Editor’s note: Kelly Mathieson is the Chief Client Experience Officer at Digital Asset. This is Part VII in our post-trade transformation blog series. Don't miss the Introduction, Part I, Part II, Part III, Part IV, Part V, and Part VI.

At the fulcrum of investment and investor, fund services is a highly manual process reliant on data from multiple participants across a complex, upstream chain of events. Fragmented, linear information-flows require constant cross-referencing to maintain an accurate register of holdings and provide correct, timely servicing for mutual funds, ETFs, and other emerging investments.

Across fund administration, transfer agency,  and fund accounting, this manual environment leads to high operating costs in a low-margin business. Beyond cost, the risk is significant both operationally and financially. From onboarding to an incorrect or late NAV, providing fund services demands a level of transparency and access to accurate, real-time data that is not currently available or accessible in a digestible form. Errors and delays lead to liabilities and losses, from direct costs to the service provider to regulatory fines for the asset owner or reputational or financial harm to the fund manager. 

“The issue comes down to transparency into operations and distribution.”

Bank of New York Mellon¹ 

A patchwork of systems and processes

Built over time, the infrastructure supporting fund services relies on legacy technology that is hard to modernize, with multiple parties recording and reconciling the same transaction on a daily basis. 

According to research conducted by Global Custodian and Calastone in 2021,
only 30% of fund administrators said that transfer agency was fully automated.² 

As funds have grown in scope and popularity and asset managers have expanded to more jurisdictions, the challenge has only become more complex. Even more problematic, many of the tactical solutions initially devised to address short-term needs have become entrenched, locking inefficiencies in place.

Very real consequences for growth

The lack of automation and transparency has profound consequences for everyone in the fund universe, starting with the providers who face relentless pressure to reduce cost, manage risk, and meet tight deadlines, even as funds proliferate and become more complicated. NAVs must be struck and published within a narrow window following market close so that the day’s orders and redemptions can be processed using that data.

For managers, a costly and manually intensive operational model limits the ability to develop innovative structures or customizable strategies for different investors, restricting their ability to grow and create deeper client relationships. More complex fund structures such as alternatives can’t be readily supported with current systems, and the inability to solve some basics (such as buying fractions of mutual funds) narrows the potential investor universe by preventing smaller purchases. 

For investors, basic information about their mutual fund purchases or redemptions (including price and number of shares) is not available until the next trading day, since it’s dependent on the prior day’s NAV. Orders need to be provided by specific cut-off times to be processed at that day’s NAV; otherwise, a transaction instructed today won’t take place until the following day—at which time market conditions could be quite different. And high processing costs drive up unit costs, which can disincentivize investment.

67% of large asset owners see investment governance as a key operational priority. 

Barnaby Nelson, The ValueExchange

Now add environmental, social, and corporate governance (ESG) to the mix. According to a recent survey of asset owners by The ValueExchange, rising ESG demands and cost pressures are a growing concern. Beyond simply tracking and managing their investments and asset allocations—for which a stunning 45% rely on excel spreadsheets—asset owners are under increasing pressure to evidence sufficient oversight of key functions, whether that is pre-trade compliance, NAV, tax, or regulatory reporting. Unable to provide evidence that the in-house checks and verifications required as part of their fiduciary responsibilities have taken place, asset owners are seeing an increase in regulatory sanctions.³ 

Given these mounting demands, the case for innovation in fund services is clear—and distributed ledger technology (DLT) holds the key. 

“In a recent survey undertaken by Calastone, a third of respondents identified DLT as the technology that could have the biggest impact on the future landscape of funds, citing its benefits to create greater efficiency in fund trading and cooperation between participants.” Gartner, 2021⁴ 

From operational complexity to operational agility

With smart contracts running on DLT, fund services can be significantly streamlined and de-risked from start to finish.

• Investor and fund onboarding is simplified and expedited with permissioned access to core documents and digital identification (including KYC and AML documentation). 

• Fund details and investment parameters can be baked into the asset, and smart contracts can trigger automated checks against ownership thresholds and eligibility requirements to facilitate governance.

• A golden source of truth eliminates the need for constant data reconciliation, significantly streamlining operations and accelerating accurate NAV production. An improved NAV process could allow new orders to be accepted closer to market close, minimizing the gap between instruction and investment. 

• A single registry gives all entitled parties an accurate, real-time view of ownership, transactions, and positions at a fund, at the asset and owner level, providing better intelligence to fund managers about demand and liquidity and improving investor communication and distribution. 

• Risk decreases with fewer manual touchpoints and repetitive actions across multiple systems. 

• The entire process becomes more transparent, providing better regulatory control. Immutable records show the full lifecycle, including traceability and provenance. Observers and auditors have real-time access to data. 

Importantly, the transition can be incremental as long as the technology is interoperable and extensible. This is essential given decentralized markets and the number of participants involved with fund services; in addition to not using the same systems, not everyone would be ready to make a change at the same time. 

Initially, existing funds could be tokenized to coexist with the digitally-native assets that are emerging. As a single registry running on DLT expands, the elimination of repetitive reconciliations will be a quick win. Early adopters will see significant improvements in their operating costs and risks, creating a competitive advantage that will encourage broader adoption.

Investors will have more economically attractive options, while fund managers will have a more dynamic view into fund activity and be able to create new structures to meet investor demand. Asset owners will be able to manage their holdings and exposure more actively and with greater confidence in the underlying performance data. They may also be able to redirect some investment spending: According to The ValueExchange, 66% of asset owners plan to run system automation projects in the next three years—with spreadsheets and outdated macros in sight.⁵ Improvements made more holistically across fund services may reduce the need for asset owners to address certain issues at an individual level.

The shift is already underway

Given the scope for transformation, we are seeing the emergence of a better fund-services infrastructure. To name just a few initiatives:

• In the alternatives space, CAIS has partnered with Digital Asset to explore faster investor authentication methods, reduce transaction costs and friction by creating workflow efficiencies, and enhancing product liquidity using DLT, smart contracts, and blockchain. The use cases apply across alternative strategies, including private equity, venture capital, real estate, real assets, and private debt.

• Multiple providers are working to digitally transform components of the fund ecosystem, including Allfunds, DMI Fund Services from Calastone, Fundnode, Iress, and SETL. Respectively, initiatives focus on data, analytics, reporting, research, and regulatory services; digitized fund distribution, administration, and issuance; automated end-to-end fund settlement; improved fund data distribution and a single registry for listed and unlisted funds; and mutualized fund distribution and instant information exchange. 

• Buy-side focused innovation can be found in initiatives like HUB—a new asset management platform seeking to transform asset managers’ operations technology with a digital operating model focused on improving distribution and analytics and driving investment solutions. 

• OSTTRA is an exchange-led joint venture between S&P Global and CME group, providing post-trade, cross-asset services (derivatives, FX, repos, cash equity, commodities, and bonds) including the ability to optimize a variety of exposure and capital requirements. 

As a technology provider, Digital Asset has created reference applications that jumpstart exploration. The ETF reference application allows required parties to immediately see NAV data when the sponsor updates it and provides a scalable back end to simplify ETF creation and redemption. The Compliance and Regulatory Reporting reference application streamlines governance with transaction data analysis, customizable reporting, and data aggregation within or across markets. This could include daily short-sell reporting, foreign ownership limits, liquidity use and availability, repo/financing volumes, and a single view of FX flows—all information that is not readily available today.

Are there broader opportunities? 

As we've discussed in other blogs in this series, there are fundamental shifts taking place earlier in the post-trade cycle. Let’s take a moment to consider how these changes might affect fund services in the longer term. 

• Asset tagging at issuance embeds conditions, reference data, and lifecycle events. This information could be used in automated compliance checks for asset owners, ensuring investments adhere to guidelines before they are made. Furthermore, investors could create the equivalent of ‘eligibility schedules’, signaling their interest in different types of investments and structures—and be automatically contacted when those opportunities arise. 

• Atomic settlement of cash and fund shares, without the need for acknowledgement, confirmation, or additional reconciliations, creates greater transparency into ownership and facilitates faster distributions and other asset services. 

• Expanded distribution could be achieved with technology that connects across public and private ledgers to reach more investors.

• Better management across the board, from using ESG criteria to manage funds (e.g., auto-redemption if funds go overweight on resources) to rapid onboarding of investors as they subscribe to new funds.

• Automation of the entire NAV process, as more components of at- and post-trade services are digitized. Mutual fund NAV calculations could potentially move to intraday (similar to ETFs), creating greater liquidity in the market.

• Deeper relationships between distributors and investors with a data-led view of investment flows and client behavior, both within different fund types and ultimately across a network of services that spans different asset classes. 

Ultimately, the biggest win comes with the expansion of investment options for investors through the creation of new, more tailored and dynamic funds with fewer ingrained costs, inefficiencies, and risks.

To support ongoing digital transformation, Digital Asset recently launched Daml Finance to accelerate the creation of new products and fund structures and expedite time-to-market. This library of tools simplifies creation, modeling, and servicing of the entire lifecycle of complex financial instruments. Asset-agnostic workflows can be easily extensible to other instruments and structures, while using a shared library increases asset mobility throughout the lifecycle. This initiative should turbocharge the creation and connection of digital asset solutions, simplifying innovation for a broader array of participants across financial services. 

Stay tuned: Treasury services

The entire trading and post-trade ecosystem are driven by imperatives for funding and the effective deployment of financial resources to meet business requirements and obligations, whether to other institutions or end investors. Our next blog explores how treasury services are being transformed by digital innovation, from capital raising to cross-border payments, transfers, and distributions. We’ll also highlight some of the opportunities and challenges facing Treasuries with a capital “T”, as central banks globally focus their attention on the promise of central bank digital currency (CBDC).

Related reading

How Blockchain is Transforming Funds Servicing, Bank of New York Mellon, 2020

The Future of Fund Administration, Calastone, 2021. Request the report 

Distributed Ledger Technology, Calastone, 2019. Request the report

Distributed Ledger Technology, PricewaterhouseCoopers, 2017

Asset Owner Transformation, The ValueExchange, 2021

Citations

¹How Blockchain is Transforming Funds Servicing, Bank of New York Mellon, 2020

²The Future of Fund Administration, Calastone, 2021. Request the report.

³Asset Owner Transformation, The ValueExchange, 2021

⁴The Future of Fund Administration, Calastone, 2021. Request the report.

⁵Asset Owner Transformation, The ValueExchange, 2021