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Theory is being put into practice with blockchain. Jeroen van Oerle, trend analyst for Robeco New World Financial Equities, sees more and more applications for this promising technology in the financial sector. “Banks are leading the way and are in the implementation phase. Insurers are following suit and are moving from the concept to the test phase. Asset managers must be careful not to miss the boat."
Blockchain – the technology behind an online ‘distributed ledger’ or a shared administration – is proving an increasingly valuable solution for labor intensive, complex and expensive administrative processes, according to Jeroen van Oerle. He researches trends in the financial world in which the mutual fund Robeco New World Financial Equities managed by Patrick Lemmens invests. Digital financial services using blockchain is one such trend.
Van Oerle sees opportunities for asset managers to settle transactions more quickly and easily with blockchain, while cutting costs along the way. “Take, for example, the mandatory ‘Know Your Customer’ and ‘Anti-Money Laundering’ regulations or corporate actions such as stock dividend and coupon payments. They can be made more straightforward with a digital smart contract than they are now.”
The analyst also has high hopes for a pilot set up by Swift, Rise Financial, Deutsche Börse, Commerzbank, State Street and Robeco. “Providers of interbank communication technology, blockchain technology, a bank and asset managers are working together in this pilot to ensure time-consuming post-trade transactions can be processed more efficiently.”
When Robeco buys a stock or bond position from Commerzbank through Deutsche Börse, a so-called smart contract is established that digitally and automatically arranges the payment (clearing), the transfer (settlement) and custody (safekeeping) relating to the assets. Manual procedures and confirmations are no longer used to screen the counterparty as regards reliability, money laundering and compliance with the rules applying to the trade. This is possible because all the relevant information relating to the transaction and the parties involved is kept in a decentralized, online database. Participants can only access the data that they require. The trade is saved in a central cash book which means that the regulators can always check everything.
“While the administrative processing of a trade now takes two days to complete, blockchain could reduce this to just one hour”, according to Van Oerle.
“Trade financing was one of the more obvious areas where blockchain could be used to improve efficiency, because it is a complex administrative process. There is now a great, first example of this”, says Van Oerle.
The Commonwealth Bank of Australia and Wells Fargo, along with cotton trader Brighann Cotton have combined the use of blockchain, smart contracts and the Internet of things for the first time to ship bales of cotton from the US to China. Consignment notes and letters of credit, indicating the time, conditions and currency of the payment, have been replaced by a smart contract. This also contains all kinds of product information. The cotton's movements can be traced with GPS.
As soon the bales reach China the digital smart contract automatically receives a signal to pay and to transfer the ownership of the cotton to the client. All the transaction details are saved in a decentralized database and can be accessed by all parties involved at any time. “That cuts back a lot on paperwork, the need to perform manual data validation in the interim and time”, believes the analyst.
One insurance-related application is InsurETH. If a flight is delayed a smart contract automatically makes a payment. The affected travelers don't have to take any action and manual transactions are no longer necessary. Van Oerle: “This type of standard insurance where ‘if X happens then Y will be paid out’ can be perfectly automated with blockchain.”
‘Blockchain creates trust in an environment of distrust’
What all of these examples have in common is that the transfer of information, the verifiability of data, paper settlement of contracts and payments all occur more efficiently thanks to blockchain technology. It all revolves around a decentralized, online ledger in which the ownership and transactions involving an asset are kept fully updated and can be consulted at any time.
Data is no longer saved in one central location, it is spread across the Internet. All the parties involved have real time access to the central administration and no one can change information without someone else’s authorization. Only new information can be added and nothing can be removed. There is always a complete, historical transaction overview available and the encryption and decentralized storage of data makes it less vulnerable to hacking “Blockchain creates trust in an environment of distrust”, states Van Oerle.
Blockchain is one of the technologies available for a shared administration. And as one of the most well-known, it has already become synonymous with the underlying technology. While applications are being developed with various techniques, establishing a standard is already under discussion. Banks do this as part of a collaborative venture called R3CEV and insurers have recently established a platform called B3i. “R3CEV has an advantage because it has brought in both regulatory and legislative bodies. That means that blockchain applications will receive approval more quickly", suggests Van Oerle.
However, recently banks Goldman Sachs, Morgan Stanley and Santander left R3CEV because they did not see sufficient added value in the collaboration. Van Oerle is aware of the dilemma of working with others versus going it alone. “If the collaboration does not progress quickly enough for larger parties, they will go their own way. It is necessary to make certain agreements so that there are not a range of different systems that do not work well together or are even totally incompatible. Although parties have now emerged that are linking various types of blockchain technology together. The details have not yet all been hammered out. Perhaps the various blockchain technologies will evolve into specific applications in, for example, the financial or industrial sectors.
Van Oerle is surprised that a third group of financial service providers, the asset managers, have not yet gotten themselves organized. “Now is the time to get involved in the discussion on establishing a standard. Soon it will be a fait accompli and you will no longer have any influence. Asset managers must be careful they don't miss the boat, which in some ways has already set sail.”
To learn more about what blockchain is, how it works, what its implications are for banks, insurers and asset-management companies, what the situation is today and which technical problems have not yet been solved, read the article Blockchain – short-term impact exaggerated, long-term impact underestimated and the white paper Distributed ledger technology for the financial industry. Blockchain administration 3.0.