What trends are you seeing in the digital custody space?
Digital assets have been really interesting to a large retail segment but to the broader institutional investment segment, they were seen to be too risky.
Over the past few years, in terms of custody, we have seen the evolution of various platforms providing custody specifically to a retail audience but they were not fully accessible to an institutional audience.
This is because an institutional investor looks at risk across a broad spectrum; not just whether the asset’s price will go up or down. They also look at whether the provider of custody is able to deliver to their needs. Additionally, the risk of a change in future regulation, which may make what they are investing in not viable anymore or not allowable anymore, among other risks.
With respect to the above points: there has been a lack of a safe custodian from the perspective of a financial institution, a traditional custodian providing a service for digital assets, as well as a lack of clarity around regulation. Large institutions cannot use a custodian that does not have a large enough balance sheet to weather downturns, and if there isn’t a specific regulatory channel with which an asset is classified then it limits the ability of institutions to gain exposure to the asset.
However, in the last year, we have seen two significant institutions entering the space, Fidelity and Nomura, who are providing digital custody, which are each more than sufficient for institutions to be comfortable using.
In addition, the German government has recently introduced legislation requiring all providers of digital asset custody to have regulatory authorisation. These are all good steps forward in allowing institutional investors to access the digital asset market.
Meanwhile, in times of market stress, like this recent sell-off, the correlation across assets increases. Usually, during stable periods, different assets such as US equities, European equities, government bonds, commodities such as gold and silver, and currencies move in different directions – the correlation is low.
On the other hand, in times of extreme market stress, correlation becomes really high because everyone panics, and money gets moved into safe assets (such as US Treasuries). On the flip side, if the stress is suddenly over then then all of that cash goes back into risky assets at the same time, which pushes the prices of all of those assets up at the same time. It is a normal pattern in a market crisis like the one we have just seen.
What’s really interesting, is that the crypto world expected those digital assets, such as bitcoin, to be a hedge for these types of situations, but in fact, they started behaving exactly the same.
The reason for this is quite obvious - institutional money has gone into digital assets. So when we had the sell-off, that same institutional money that got pulled out of all of the other assets, and put into safe assets like Treasuries for safekeeping, also got pulled out of its crypto assets at the same time.
How have attitudes changed towards digital assets over the past few years, and how is regulation stepping in?
Over time, particularly as markets start to recover and we come out of this crisis, we will start to see more institutional investor allocation through digital assets – and that is because there is more clarity around regulation of those types of assets now. Additionally, there are custodians which are large enough for institutional investors to use.
Ultimately, in good times it does provide diversification for investor portfolios – though perhaps not as great diversification as many were expecting.
To what extent is automation becoming more popular in the industry, what benefits or challenges can automation provide?
The custody landscape (not specifically digital assets) is dominated by several large players (e.g. BNY Mellon, State Street, J.P. Morgan, Citigroup, BNP Securities Services), all of which are very large organisations, and all of which have very manual processes - everything from valuation reporting to daily reconciliation - requiring an army of operational staff.
Technology has evolved rapidly in the last decade, our personal and professional lives have become increasingly digital. At Globacap, we have built an entirely automated approach to securities custody. While custody is not our core business, it does align with the same ethos our core products embody: automation.
The benefits to both issuers and investors are improved efficiency and lower costs. Indeed, businesses like ours have a tremendous opportunity right now to take the world as it stands but to apply a completely new digital process to it that makes everything more efficient.
This has got massive benefits to companies, issuers and investors in terms of proving efficiency and lowering costs. It also has benefits to the existing large players, such as BNY Mellon or State Street or large investment banks like J.P. Morgan and Goldman Sachs, whereby they can actually reduce their overall operational overheads and still provide the same, or better, service. However, the downside is that it can take a long time to make those changes.
The other factor, which applies to all industries that start to modernise or automate, is that some human capital is compromised because of it.
Automation does remove jobs but it replaces them with different kinds of jobs. If you’re one of the people that has been doing a specific role for a very long time then it can be quite difficult to change into doing something different – and in some cases, this is not always possible. There is a negative impact for some people but certainly, for others and for a younger generation it can provide different opportunities – not fewer opportunities.
On the other hand, what are the biggest opportunities for firms around technology and digital transformation?
Any large organisation has difficulty adapting quickly. This is especially true for the largest custodians, where operational processes have been carefully crafted to minimise operational risk. For them to adapt to new technology, and therefore new processes will take a very long time indeed. To change those processes not only requires changing technological systems which are integrated with many other technological systems but also requires changing the human process. On a large scale, this takes a very long time to do.
This presents opportunities for fintech firms like ours to either directly provide those custody services, or to provide technology to the larger custodians to assist their transition. Companies like ours can come in with a completely clean slate.
Looking at how much technology has advanced in the last decade, in particular, we can build automated processes from the ground up when you have got legacy overhead. The Financial Conduct Authority’s (FCA) regulatory sandbox has given a mechanism by which we can do that quite well. If we require regulatory authorisation for some of our activities, which we do, then the FCA’s regulatory sandbox means that firms like ours can come to market and prove their product effectively, in a safe format and then gain regulatory authorisation on the back of that.
How has technology changed the landscape of asset servicing over the past few years, and how will we see it evolve further in the next five?
At Globacap, we have created and deployed innovative technology to make every touchpoint more efficient. Since receiving regulatory authorisation in May 2019, we have grown rapidly – now servicing just over $250 million of private securities, mainly for small and mid-sized companies, which validates the latent demand for a more efficient service.
The asset servicing industry lags behind other industries in terms of technological innovation and revolution, however, change is being driven by firms like ours.
The largest custodians in the world are paid to be risk-averse in order to protect the assets that they service. Therefore, they naturally are going to be slow to adapt or change to new processes, which leaves a lot of space for firms like ours to provide technology to assist in driving that change more quickly.
The last 30 years have seen a meteoric change in technology. Not only that, but it’s obvious that the rate of acceleration of change is increasing – meaning we’re integrating to a greater amount of technology every year.
It’s clear that people across all demographics and industries are becoming more used to technology in all aspects of our lives, but also that our technological journey, as a species, is actually just beginning. Our interaction with technology has changed dramatically over the last 30 years, however, with the rate of acceleration increasing, it means we’re actually just toddlers on our technology evolution.
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