Our Insights

Blockchain of Command

Aligning Distributed Ledger Technology (DLT) with Regulatory Governance

As markets continue to adapt to new technologies and platforms, the role of Transfer Agents (TAs) and the support they provide to asset managers is likely to evolve. Maintaining comprehensive transaction records grows increasingly challenging in an environment where algorithmic and high-frequency trading have become the norm. In response, TAs are increasingly engaging with emerging technologies.

Since the cryptocurrency Bitcoin appeared in 2009, blockchain has been gaining traction across the financial ecosystem. Distributed Ledger Technology (DLT) can create complex and secure records for virtually any kind of asset or security and offers benefits and opportunities for the finance sector and TAs.

The World Economic Forum anticipates that 10 percent of all gross domestic product (GDP) will be stored on some form of distributed ledger by 2027.1 This technology has the potential to transform the way ownership certificates are stored and accessed, and facilitate improvements to asset trading activity.

The World Economic Forum anticipates that 10 percent of all gross domestic product (GDP) will be stored on some form of distributed ledger by 2027.1

Getting Synchronized

Unlike conventional payment processors, there is no one central authority responsible for maintaining accurate transaction records under DLT. Instead independent nodes process requests, broadcast their conclusion and then arrive at consensus by comparing results across the network. Because this process of distributed consensus synchronizes all transactions chronologically, blockchain networks may be used by TAs to establish consolidated and reliable audit trails, offering greater transparency and precision than existing systems.2

The first blockchain systems were designed to be accessible. In the case of Bitcoin, for example, anybody is able to access the network, create new transactions and search through the blocks logged on the ledger. The nodes that process and verify transactions are set up by volunteers – who may or may not choose to identify themselves – as they contribute computing power to the network. This lack of central authority is a clear departure from traditional financial sector oversight models.

Regulatory Order

Blockchains are built on transparency and universal accessibility, but transactions cannot be reversed, balances cannot be modified and authorities cannot verify the identity of traders on the network. As a result, public blockchains are currently incompatible with regulatory frameworks designed to mitigate the inherent risks of market trading. For blockchain to play a meaningful role in the future of asset transfers, it must develop the capacity to align with existing regulations that govern the sector.

For blockchain to play a meaningful role in the future of asset transfers, it must develop the capacity to align with existing regulations that govern the sector.

With this in mind, technology firms such as Google and IBM are currently competing to create private blockchains of global scope. By partnering with financial institutions around the world, initiatives such as Ripple3 and Hyperledger4 seek to establish “permissioned" ledgers where intermediaries are appointed and granted the authority to process, verify and reverse transactions.

A Trusted Source

This approach more closely resembles current processes, and given their expertise in regulatory compliance and due diligence, TAs may be ideal candidates to operate the nodes that underpin these networks in future and may become the trusted intermediaries that oversee operations on private blockchains.

From a TA perspective, the establishment of TAs as trusted network operators in the blockchain environment could enable them to build vital compliance tools such as anti- money laundering and "know your customer" regulatory requirements directly into the blockchain platform. This may be possible through "smart contracts" which could automate the application of regulations and reduce the need for human intervention.5 The ability to directly reverse or modify transactions would also enable TAs to broaden their services and deliver increased value to their clients.

Additionally, blockchain and smart contracts may provide TAs with new opportunities to diversify their service offerings, and play a leading role as the use of distributed ledgers becomes more widespread.


Sources

  1. World Economic Forum (December 23, 2016) - Deep Shift: Technology Tipping Points and Societal Impact
  2. McKinsey & Company (December 30, 2016) - Beyond the Hype: Blockchains in Capital Markets
  3. Ripple official website
  4. Hyperledger official website
  5. CapGemini Consulting (2016) - Smart Contracts in Financial Services: Getting from Hype to Reality