and thus providing greater transparency and potentially more liquidity to a market whose value is estimated $584 billion by 2027?

The Society for Global Interbank Financial Telecommunications (FAST) which has provided a secure messaging system for financial transactions to over 11,000 financial institutions in over 200 jurisdictions recently announced: “SWIFT’s breakthrough innovation paves the way for global use of CBDCs and tokenized assets”.

It should come as no surprise that SWIFT has been working with banks on how to deal with central bank digital currencies (CBDCs), but the fact that it is also considering tokenized assets, i.e. securities, could be very important. SWIFT has always offered a service allowing banks to communicate with each other. This announcement therefore means that it seeks to offer banks the possibility of henceforth treat with each other and thus exchange CDBCs and digitized assets? If so, will traditional exchanges, clearinghouses, brokers, forex traders, etc., all face a new competitor?

What is certain however, is that the financial services sector, along with other industries, is slowly going digital and in the process bringing new products and services to new customers.

Jonny Fry writes a weekly analysis titled Digital Bytes which examines how, why and where blockchain technology and digital assets are used globally in various industries. To receive your free copy, go to www.digitalbytes.substack.com

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