Few industries can remain successful without investment in innovation, structural reform or applied lateral thinking. As consumers and markets change and evolve, so too must the suppliers of services irrespective of what they are offering, otherwise they risk being surpassed. The funds industry has not been disrupted yet, but disruption will come if the technology and distribution model are not adapted to meet changing investor requirements.
Regulation continues to evolve and strengthen its grip. MiFID II has now come into force, and RDR has placed a ban on inducements. While the driver for this is to extend greater protection and benefit the end consumer, a by-product is that many investors will be less willing or able to pay for advice than others. This has created an advice gap in the sector – and this is only partially addressed today with emerging robo services.
Poor fund performance is acknowledged as driving a rotation of capital from active management into lower cost, easily accessible passive products. A recent Calastone study reported that 57% of industry experts felt passive products would take over active as the investment product of choice for mass retail, most predicting this would occur in the next two to five years.
Fragmentation and the move to new distribution channels
The global fund distribution ecosystem is highly fragmented, making the process of buying and selling funds complex. Each participant in the transaction chain has the need to process, balance and reconcile each trade independently, all of this adding to the overall distribution cost. This complexity also creates issues around transparency – meaning the distribution landscape is opaque.
Fund distributors and fund manufacturers are exploring new ways to provide services to investors. There are many new ways in which fund businesses can supply their services, including new direct to consumer (D2C) offerings and robo-advisors. A recent Calastone study, for example, reported that 57% of respondents believed online D2C distribution channels such as fund platforms would take over from existing, traditional models. This is part of a wider industry move towards digital fund distribution.
The industry has succeeded – in part – in embracing technological change...
The funds industry has undoubtedly entered a significant period of change and in order for it to successfully evolve, and importantly remain competitive, it must ensure that it addresses areas of inefficiency and cost in order to create the best possible offering for investors. Cost reduction is the purest form of alpha, and many fund firms are already analysing where savings can be made.
Digitisation of the funds distribution chain is essential for ensuring that the industry can remain competitive as consumer requirements evolve. A digital ecosystem, with trading and settlement fully automated and integrated with digital front-end investor channels, provides a platform for innovation and a digital environment able to cope with management and regulatory reporting needs. With the growth in digital platforms and advent of robo-services investors benefit from a seamless end-to-end customer experience. Furthermore, as friction across the transaction chain is reduced, funds can be more easily processed, likely resulting in an increase in trading activity. Scalability of the back office is therefore even more essential.
A recent study from Forrester* has revealed the significant value generated from introducing automation into the trading system. A global market survey of 234 mutual funds organisations showed that Calastone's automated transaction network, in removing the friction and operational inefficiencies throughout the transaction cycle across all trading counterparties, has produced more than USD 641million (£458 million) of cost savings every year for the previous six years.
Through automation, and digitising the entire funds value chain, significant cost, risk, operational and regulatory pressures have already been alleviated. However, there is far greater potential yet to be realised, and when we consider the new, innovative technologies that can be leveraged, the savings that can be retained – and, as such, value that can be unlocked – are vast.
...Though going the full distance and onto blockchain can mean a far better future for all
Blockchain technology has created a wave of excitement across many industries, as a means to revise traditional operating models and drive new efficiencies. This is with good reason as already enough progress has been made to evidence significant potential for the funds world. But how?
Blockchain, enables counterparties to create a single, immutable and non-repudiable version of the truth, accessible to anyone with the relevant permissions. It has the ability to create a digital distribution chain where all participants can agree on the data and the same outcome for a given process. With such a technology, applied across the whole funds market, participants have the ability to step away from the duplication of balancing and settlement of each transaction that takes place today. This is the vision that Calastone portrays in creating a global Distributed Market Infrastructure (DMI). Since 2014 Calastone has been investigating the potential for blockchain to support an industry wide move to a fully digital model infrastructure – as discussed in a recent white paper 'The digital fund distribution revolution: opportunity through change'.
And where Calastone's network automation has been successful already in delivering significant value to the industry, the key to opening vast value for the future truly does sit in bockchain technology. Using blockchain, our distributed market infrastructure (DMI) offers a scalable solution to meet the needs of fund industry participants and investors now and for the future. And we have the numbers to back it up – our own recent piece of research** has revealed migrating to blockchain could generate more than USD 2.6bn (£1.9bn) cost savings for the global mutual funds market.
By normalising all orders across the mutual fund purchasing chain, all market participants are able to share a single consistent and accurate view of each transaction and all balances. This approach hugely simplifies what is otherwise a complex market and importantly drives down the cost of trading and settlement across the whole value chain.
Technology is evolving at a faster pace than ever, and with recent announcements such as the Australian Securities Exchange's planned adoption of blockchain technology to manage the clearing and settlement of equities, we are starting to see it achieving the maturity required to adopt and use at scale.
No other part of the financial services sector is as challenged as funds – however with vision, innovation and investment in transformative technology, it has the potential to continue to support the changing needs of future generations of investors.
**Calastone has calculated the potential cost savings of moving to a distributed and mutualised market infrastructure using data from Deloitte's recent 2016 study, "Europe's fund expenses at a crossroads; The benefits of mutualizing the cost of distribution." Calastone's calculation determines the potential basis point (bps) savings across key global markets. Calastone's bps calculation has been applied to mutual fund assets under management, at an individual market level, in the following markets; UK, Ireland, Luxembourg, Hong Kong, Singapore, Taiwan & Australia.
Ken Tregidgo is Deputy CEO of Calastone, the global funds transaction network. The views expressed are those of the author and not necessarily the views of Calastone, its management, its subsidiaries, its affiliates or its other professionals.