Custodian banks serve a critical function in financial markets through their safekeeping activities. At their core, they provide securities and cash accounts for clients and administrative services such as processing payments, client reporting, corporate action processing, fund administration and accounting services, depository receipts services and transfer agency services. Custodians also provide clients with related ancillary services, including agency securities lending and foreign exchange services.
However, the custodian bank selected and appointed by clients is often just one participant in a long chain of participants in the custody chain – investor, broker, another global custodian, possible sub-custodians and a central securities depositary (CSD). The recording of movements in ownership and execution of entitlements (rights) along this chain can often be manually intensive and opaque.
The rise of blockchain technology brings significant opportunities to gain efficiencies and achieve increased transparency in the custody business. The introduction of distributed ledger technology and the knock-on impact of initiatives such as the Utility Settlement Coin (USC) have the potential to significantly change the global custodian bank operating model and custody network as a whole. As a result, the roles of those overseeing the operations of such institutions will also need to evolve, such as that of the Client Asset Oversight Officer (CAOO), a role accountable for ensuring the operational effectiveness of the firm’s systems and controls.
Distributed ledger technology allows multiple counterparties to have simultaneous access to a single, shared, constantly updated digital ledger that cannot be altered. These ledgers can accept inputs from multiple parties, however they can only change with consensus. In a world where your core business is based on a trusted third party record and maintaining a log of ownership, blockchain has the potential to address many custody-related inefficiencies and risks.
With these changes, the CAOO will see a significant shift in their role:
- Data Accuracy
- Client asset books and records are held in disparate, semi-automated systems, which introduces operational risk and data validity concerns, necessitating the global asset safety office (i.e. the team responsible for the monitoring and oversight of custody activities). Blockchain enables access to data through a decentralized, open and cryptographic network that eliminates doubt. Due to the established data model within the custody business, data accuracy is also addressed; a challenge to many new industries adopting blockchain who have to create their own data standards
- Today, records may be held in as many as six layers of custody (stockbroker, sell-side bank, global custodian, etc.) with different accounting views. With blockchain, all parties have access to the same record of ownership, eliminating the need for time and resource intensive reconciliations without sacrificing data accuracy
- Once the distributed ledger is adopted and integrated with internal systems (e.g. for reporting, etc.), legacy books and records systems may be retired, resulting in significant internal efficiencies and cost savings.
- The distributed ledger could act as a golden source, simplifying the extensive internal and external reporting obligations
- Analytics and reporting could be streamlined using blockchain technology by extending access to the blockchain to regulators and potentially eliminating certain reporting requirements. Currently, the FCA is exploring this possibility as part of Project Maison.
- Client Service Offerings
- As ownership data is migrated to blockchain technology, it could result in the automation and de-duplication of servicing processes. For example, corporate action processing could be inbuilt to a smart contract (a self-executing contractual activity, stored on the blockchain) and processed automatically
- Accounting and administration could be decoupled from other services, simplifying fund servicing, accounting, allocations and administration. Ultimately, primary issuance could happen directly onto the blockchain and subsequent changes in ownership tracked, significantly reducing administrative overhead and the risk of error
- As services are rationalized, the control frameworks that the CAOO oversees are simplified
- Development of custody offerings for new crypto-assets such as bitcoin keys.
For a business predominantly designed to address inefficiency and manual data management, blockchain introduces opportunity and potential disruption. However, custodial business management need to be aware of changes on the horizon, seize the opportunities and evidence control for the new risks introduced. Although it may not be an imminent threat to the current custodial model, blockchain technology is gathering speed and Client Asset Oversight Officers must consider how they adapt to this new environment.