Blockchain and the investment industry stackSome reflections March 2016

Evolving from Bitcoin to Distributed LedgerBitcoin• A de-centralised, globally distributed cryptocurrency devised in 2008 and launched in

2009 introducing Blockchain technology to the world • Bitcoin Public Blockchain uses computationally expensive mining with rewards and

proof of work processing to maintain system integrity amongst anonymous counterparties (trustless)

Distributed Ledger • Rebranded from “Blockchain” to distance from Bitcoin reputation• Known counterparties, no mining or proof of work (trusted)• Suitable for regulated institutions and existing legal frameworks• Smart contracts automate business rules and industry standards

Seven characteristics of Distributed Ledger

# Characteristic Description1 Decentralised All participants (nodes) have own copy of all data in the system. No central authority. No

single point of vulnerability or failure2 Distributed Standard network protocol ensures every node receives every transaction in near real-time

and applies same rules. Transactions are grouped into blocks for processing3 Consensus Mechanism to ensure all nodes agree on the integrity of transaction data in the system,

replacing the need for a trusted third party with technology4 Traceable Every transaction block is immutably and verifiably linked to the previous block. A full history

can always be reconstructed right back to the beginning (the genesis block) 5 Scripting Every transaction has standardised scripted rules built-in to enforce rules and conditions.

Sophisticated “Turing complete” scripting is currently referred to as “Smart Contracts”6 Security Encryption with Public Key Cryptography. Anonymous Public Key stored with every

transaction on ledger. Matching Private Key required for authority to access that transaction7 Accessible On Permissionless (No Trust) systems eg Bitcoin, anyone can install software and participate.

On Permissioned (Trusted) systems, participation is restricted and governed.Levels of access between these two extremes. e.g. read/write or read-only access.

• Inefficiency and waste in the investment industry stack• Multiple and duplicated processes

and systems• Drive for cost transparency • Poor investment returns• Pressure on margins • Regulatory action: MIFID2, charge

caps, FCA thematic reviews

The industry stack: inefficiencies & duplications

• Transformation of financial services industry infrastructures• Counterparties share unbreakable copy of same digital record• Changes updated in near real-time• Industry market practices captured in code and automated as ‘smart contracts’

on distributed ledgers• A new trusted industry fabric for financial services• Fostering ever closer industry collaboration and transparency• Reduction of the industry stack by removal of trusted third parties• Certain organisations must reinvent or risk disintermediation

The potential

Opportunities: possible use cases

Screening criteria• Multiple databases and parties recording their view of common data• Lack of complete trust between those parties (competitors)• Non-synchronised processes• Troublesome, expensive reconciliations• Lots of offline interactions• Activities where greater standardisation would be beneficial

Use Case 1: adviser CRM/ platforms: now Input Process OutputAdviser CRM

Customer dataCustomer authorisations/approvalsAdviser data eg authorisationsUpdates from fund adminMoney in

Customer marketing and onboardingFact finding and risk profilingCashflow planningTax planningRecommendations investments, decumulation strategyPortfolio servicingAdviser business managementAdviser professional development

IllustrationsInvestment portfolio buy/sell requestsReportsEvent prompts & triggers, e.g. reviewsClient comms and reportsMoney outFCA data updates e.g. Gabriel

Platform/ Product Provider

Investment buy/sell requestsData from fund managers/fund admin, e.g. factsheets, pricesMoney in

Process investment buy/sell requestsDeduct adviser and platform remunerationAdminister tax wrappers (pension, ISA, onshore & offshore bonds)Administer payroll (for drawdown)Monitor accounts (individual and nominee)Reconciliations

Investment buy/sell ordersIllustrationsTax reportingAdviser commsEnd-customer commsMoney outInvestment buy/sell confirmations

Fund Admin Buy/sell orders from platforms & product providersData from financial data vendors and share registrars, e.g. corporate actions

Process buy/sell ordersManage suppliers e.g. brokers, custodiansCollect incomeAdminister fund accountsAdminister corporate actionsMaintain registersMonitor accounts (individual and nominee)Reconciliations

Confirm buy/sell ordersReports to fund managersData to platforms

Use Case 1: adviser CRM / platforms: de-duplication

Input Process OutputAdviser CRM

Customer dataCustomer authorisations/approvalsAdviser data eg authorisationsData from fund managers/fund admin, e.g. factsheets, pricesMoney inBuy/sell confirmations

Customer marketing and onboardingFact finding and risk profilingCashflow planningTax planningRecommendations investments, decumulation strategyPortfolio servicingAdminister tax wrappers (pension, ISA, onshore & offshore bonds)Administer payroll (for drawdown)Adviser business management and remunerationAdviser professional development

IllustrationsInvestment portfolio buy/sell ordersReportsEvent prompts & triggers, e.g. reviewsClient comms and reportsMoney outTax reportingFCA data updates e.g. Gabriel

Industry Distributed Ledgers for Product and Fund Registers

Fund Admin

Buy/sell orders from AdvisersData from financial data vendors and share registrars, e.g. corporate actions

Process buy/sell ordersManage suppliers e.g. brokers, custodiansCollect incomeAdminister fund accountsAdminister corporate actionsUpdate registersMonitor accounts (individual and nominee)

Confirm buy/sell ordersReports to fund managers

• Single record• Re-use of data• No reconciliations• Straight-through-

processing• Realtime

transparency• Fewer systems• Less risk• Lower costs

Use Case 2: Funds settlement on industry distributed ledger

• No reconciliation, lower costs• APIs ISO20022-compatible• Fewer mismatches• No net payment authorisation • Real-time transparency• Settlement period 0 to 2 days• Reduced:

• Counterparty risk• Counterparty infrastructure• Investor out-of-market risk• Investor costs (lower

charges)

The UK Government is concerned about proliferation of pension pots as people change jobs every two years….

A consumer “dashboard” that can find and report on all of an individual’s pension pots will provide vital information and encourage pensions saving

Use Case 3: UK pension dashboard

• Immature technology that currently does not meet the non-functional requirements of very large systems ie transaction capacity/ scalability• Development tools and environments are also immature• Does not permit high speed data searching equivalent to modern databases• Being immutable, existing transactions cannot be directly cancelled or reversed to

meet legal/ contractual obligations• Regulators are supportive but may be slow to catch up• Collaborative business models and agreement of standards• Open Source software development, legal risks and management

The challenges

Implications

Some possible first steps• Work on new services / processes rather

than legacy• Choose non-critical applications first• Engage and experiment with the new

technology• Build coalitions of the willing• Consider how to help less capable

counterparties with “on- and off-ramps”

Implications for incumbents• Existing business models under threat• Current industry infrastructure providers are well-

placed• Disruptive new entrants may struggle to build

consensus• Legal and business challenges are at least as

significant as tech issues:• Collaboration, governance, legal framework, security,

market practices, standards, SLAs

• An effective response will require:• Horizon-scanning and open-mindedness• Consensus-building• A readiness to experiment

People are doing discovery projects

Discovery tasks• Select scope of processes / stack layers to be addressed

• Identify organisations, systems, resources involved

• Assemble and analyse current performance data: Cost, timeliness, waste / rework, risk management

• Involve representative players

• Confirm processes offering best potential

• Identify use case(s) and indicative costs & benefits

• Assess major barriers to adoption e.g. Lack of collaboration, no common standards, scalability, data security and privacy concerns

• Identify potential coalition of the willing

Discovery outputs• Assessment of potential for Distributed Ledger:

• Scope of potential use case(s)• Business case for each major type of player

• Revenues, costs, risks• Potential benefits of auditable chain of transactions

• Template and proposal for collaborative Proof of Concept:• Basis for collaboration: shared interests• Parties to collaborate: representative players• Governance arrangements • Identify emerging legal / regulatory implications• Funding

Discussions held with…• Transaction automation provider

• Institutional payment & settlement blockchain infrastructure provider

• Global systems integrator involved in multiple blockchain proofs of concept

• Transfer agent

• Investment admin software provider

• Tech legal firm

• Industry standards body

Recent forums …• Ethereum DEVCON1, London, November 2015• SWIFT Sibos15, Singapore

Recent reports studied …• UK Government Office for Science, Blackett

report, January 2016• DTCC Report, January 2016• Euroclear Report, February 2016

Recent developments examined…• Ethereum Homestead Release• Microsoft Azure “Blockchain as a Service”• Linux Foundation, Hyperledger Project

A note on our methods so far….

Alan Sherriff, MDwww.cboxx.com alan.sherriff@cboxx.com+44 7939 222 354@CBoxxLtd

David Taylor, Partnerwww.ocp.co.uk david.taylor@ocp.co.uk+44 7768 077 796@rdavidtaylor

Contact us to discuss Distributed Ledger discovery projects …

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