The Network Forum (TNF) returned to Hong Kong this month for the 2019 Network Asia Forum meeting on 13-14 November, although increasing security concerns and travel disruption resulting from the street protests meant that only the first of the two-day event was completed.

Among the topics in focus on Day One was the impact of persistently low interest rates, volatility, the reallocation of assets from active into passive investments and extensive post-crisis regulations, which are weighing heavily on institutional investor returns.

Consultancy Bain & Co reports that the global revenue pool for the traditional buy-side is expected to fall 20% by 2025. This will be felt by post-trade services, who could see their own profits plunge by anywhere between 35% to 40% over the same time horizon.¹

New technologies and the emergence of digital assets will offer opportunities to offset some of the declines facing the post-trade industry.
Tony Chao

“The industry has refined its attitudes towards DLT, and is now looking at the technology as a remedy for specific market or client issues, as opposed to a blanket solution for all of the industry’s problems.”
Samar Sen

Distributed ledger technology, or DLT, has the potential to reconfigure the way securities services works and delivers value to clients. Deutsche Bank is adopting a multi-pronged approach towards blockchain, said Samar Sen, the bank’s global head of digital products at the Forum.

“Firstly, we are looking to use the technology as a mechanism to improve post-trade processes such as trade settlement and to that end we are partnering with financial market infrastructures (FMIs) on various proof of concepts (POCs),” he told delegates.

“Secondly, we are using the technology to solve real business challenges that we as a bank routinely face. This may include applying distributed ledger technology to address issues around manual reconciliations or transactions involving multiple counterparties.” Chao concurred, stating DLT will help the industry move away from the existing two dimensional electronic entry process, and instead allow users to build in self-executing codes, rules and delivery solutions in what could make it possible for transactions to settle in real-time instead of T+2.

Deutsche Bank is participating in several DLT initiatives. The bank is working on a SWIFT-led DLT project alongside the Singapore Exchange and the Hong Kong Stock Exchange to expedite proxy voting. It has also leveraged the technology to facilitate withholding tax processing at the ultimate beneficial owner level, said Sen.

A lack of standardisation could impede the integration of DLT into the global post-trade ecosystem. There are a number of competing protocols including Ethereum, R3, IBM, Corda, Hyperledger and JP Morgan’s Interbank Information Network, not all of which are fully interoperable. “There is a bit of confusion in the market because there are so many different protocols,” explained Sen.

In response, experts at TNF repeatedly advised market participants to collaborate in order to produce comprehensive standards overseeing DLT. Many believe that the Brussels-based SWIFT – because of its commendable track record in supporting harmonisation initiatives for financial messaging standards through the ISO 20022 format – could have a positive influence in helping the industry systematise all of its DLT protocol.

The securities industry is championing the use of digital assets, or tokenised securities, as they can be applied to any asset or instrument. Tokenisation can be applied to any asset or instrument, whether it is a listed equity, over-the-counter bond or something more tangible, such as property. By tokenising these assets, they can be traded like any normal on-exchange financial instrument and adopted by stock exchanges such as Swiss Digital Exchange, the New York Stock Exchange, the Singapore Stock Exchange, Australian Securities Exchange (ASX), Hong Kong Stock Exchange and the Thai Digital Exchange.

If executed smartly, tokenisation could positively impact on liquidity; particularly if it allows for the fractionalisation of illiquid instruments and makes it cheaper for investors to participate in capital markets. The securities services industry is excited about digital asset developments, not least because it could help the industry usher in a new range of product suites including digital vaults to safe-keep private keys and digital money solutions for the cash leg of settlements, commented Chao. Bain & Co is already sufficiently confident to predict that digital asset servicing could make up 20% of all post-trade revenues by 2025.²

Partnerships are likely to reshape post-trade, but often “require a leap of faith” according to Chao. The growing participation of fintechs and major technology companies in financial services also promise to reshape post-trade. Chao told TNF that circumstances in China – where established technology companies such as Alibaba and WeChat are developing their own fund distribution channels – would likely force providers to rethink their traditional asset servicing models. In addition, financial market infrastructures and custodians are also collaborating more with fintechs to optimise their existing operating models. For example, the exchanges in Australia and Hong Kong have both worked directly with Digital Asset Holdings as they implement their respective distributed ledger initiatives.

One financial market infrastructure participant at TNF said the decision to partner with fintechs on critical projects often required a leap of faith at the board and C-suite levels - especially as these stakeholders are more commonly used to working with mature technology providers. He concluded that while it was positive that financial market infrastructures and banks are working more closely with fintechs, it is critical that financial institutions do not compromise on consumer protection.

In a session focusing on India, Sriram Krishnan, head of securities services for India at Deutsche Bank, reported that the country faces certain macroeconomic headwinds at this time. India’s GDP grew less than six percent for the first time in seven years as a slowdown in consumption, private investment and exports took their collective toll. Consumption, which has been India’s biggest growth engine fell to 3.1% in Q1, its lowest rate since Q3 2014, while exports continue to be volatile owing to the general slowdown in global growth and ongoing trade tensions. Furthermore, Krishnan added that collections from the much-anticipated Goods and Services Tax (GST), the country’s simplified tax code introduced in July 2017, had fallen somewhat below expectations.

However, India has made impressive strides to liberalise its economy, making it easier for foreign investors to trade in the domestic market. Krishnan said the local market had become more efficient, evidenced by the fact that India now ranks 63^rd on the World Bank’s ‘ease of doing business’ index, having climbed up from 142^nd place in 2014. As the country looks to reverse its economic slowdown, the Securities Board of India, or SEBI, has opted to further loosen restrictions on foreign investors accessing the market by reducing the number of foreign portfolio investor categories from three to two, continued Krishnan. Deutsche Bank have produced a video on AccessIndia, our web based portal, which helps clients obtain the FPI license expeditiously.

Under the latest revisions, Category 1 foreign portfolio investors will comprise all regulated institutions including sovereign wealth funds, central banks, pension funds, asset managers, portfolio managers and entities from Financial Action Task Force countries whereas Category 2 foreign portfolio investors now consist of charitable organisations, family offices, individuals, corporate bodies and unregulated funds such as limited partnerships and trusts. In addition, Krishnan said the know-your-customer (KYC) process for foreign portfolio investors would be streamlined, adding that SEBI had also become more open to the demand from private banks and other such regulated entities who wish to invest client monies through their FPI account. This is being very well received, and such entities are quite happy to furnish the break-up once a quarter as stipulated. Such market-friendly initiatives will be pivotal in accelerating foreign portfolio investor inflows into Indi

“China’s government has realised that its international investor base – relative to the size of its equity and bond markets – continues to be quite small.”
Tony Chao

China’s economy has slowed down markedly over the past 12 months with GDP growth slowing to six percent, its lowest level since the early 1990s.³ The National Institution for Finance and Development (NIFD), a Beijing-based think tank, forecasts that growth will dip even further, to 5.8% in 2020 as the country grapples with the global economic slowdown and continuing trade tensions with the US.⁴ Despite these challenges, Chinese regulators are continuing to open up the country’s capital markets with extraordinary zeal. 

In September 2019, China’s State Administration of Foreign Exchange, or SAFE, eliminated investment quotas for the Qualified Foreign Institutional Investor and Renminbi Qualified Foreign Institutional Investor (QFII/RQFII) access channels to stimulate inbound flows. While regulators hope the changes will help offset outflows, bolster the Yuan and strengthen the country’s balance of payments, reports suggest expectations may need to be tempered.⁵ Some experts believe the move may only have a limited impact, mainly because two thirds of the quotas have still yet to be used.⁶

This low take-up is partly because many foreign institutional investors are already using other access mechanisms such as Stock Connect and Bond Connect to trade onshore equities and fixed income as opposed to going through QFII and RQFII. Chao also said that continued uncertainty around withholding tax and capital gains tax in China may also dis-incentivise wider international investment. Despite its challenges, China’s reforms were impressive enough to induce global index providers into adding the country to their benchmarks; a move which is likely to result in sizeable inflows from global asset managers.

Elsewhere, China is attempting to lure foreign asset managers by making it easier for them to operate onshore. “The wholly foreign owned enterprise, or WOFE, programme will make it easier for foreign fund managers to obtain a license,” said Chao. “Previously, foreign managers could only distribute inside China if they operated as a joint venture with a local financial institution. This requirement has since been removed.” There is clearly interest in the WFOE, evidenced by the fact that the Asset Management Association of China has so far granted WFOE licenses to 19 global asset managers, who have since launched 38 private fund vehicles running circa US$751 million.⁷

Since its rollout, several high-profile asset managers have acquired WFOE licences including Aberdeen Standard, BlackRock, Schroders and Man Group.⁸ While WFOEs can only target institutional investors through their private fund management licenses, local regulators have since confirmed they will permit firms to convert their licences into public fund management companies giving them access to the country’s US$2 trillion retail market.⁹ This could prove very attractive for managers trying to widen their distribution footprints. Chao added the Mutual Recognition of Funds (MRF) scheme, a cross-border fund distribution channel between Hong Kong and China, had also enjoyed a resurgence of activity.

Aside from the exciting market openings in China and India, Asia as a whole is at the forefront of technological innovation, illustrated by its enthusiastic adoption of DLT and digital assets. It is a region that financial institutions simply cannot afford to ignore.

Sources

¹ Bain & Co
² Bain & Co
³ BBC (October 18, 2019) China economy: Third quarter growth misses expectations
⁴ South China Morning Post (November 14, 2019) China think tank becomes first government linked body to predict 2020 growth will drop below 6.0%
⁵ Reuters (September 10, 2019) China to scrap quotas on QFII, RQFII foreign investment schemes
⁶ Reuters (September 10, 2019) China to scrap quotas on QFII, RQFII foreign investment schemes
⁷ Asia Asset Management (June 18, 2019) China units of foreign fund managers gear up for retail market opening
⁸ Fund Selector Asia (June 7, 2018) Global managers in China onshore push
⁹ Fund Selector Asia (June 20, 2019) China to relax onshore fund rules