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Blockchain Technology Will Power Next-Generation Investment Banks

Published on 15 March 16
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A blockchain is a public ledger made up of all Bitcoin transactions ever executed and stands as proof of all the transactions on the network. The development of blockchain technology can potentially redefine the economics and operations of the financial services industry. In fact, the technology has already substantially transformed the means by which data is managed and moved from a setup where each organization keeps a copy of a data set, to one where individuals have controlled access to a shared copy, which is consistently updated through shared a network.

Despite significant technological advances in capital markets over the two decades, middle- and back-office functions often remain antiquated, slow and inefficient due to overly complex processes involving many counterparties, manual tasks, and third-party services. This is especially true in Investment banking, where high-frequency electronic trading still takes many days to settle because of a long list of complex processes created on a system of settlements. The problem is that this growing divide has become gradually untenable for both banks and their clients.

However, what will blockchain technology do here? Blockchain will likely solve these issues for investment banks.

The need for innovation is now greater than ever before. Perhaps this is why UBS announced to open a research lab, wholly focused on how blockchain technology can be used to leverage its operations. Citi Bank has revealed that it is testing three blockchain mechanisms it has developed.

Let’s have a look at how blockchain technology offers a unique opportunity to change how data is managed in investment banking transactions and the challenges that investment banks face in implementing this technology.

Potentially Disrupt Business Models

The ability to settle equity, currency, and fixed-income trades almost instantaneously through permission dispersed ledgers can create a substantial opportunity for banks to drive proficiency and reduce operating costs by improving regulatory control and even eliminating redundant intermediaries. There will not be much need for thousands of middle and back-office staff that the brokerage function of banks employs. Deutsche's investment banking division, as of December last year, uses about two-third of its 28,280 employees in such roles. Also, about one-third of the total cost base of investment banks is IT based, and so research by Breakingview shows that this technology could push the industry’s ROE well above 10 percent; which is a hefty gain given the current 6 percent industry average.

Implementing blockchain technology within the capital markets industry is substantial if we take into account the existing legacy technology, operations and established infrastructure landscape in capital markets. Since the blockchain transaction is a compound of all relevant information, it ensures successful transfer of assets and related contracts. Ultimately, the number of applications within and outside the banks are reduced.

Faster settlement times that are user-optimized

Blockchain technology has the potential to unlock both efficient and effective trade settlement terms, optimized around the user’s needs. For retail traders, the trade will be settled in seconds and for market makers, hours or even days. Moreover, Execution is open to the Internet and settlement is automatic; can run without any human interference and under the control of a straight set of business rules. Reduced transaction costs associated with contracting and Faster settlement have to potential to lead to reduced costs, and lower counterparty settlement risk and fraud.

Smart Contracts When paper knows what you told it to do.

The promise of a smart deal holds for all key clauses are automatically executed. If we assume the blockchain technology of choice is helping keep records in sync between multiple parties (e.g. which shipping container is which television in), then Smart Contracts are the logic layer on top that allow for if this, then do that conditions to be actioned directly from the agreement. This will automate many processes.

Lower regulatory reporting costs and greater transparency

The technology can eliminate costs associated with producing regulatory reports because with a shared ledger; regulators will be equipped to access directly the information they need to produce those reports. A reliable, well-defined and authentic source of data improves transparency.

It is important to understand that the benefits of this technology, are not without challenges;

Challenges Investment banks face with Blockchain Technology

Primarily, the investment banking industry must create a balance between the privacy and traceability of trading data. Simply put, if data cannot be traced, the system cannot be implemented to reduce operating cost and drive proficiency.

It is also important for banks to find ways to safeguard the information against reorganization by one or more participant. Reorganized data at any level will become a hurdle to implementing smart contracts and unique settlement times. Reorganized data can also become hard to interpret and even become useless. However, data can be protected from reorganization by limited user access at different levels of the hierarchy.

Banks must also establish standard tools and significant administrative interferences while simultaneously creating a uniform user interface, to facilitate transparency and reduce reporting costs.

If investment banks can overcome these challenges that come with Blockchain technology; the benefits of this technology are immense.

Takeaways

We can see how Investment banking divisions of large banks like UBS and Citi Bank, continuously engage in efforts to overcome the challenges that come with implanting and capitalizing on blockchain technology because they realize that there are significant benefits to it. Overcoming the challenges will change the cost structure of investment banks so quickly, that banks will redefine their business models. Transactions will be executed around the user’s needs, automating many critical processes and simultaneously, leveraging the return on equity for investors.





A blockchain is a public ledger made up of all Bitcoin transactions ever executed and stands as proof of all the transactions on the network. The development of blockchain technology can potentially redefine the economics and operations of the financial services industry. In fact, the technology has already substantially transformed the means by which data is managed and moved from a setup where each organization keeps a copy of a data set, to one where individuals have controlled access to a shared copy, which is consistently updated through shared a network.

Despite significant technological advances in capital markets over the two decades, middle- and back-office functions often remain antiquated, slow and inefficient due to overly complex processes involving many counterparties, manual tasks, and third-party services. This is especially true in Investment banking, where high-frequency electronic trading still takes many days to settle because of a long list of complex processes created on a system of settlements. The problem is that this growing divide has become gradually untenable for both banks and their clients.

However, what will blockchain technology do here? Blockchain will likely solve these issues for investment banks.

The need for innovation is now greater than ever before. Perhaps this is why UBS announced to open a research lab, wholly focused on how blockchain technology can be used to leverage its operations. Citi Bank has revealed that it is testing three blockchain mechanisms it has developed.

Let’s have a look at how blockchain technology offers a unique opportunity to change how data is managed in investment banking transactions and the challenges that investment banks face in implementing this technology.

Potentially Disrupt Business Models

The ability to settle equity, currency, and fixed-income trades almost instantaneously through permission dispersed ledgers can create a substantial opportunity for banks to drive proficiency and reduce operating costs by improving regulatory control and even eliminating redundant intermediaries. There will not be much need for thousands of middle and back-office staff that the brokerage function of banks employs. Deutsche's investment banking division, as of December last year, uses about two-third of its 28,280 employees in such roles. Also, about one-third of the total cost base of investment banks is IT based, and so research by Breakingview shows that this technology could push the industry’s ROE well above 10 percent; which is a hefty gain given the current 6 percent industry average.

Implementing blockchain technology within the capital markets industry is substantial if we take into account the existing legacy technology, operations and established infrastructure landscape in capital markets. Since the blockchain transaction is a compound of all relevant information, it ensures successful transfer of assets and related contracts. Ultimately, the number of applications within and outside the banks are reduced.

Faster settlement times that are user-optimized

Blockchain technology has the potential to unlock both efficient and effective trade settlement terms, optimized around the user’s needs. For retail traders, the trade will be settled in seconds and for market makers, hours or even days. Moreover, Execution is open to the Internet and settlement is automatic; can run without any human interference and under the control of a straight set of business rules. Reduced transaction costs associated with contracting and Faster settlement have to potential to lead to reduced costs, and lower counterparty settlement risk and fraud.

Smart Contracts When paper knows what you told it to do.

The promise of a smart deal holds for all key clauses are automatically executed. If we assume the blockchain technology of choice is helping keep records in sync between multiple parties (e.g. which shipping container is which television in), then Smart Contracts are the logic layer on top that allow for if this, then do that conditions to be actioned directly from the agreement. This will automate many processes.

Lower regulatory reporting costs and greater transparency

The technology can eliminate costs associated with producing regulatory reports because with a shared ledger; regulators will be equipped to access directly the information they need to produce those reports. A reliable, well-defined and authentic source of data improves transparency.

It is important to understand that the benefits of this technology, are not without challenges;

Challenges Investment banks face with Blockchain Technology

Primarily, the investment banking industry must create a balance between the privacy and traceability of trading data. Simply put, if data cannot be traced, the system cannot be implemented to reduce operating cost and drive proficiency.

It is also important for banks to find ways to safeguard the information against reorganization by one or more participant. Reorganized data at any level will become a hurdle to implementing smart contracts and unique settlement times. Reorganized data can also become hard to interpret and even become useless. However, data can be protected from reorganization by limited user access at different levels of the hierarchy.

Banks must also establish standard tools and significant administrative interferences while simultaneously creating a uniform user interface, to facilitate transparency and reduce reporting costs.

If investment banks can overcome these challenges that come with Blockchain technology; the benefits of this technology are immense.

Takeaways

We can see how Investment banking divisions of large banks like UBS and Citi Bank, continuously engage in efforts to overcome the challenges that come with implanting and capitalizing on blockchain technology because they realize that there are significant benefits to it. Overcoming the challenges will change the cost structure of investment banks so quickly, that banks will redefine their business models. Transactions will be executed around the user’s needs, automating many critical processes and simultaneously, leveraging the return on equity for investors.

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