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Transforming the Investment Lifecycle: the Future is Digital

Digital assets will profoundly transform the financial ecosystem. Industry participants, institutional investors and asset managers will soon experience those changes and need to consider the opportunities and risks that the new digital paradigm presents to their existing approaches. It is no longer a question of when digital assets will bring change, but a question of how.

It might be possible to ignore the hype around digital assets and their future impact if that future wasn’t already being shaped. Emerging digital asset classes, new products, and new infrastructures are transforming the market every day, even as regulators globally are considering how best to oversee these developments.

Industry participants cannot afford to ignore the rise of digital assets, says Justin Chapman, Global Head of Market Advocacy & Innovation Research at Northern Trust.  He believes that asset managers and institutional investors should engage with the emerging digital landscape now. “Asset owners and asset managers will need to think about the future impact on their business models. Investment strategy, asset allocation and strategic decision-making will all be transformed by new products and asset classes. The risk of not engaging with digitalisation is significant,” he suggests.


Digital assets are any assets, physical or non-physical, that can be captured in a digital representation of value or rights, and can be electronically stored, traded, or transferred between counterparties. Often cryptographically secured, they can include cryptocurrencies, stablecoins, central bank digital currencies (CBDCs) and digital tokens, all of which have posted significant market growth in recent years.
 

There are a significant number of digital assets but we like to look at things in three categories.

  1. A tokenized asset is a traditionally issued asset that is converted, at a later date, into a digital token.

By tokenizing an asset, we’re not changing the asset itself – it keeps its original form – we’re just changing how that asset is held and digitally transferred in terms of value and workflow.

This is seen as a key step in terms of digitalisation of our marketplaces where current legislation and legal agreements require certain assets to be issued in certain ways but then the benefits of electronic markets can be applied to them further downstream.

  1. A natively issued digital asset is where the legal form of the asset is issued directly into a digital ecosystem or environment.

For this to happen, both the legal and regulatory framework has to recognise the asset in its digital issued state.

  1. As digital marketplaces and ecosystems evolve, one critical element in the future will be digital cash. Digital cash is required to create settlement within these infrastructures and really, truly get the benefit out of the digital environments.


The digital ecosystem has the potential to increase transparency, reduce settlement times, and create stronger reporting systems, as well as drive a plethora of other innovations and developments across the value chain. Chapman points out that, unlike traditional assets, digital asset transactions can settle in real-time.

In addition, the introduction of capabilities such as tokenisation  have implications for both investors and asset managers. “Tokenisation is an opportunity. It creates value all the way through the chain, from the creation of an asset, to its issuance in digital format, to its trading, and to the embedded management of lifecycle events through the life of the asset. Tokenisation also offers new ways to think about sustainability and ESG, and creates new intelligent data and insights that weren’t possible before,” he says.

As a global asset servicer, Northern Trust has long recognised that digital assets will play a crucial part in the future investment landscape. It has developed a multi-year strategy to create the building blocks needed to support the move to digital markets. This includes supporting clients’ evolving needs through all aspects of the investment lifecycle, from issuance, to trading and execution, to post-trade and settlement.

Issuance

From an issuance perspective, innovations such as tokenisation and fractionalisation open up opportunities for firms to issue digital securities and debt and may reduce the cost of investing for primary market investors and help drive further democratisation in financial markets.


A tokenized asset can be divided into a number of component parts, a process called fractionalisation. This technology will disrupt several asset classes.  For example, previously illiquid assets such as art, real estate, precious metals and private debt will become liquid assets accessible to a broader investor base. Further, fractionalised wholesale markets will become more available to investors.


Market infrastructure participants continue to build capabilities in this area. Deutsche Börse Group’s D7 platform provides a fully digital alternative conventional physical issuance and processing of securities, for example. i

Last year, Northern Trust teamed up with BondEvalue to deliver integrated fractionalised ownership of fixed income bonds. BondEvalue’s regulated platform facilitates the trading of fractionalised investable assets based on wholesale assets, with Northern Trust as an asset servicing provider. The platform allows investors access to investments that were historically only available to larger institutions. ii

These types of tokenisation capabilities bring benefits over the wider lifecycle, because they have embedded triggers and actions that are related to events over that period. Smart contracts in asset tokenisation have the potential to deliver efficiency gains across automation, disintermediation, transparency, improved liquidity potential, and the tradability of illiquid assets, according to the OECD. iii

Northern Trust has developed and continues to work on an asset agnostic tokenisation capability, one which allows any asset to be tokenised and deployed and connected to any marketplace or platform.

“We believe that having a solution that is asset agnostic will be extremely important as the tokenisation environment evolves. The system allows for flexibility, agility, and adaptability. Ultimately, as markets mature and the number and types of tokens increase, solutions will have to accommodate a range of assets. Providers without flexible solutions will struggle to future proof their business,” Chapman says.

He points out that digital assets will also provide post-trade compliance and risk management opportunities for clients, who will be able to check their portfolios in real time, and ensure that their assets are achieving what they are meant to achieve.

Trading and Execution

“Trade execution, portfolio rebalancing, cash management, and asset disposal will all look different in a digital ecosystem, and innovation in digital infrastructure is driving some of these changes,” says Chapman.

For example, Northern Trust’s own distributed ledger technology (DLT) platform for private equity asset servicing, transferred to Broadridge Financial Solutions in 2019, marks a significant step towards delivering an industry-wide private equity (PE) blockchain. iv The technology is providing data and analytics tools connecting the PE lifecycle for all market participants, allowing PE firms to communicate with investors with greater efficiency, while also enhancing capital and cash flow management.  The DLT PE platform has been an industry milestone, delivering real time insight and transparency to all parties, while streamlining business processes and allowing expansion for more digital growth.

More widely, several existing market infrastructures are deploying new DLT architecture to make current processes more efficient. For example, Hong Kong Exchanges and Clearing Limited (HKEX) is launching HKEX Synapse, a new integrated settlement platform using DAML smart contract technology to standardise post-trade workflows and maximise connectivity and efficiencies in a transparent way. v Meanwhile, new financial market infrastructures (FMIs) are emerging to compete in this space, unencumbered by legacy technology, and with the potential to do things differently.

Post-Trade and Settlement

Chapman also highlights the fact that the post-trade environment is also changing. Digital assets are transforming settlement, clearing, reconciliation and more. With everything occurring in real time, assured settlement becomes a reality, and investors will know where their assets are at all times. However, cash in real time also brings its challenges, not least with the need to have long balances or needing time to accommodate cash settlements.

Against this background, digital trust firms will increase in importance, believes Chapman. “Clients will need to know that everything is running properly and that all those assured transactions are transacted correctly across the whole ecosystem,” he says.

The firm is also engaging with technology and financial service partners, leveraging DLT to create a more efficient payment marketplace through the use of digital wallets. The network will use dollar-backed tokens as digital claims. These claims allow for on demand real time settlement and reconciliation, or payment on cash transactions,  which can potentially mitigate credit and float risk on cash settlements.

Asset Servicing

As with other steps within the investment lifecycle, asset servicing is also evolving as new digital assets continue to emerge.

Earlier this year, SC Ventures and Northern Trust launched Zodia in order to provide services to institutional clients as a cryptoasset business. vi Zodia provides custody services for the most institutionally traded cryptocurrency assets, Bitcoin and Ethereum, which account for approximately 80% of the current institutional cryptocurrency activity.  This will be followed by XRP, Litecoin, and Bitcoin Cash. vii

Northern Trust has invested and will continue to invest in new technology developments across multiple areas of its fund administration platform, says Chapman. It has built out its crypto fund administration capabilities, providing clients with support for Exchange Traded Notes (ETNs), which are also physically backed by Bitcoin.  The system architecture and operating model has been designed to be scalable, with the ability to expand into other assets and support more advanced digital capabilities.

Chapman points out that innovations rarely change the world overnight, and digital assets will be no exception. “For some years, we expect to see an overlap between legacy, analogue systems, and new digital innovations. Successful industry participants will be those who can manage both ecosystems at the same time, ensuring that they are connected and embedded into one another. Managing and navigating both worlds, while remaining flexible to changing client requirements, is a key priority for Northern Trust,” he says.

 


i https://www.deutsche-boerse.com/d7/  As of: 15 November 2021
ii https://www.northerntrust.com/united-kingdom/pr/2020/bondevalue-northern-trust-first-blockchain-based-bond-trade Last Updated: 12 August 2020
iii https://www.oecd.org/finance/The-Tokenisation-of-Assets-and-Potential-Implications-for-Financial-Markets.pdf Last Updated: 17 January 2020
iv https://www.northerntrust.com/united-kingdom/pr/2019/northern-trust-to-transfer-pe-blockchain-technology-to-broadridge Last Updated: 26 June 2019
v https://www.hkex.com.hk/Mutual-Market/Stock-Connect/Reference-Materials/Synapse?sc_lang=en As of: 15 November 2021
vi https://www.northerntrust.com/united-kingdom/pr/2021/zodia-custody-receives-fca-registration Last Updated: 29 July 2021
vii https://www.northerntrust.com/united-kingdom/pr/2020/standard-chartered-northern-trust-launch-zodia Last Updated: 9 December 2020

Justin Chapman

Executive Vice President, Global Head of Digital Assets and Financial Markets
Executive Vice President, Global Head of Digital Assets and Financial Markets

  

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