Blockchain, big data, cyber-crime and outsourcing – Deutsche Bank

December 2017

The Network Forum (TNF) Asia meeting took place in Hong Kong on November 13, 2017 bringing together a host of leading regional and global experts across the custody industry. Deutsche Bank takes a look at some of the key themes which dominated the inaugural Asia event, attended by over 115 people

Blockchain: The securities services world sits up and listens

The securities services industry is on the cusp of a transformational digitalisation, which has been enabled through rapid advancements in fields like Blockchain. Beta testing of the technology is now transitioning into real-life applications as banks increasingly roll-out Blockchain tools for clients as they strive to introduce greater efficiencies in antiquated, low-risk processes such as corporate action issuances, proxy voting and reconciliations.

The T+0 settlement finality of Blockchain-supported transactions could heavily impact clearing and settlement, potentially disintermediating central clearing counterparties (CCPs) and central securities depositories (CSDs). One expert at TNF said the emergence of Blockchain enabled initial coin offerings (ICOs), a cryptocurrency-based equity fundraising tool, would allow trading, clearing and settlement to complete in a matter of seconds casting further doubt on the future of CSDs and CCPs. 

Banks and market infrastructures are under no illusions about the disruptive nature of Blockchain but there are clear concerns about absorbing the technology into systemically important processes precipitately. Financial institutions want to ensure the technology is fully understood and can co-exist with legacy systems, some of which are more than 20-years old, before any integrations can begin seriously. 

A number of providers are therefore examining developments carefully at the Australian Securities Exchange (ASX), which is testing distributed ledger technology (DLT) as a possible successor to the CHESS (Clearing House Electronic Subregister System) post-trade platform currently used in the cash equity market. Blockchain’s broader adoption by the industry may well reside on ASX’s experiences with the technology.

Working with Big Data

Data is a commodity which custodians have an abundance of, and many are now trying to figure out how this precious information can be monetised. One panellist highlighted big data was the “new oil”, with custodians looking to sell the information back to clients, something which could generate impressive revenues at a time when returns have been stagnating.

Structuring the sheer enormity of data into a comprehensive and digestible format, however, has been an obstacle for banks, but the emergence of artificial intelligence (AI) tools like robotic process automation (RPA) and machine learning is likely to provide a remedy to this due to their processing powers and unrivalled levels of accuracy.

Cyber-Crime: Nobody is Safe

The US$81 million cyber-heist at the Central Bank of Bangladesh in 2016 was a defining moment for financial institutions. Having long been siloed with IT, cyber-security now occupies boardroom and C-suite conversations, and it is widely considered to be one of the biggest systemic risks currently facing the banking industry. In addition to having strong IT protections, many organisations are investing huge resources and efforts into educating staff about the warning signs of cyber-crime.

New technologies have reshaped the cyber-risk paradigm forcing banks to continually stay up to date with innovations and their potential flaws. The fruition of crypto-currencies, for example, has created a lot of investment opportunities but its success must be caveated by the fact that cyber-criminals have spotted vulnerabilities on cryptocurrency exchanges, and have successfully stolen large sums from users’ digital wallets.

There is also growing concern that Blockchain’s encryption-enabled security could be undone by the unprecedented processing power that may be unleashed by quantum computing in the next five to ten years.

Outsourcing: the new normal

As banks look to control costs, many are assessing the viability of outsourcing parts of their middle and back office processes. According to an audience poll at the event, 48% of Network Forum Asia  attendees said they were actively considering outsourcing as a means to transform their operating model and reduce costs. 

Outsourcing allows organisations to eliminate structural costs enabling them to devote more resources to less commoditised processes and client servicing. A further 24% acknowledged outsourcing would help support product complexity and diversification into new asset classes or markets. Only 28% confirmed outsourcing was not under consideration.

People-heavy processes like reconciliations, KYC, AML and settlement are particularly ripe targets for outsourcing, although several panellists warned banks they were still responsible and accountable for these activities even if they have been delegated to third party providers.

Network Managers: A constantly changing role

Network managers’ due diligence questionnaires (DDQs) are not homogenous despite broadly covering similar ground, and this creates inefficiencies at sub-custodians, who have to tailor responses across different clients. In response to this, the Association for Financial Markets in Europe (AFME) created a standardised template for network managers to use, but the initial results have so far been mixed.

Network managers support the AFME initiative but they are not relinquishing their own DDQs. Instead they are supplementing their DDQs with AFME questions, which is likely to complicate and elongate the sub-custodian due diligence process rather than streamlining it. As such, the majority of The Network Forum Asia attendees said the AFME DDQ had not simplified network manager due diligence.

UCITS V and AIFMD have also forced network managers to strengthen their due diligence assessments due to the fiduciary liabilities the rules impose on those responsible for asset safekeeping and monitoring. As such, network managers are now expanding their due diligence and conducting reviews on more counterparties, including cash correspondent banks, CSDs and CCPs across their markets.

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