Widescale adaption of digital ledger technologies in the financial sector has been ‘just around the corner’ for the past decade. The corner appears to be a bit closer these days.
Delano put that premise to Serge Weyland, CEO of Edmond de Rothschild Asset Management Luxembourg, a fund management company with €94bn in assets under management and assets under administration, and with 150 staff in Luxembourg and 660 employees globally. He concurred: “People started to get tired of not seeing any tangible results. And I would agree that things are definitely starting to move.”
Weyland said part of the expectation mismatch was self-inflicted. “As an industry, we have had a tendency to focus on the technologies and really look at what those technologies will be able to do, instead of looking at it from a higher level perspective, saying, ‘okay, what are we trying to achieve here?’”
Opening up access
In his view, what the funds sector is trying to accomplish with DLT is firstly “about democratisation of private assets,” such as private equity and real estate funds, that typically are reserved for institutional and professional investors, such as pension funds and insurance companies. Private banks, including Edmond de Rothschild, have “opened these illiquid strategies to our private client base for a number of years now, and this is picking up.” Other financial outfits have launched feeder funds which, for the moment, are available only to wealthier and savvier punters.
This has led to more complex fund administration and fund operation challenges. “It means that you have to deal with a broader investor base and more complexity in terms of onboarding, in terms of managing that investor base, managing all the changes that go through that investor base, the credit risk, etc. And that’s where I think the technology comes in--to solve the problem that I would call access.”
Secondly, “when you talk about private assets, of course, what everyone wants, and especially if it is more broadly distributed, is liquidity. How can you create some sort of liquidity?” In the past, asset managers have found bespoke ways to help investors in urgent need of liquidity sell their stakes. “But I think we are probably at the beginning of something in that space, where some of the larger players--we’ve seen the likes of Moonfare or Icapital--have gone through that democratisation process, and now they are at the stage where they can say, ‘well, we have this broad investor base, they’re all invested in a broad range of products, and why don’t we build a secondary market for this? Because if my client A wants to sell and perhaps I have client C who would like to have more exposure, then why don’t we match those two needs?’” While DLT is not the only way to increase private market liquidity, “it is a mean to achieve that.”
“Then there are more and more product manufacturers also toying with the idea of disintermediation.” These fund firms are thinking to themselves, “‘are the banks really doing their job? If they’re sitting on €10trn of cash, why is that? And why haven’t they been able to move some of that cash into financial products? And why shouldn’t I do it myself?’ That’s the whole direct to consumer distribution” premise.
“If you combine those elements, that is a strong case for finding a technology that makes it efficient to onboard clients. I think distributed ledger technology does not solve your AML/KYC issues. That’s a completely different story, which I think the industry is also struggling with. But, you know, gradually you start seeing solutions of identification through video, e-signatures, etc., but that is a key component to all the rest.”
Switch from cash
Individual investors would be well served by putting some of their savings into the private markets, “given the inflationary environment we’re in,” Weyland reckoned. “The average European still has a lot of cash sitting in their bank account. As we face that inflation, we need to do something with that cash, otherwise, we’ll just get poorer and poorer as time passes by. If we are able to provide solutions, to create well-functioning secondary markets for private assets, it will create liquidity, and that will make access easier and will protect investors, ultimately.”
He noted that many products--such as fonds en euros, a popular savings account-like insurance investment--are heavily exposed to fixed income, “which is not necessarily ideal from a returns perspective.” Supposing “those holdings could be gradually converted into private assets, if these private assets are liquid enough, that’s a big asset pool you can tap into.”
In the past, cost savings have been touted as a key benefit of fund firms using DLT. But today, Weyland said, the technology would not necessarily be expected to yield cost savings, so much as help keep costs from exploding as more investors pile into private markets. That is also why private equity and real estate are more focused on DLT than other asset classes.
Private debt and infrastructure fund investors are “very institutional” so “DLT has less value add, because you’re not looking at the same number of investors, in the efficiencies of scale, and the cost element of servicing these is less of an issue.” In addition, infrastructure funds typically have much longer timescales, which are probably better suited for institutional investors like pension funds than for private individuals.
Creating a marketplace
Weyland said he hopes that market utilities will emerge to create streamlined and interoperable primary and secondary markets. Having an effective platform, “for the primary market, of course, is very important. But then, if you want to build a secondary market, if you want to transfer shares or refund easily, you will have to automate that process as well.”
“I’ve always been a bit of a sceptical person when it comes to the use of DLT alone, just for the sake of making your illiquid assets transferable, because that was already in existence before.” Securitisation of real estate and hedge funds are hardly new, he observed. However, DLT can help with “the creation of a marketplace, ultimately, because it’s the interoperability of the different blockchains you have. If you want to create a secondary market, ideally, you will have a market player which will provide the infrastructure onto which other players would then plug in.”
New market players
And just who should start up those primary and secondary markets? Right now, private players are launching their own initiatives, such as “a large, French private capital manager” that has not yet publicly announced its plans and Berlin-based Moonfare, which “uses Luxembourg-based vehicles, so Luxembourg is part of the equation. Now, I think the other type of players that might enter that space are the big retail digital platforms. I always wondered why we haven’t seen more of the Apples and Amazons of this world enter the financial services market.”
Weyland said he theoretically would be willing to sell funds through a company like Amazon or Facebook. “Why not? I mean, if these firms have enough capital to structure themselves properly, to have the relevant licenses, to be able to distribute and to do that abiding by the rules, why not?” Currently, “we are a partner with a number of online banks, so why not look at these new platforms?” That said, Edmond de Rothschild Asset Management is presently pursuing a “traditional wholesale” and institutional sales strategy, he said.
Not for retail now
Would it ever make sense for public market funds, like Ucits, to use DLT? Weyland said that was a distant prospect. For Ucits, DLT would have to substantially improve “efficiency or reduce costs. Do you want to cut the middleman, cut out the transfer agents, in a way? Can you build an infrastructure that will completely cut out the transfer agent? Why not? Maybe that’s where we’re heading. But I don’t think it’s for tomorrow. I think it will take time because of the connectivity you need.” It “took 15 years or so” for the transfer agent transactions to use today’s XML standard, he observed with a hearty laugh.
His firm is not working on a specific DLT solution, per se. “We are looking at what the various service providers can offer,” Weyland said. “We don’t have a DLT project, per se, at the moment, with a ‘live date’. I think where probably our need is the greatest is indeed in finding further efficiencies in the way we distribute our private asset funds.
“Because we have an existing book of investors which is already quite broad, we’re looking at how to become more efficient there. And we’re also looking at, through wholesale distribution, increasing our book of business in the liquid space, through wholesale distribution, and that will probably also mean having to deal with more and more direct private investors.
“We’re now focusing really on the AML side of things, where we’ve done a lot of work with our existing platforms. We are looking at various options to how to see how we can further increase efficiencies, because that’s the biggest cost element. I think, for the rest, we were able to automate quite a bit. But if we could find a solution covering full AML spectrum plus the transfer agency infrastructure, then we would certainly look into it. But it’s not there yet.
“I mean, even on the AML/KYC front, the outsourced solutions are typically focused on one element. Either they’re focused on pure retail or they’re very institutional focused, but you’ll rarely find a provider covering a very broad spectrum of investors, which we have traditionally had.”
The real push
To really shift the speed of travel, several heavyweights will need to get behind DLT, and then others will follow, Weyland said. The “real push” will come from bigtime distributors or “some of the manufacturers that have a distribution arm or strong distribution capabilities.” However, “there will be the problem of interoperability of different blockchains.”
If several competing standards emerge and fracture the market, “you could end up in the same spaghetti model that we currently have with the transfer agents and anyone having to plug into the infrastructure.”
Whoever emerges as the standards-setter, “I think it should be based in Europe. That’s my opinion, also given the geopolitical situation,” such as tensions between the US and China. “Hopefully Luxembourg will be able to position itself there; it would be interesting to be part of that.... if Luxembourg as a country wants to move forward, I think we need to shape those new projects together with some of the players that are most likely to actually take the lead in this. So it’s important, I think, to grasp the opportunity now.”
Originally published in Delano’s June 2022 print edition.