There is great hype around the Blockchain, with organisations seemingly falling over themselves to make sure they are at the forefront of the new technology.
Indeed, Deloitte recently announced five new Blockchain partnerships and 20 prototypes. However, it might not be the catch-all, silver bullet solution it seems. In fact, before financial services firms can benefit from the great potential of a distributed ledger, the industry first needs to undergo a complex transformation—one that, as yet, has no clear endpoint. Companies need to effectively address today’s challenges in order to reap the rewards in the future.
Any technology that promises large improvements in market-wide efficiency, such as significantly reduced settlement times and faster collateral movements, will always gain broad interest. There are always hurdles to overcome before big ideas become reality, especially for something as radical as the distributed ledger, which seeks to transform various established business models from trading to settlement. This transformation is so disruptive to some existing businesses that their business models will be almost completely redrawn. It will challenge many banks’ ability to survive, create value in their long-standing businesses and deliver profits to shareholders. As a first step, banks need to re-evaluate their business models and architectures in the context of reduced complexity and fewer opportunities of differentiation in basic services.
This change will not happen overnight and financial institutions cannot afford to simply wait for it as followers. They need to consider existing problems and issues and find common ground with other market participants in terms of their business operating models. Banks have opportunities to collaborate now and address a number of the issues found on the road to the Blockchain model of the future. If they work to create shared platforms, the transition to a distributed ledger will be simpler. Blockchain will not magically reduce requirements for cost reductions, increased transparency and higher efficiency in the short term. This is why addressing these problems today will better position the markets for the move.
It is easy to identify the challenges—actually addressing them is the hard part. Financial institutions have a range of questions to answer as they take the next steps towards Blockchain. First of these is the existing legal and contractual framework. Where does the trust really reside in these platforms? Who owns a platform and the data? Regulators need to play an as-yet undefined role in deciding what changes to the legal framework and laws will be needed. Firms will also have to look carefully at the operational landscape as well as how early adopters will integrate with legacy systems— a company will not simply wake up one day and be fully migrated!
All that is even before considering aspects of security, identity or cost, revenue and ROI models. Equally, how would institutions address operational risks and failures? It is clear that there is a lot of complicated groundwork, planning and adjustment to be done before this particular silver bullet can be fired. One potential approach is increasing the use of outsourcing services from third parties or market utilities – in effect creating shared platforms that are simpler to migrate into from current operating models. Outsourced services can span a bank’s key business lines, from the cash equities brokerage arm to securities finance, money management and Foreign Exchange (FX), to name a few.
Of course, there are many points to be examined before taking advantage of outsourced services and the efficiencies they offer. Banks need to place their trust in the outsourcing service providers and therefore may not develop or operate their own versions of these services. Outsourced solutions need to work across business lines and service levels must be carefully monitored, with a clear understanding of who is responsible for meeting them, or accountable for missing them.
Importantly, outsourcing services pave the way for the collaborative model of the distributed ledger, as well as building new contractual frameworks and trust models. Banks are also free to concentrate on strategic investments that drive revenue and profitability rather than spend time on commodity activities. Outsourcing should also improve ROI ratios and reduce operational costs—key benefits in an age of ever-mounting cost pressures. Common platforms and shared services may also reduce the cost of compliance, mutualising many areas of the work currently repeated at every institution.
Many market areas are making promising strides on the road to Blockchain, which may be the ultimate goal for a common platform. To prepare for it, financial services companies should carry out an honest assessment of their future business models in the context of Blockchain. With that backdrop, they should further review the current challenges and their progress towards collaboration using outsourced services. Until then, there is still no clear picture of exactly how many miles there are left to travel, or on how long it will take to load that silver bullet.
Trevor Belstead is partner & head of Transaction Banking at Delta Capita.