Fund jurisdictions will need to keep their finger on the pulse of digital technology if they are to remain competitive over the coming years. Disruptive players are springing up on a daily basis offering innovative payment solutions, transaction solutions to improve efficiency.
Blockchain technology is set to be widely embraced by financial institutions. Just this week, Reuters reported that the first cross-border transaction between banks using multiple blockchain applications had taken place between Commonwealth Bank of Australia and Wells Fargo & Co.
Luxembourg is well aware of the challenges and opportunities that disruptive technology presents and recognises the key role it has to play. As a jurisdiction that prides itself on legal and fund product innovation, ‘fintech' is no exception and whilst it is not likely to ever seriously compete with London – fast becoming the world's leading fintech hub – and Silicon Valley, it does have a growing digital ecosystem.
Various firms have popped up in recent times: Birdee (birdeeinstitutional.com) offers an online discretionary portfolio service for HNW investors; Governance.io (governance.io) provides a document management system and workflow management tool; Digicash (digicash.lu) is a mobile payment technology specialist. The list goes on. And with more 150 banks and thousands of investment funds domiciled in Luxembourg, the opportunities for asset servicers and technology specialists to drive forward change are huge.
"We strongly believe that digital innovation will have a substantial impact on the way funds and financial products in general will be manufactured, distributed and consumed in the future," comments Jean-Jacques Picard, Senior Communications Manager at ALFI. "That's why ALFI has set up a dedicated Fintech Forum with the task to identify, discuss and analyse digital/fintech developments that might have a `disruptive' impact on the asset management industry.
Fintech is a broad term that covers a broad variety of financial technologies whose joint goal is to make traditional financial services easier, more efficient and less expensive.
"Seen from that point of view, fintech has the potential to threaten any player of the fund industry value chain to be squeezed out of the market by more efficient start-ups.
"On the other hand, it may offer them the opportunity to improve their processes, enlarge their services offering and get more competitive as well. Whether they consider financial technologies to be an opportunity or a threat, fund industry players would be well advised not to adopt a `wait and see' position and to tackle the challenges in a pro-active and open-minded fashion and to rapidly adapt their activities to an increasingly disintermediated business environment," suggests Picard.
Ernst & Young make reference to the disruptive behaviour of fintech in its 2016 edition of Investment Funds in Luxembourg – A technical guide. In an accompanying press release, they point out that "this is perhaps the very time that the industry needs to prove itself more than ever in providing products that truly meet investors' needs at a competitive price."
With the rise of robo-advisors and passive funds at ultra low costs to investors, asset managers too need to embrace technology as Picard alludes to; especially those at the top of the food chain. Large asset management groups might feel immune from competition but the biggest threat comes from non-traditional players. Take Alibaba, the giant e-commerce platform in China. It has managed to build the world's 3rd largest money market fund (Alibaba Yue Bao), taking just nine months to reach USD100 billion – by comparison, it took Vanguard more than 10 years to hit that same figure.
Commenting on Luxembourg's position, Kai Braun, EY Business Advisory Services, thinks that it is well positioned given its strong entrepreneurial spirit: "More fintech companies are operating here and we believe they will play a positive role. I think we will see more fintech being used for payments, possibly back- and middle-office functions as well. I certainly do see a role for Luxembourg.
"If Luxembourg firms cannot continue to compete, for whatever reason, it would hand the advantage to other jurisdictions like Ireland, for example. But I don't see this as too much of a threat."
Marc-Andre Bechet is Director, Legal & Tax at the Association of the Luxembourg Fund Industry (ALFI). He says that one area that fintech could benefit the jurisdiction is with respect to doing KYC checks on investors; a typically time-consuming, labour intensive process.
"By making the KYC process more digital it would ease the process for the benefit of both asset managers and investors. I think fintech will be an important area of growth and innovation, going forward."
Another area that is likely to gain traction is in respect to how digital technology can be employed to enhance client engagement. With a new generation of millennial investors having been brought up on the Internet, they increasingly expect to receive digital interaction with asset managers. They want instant access to portfolios, to be able to rate their fund managers and so on; this is just one example of the knowledge sharing economy we all live in today.
"Clearly, there is a focus now for asset servicers and asset managers to enhance their IT and data infrastructure in order to be able to connect better with their investors. Fund managers want to use reports/analytics on their mobile devices to slice and dice data, and to be able to allow their end investors to consult these different reports themselves. That is where a lot of asset managers are focusing their attentions. Most of us have mobile apps to do online banking today, but this has yet to be standardised in the asset management industry," says Braun.
Picard believes that most fund industry players are still in the process of investigating potential areas of application of new financial technologies but thinks fund distribution will be another key area of fintech growth.
"As far as we can judge at this point, we expect fund distribution to be strongly impacted by digital investment platforms and robo-advisors, portfolio management should benefit from Big Data and machine learning techniques. In addition, blockchain technology might help back and middle offices to facilitate transaction flows and reporting. No fund industry actor across the value chain is fully immune to fintech repercussions," says Picard.
With technology evolving at such a rapid pace it could be argued that asset managers and servicers alike might find it hard to know which way to turn. To assuage some of the anxiety that this might create, Lee Godfrey, Deputy CEO of KNEIP, one of the industry's leading legal and regulatory report specialists, suggests that technology can be an enabler when things change. But rather than constantly looking for the next best technology to cope with change, asset managers and servicers should take a step back and look at the processes behind the technology. Often, he says, the solutions already exist.
"That said, I think people need to challenge the model within the fund industry rather than technology. Why is it there are 78 companies in Luxembourg alone all performing the same repetitive back-office task? Why is it that when I buy a fund there are 14 intermediaries between me and the fund sponsor? The whole value chain needs to be rethought.
"As a result, I think you will see an initial trend by many asset managers to move away from B2B and towards B2C. That could create an advisory issue because it would cut out a lot of healthy advice that some investors need. Then again, if you offer direct personal advice only to HNW individuals who know what they are doing, it could lead to significant savings for those investing in pension funds and other institutional products," comments Godfrey.
If fintech start-ups manage to translate their ambitions to make both B2B and B2C financial services easier, more efficient and less expensive into reality, "the Luxembourg fund and asset servicing industry should end up with an even better and more competitive range of products and services," adds Picard.
At a broad level, not just in Luxembourg but globally, there are signs that more and more hedge funds are diversifying their products to offer not only more liquid regulated funds – liquid alternatives – but more PE-like hybrid fund structures to lock up capital for longer periods to harvest yields in more illiquid areas of the market. Private equity managers are doing likewise, signaling a degree of convergence in the alternatives world.
It is therefore incumbent upon service providers, in any jurisdiction, to respond to these changes and adopt cutting edge technologies to allow them to better support the activities of their clients.
One firm that recognised this convergence early on and updated its systems to cope with more demanding cash flow monitoring, waterfall calculations, etc, is SS&C Advent, an independent unit of SS&C Technologies. But whilst the firm has been well placed to support the complex demands of its clients, it does not look to innovate just for the sake of it. Every product enhancement it introduces is based explicitly on clients' needs.
"We do not force any product onto our clients. We try to work with them based on what they need today, not tomorrow. You can't force innovation on clients. We can talk about disruptive technologies but part of our ethos is to adapt our approach based on where our clients are today," comments Jesper Steiness, Director of Global Accounts. "In two years' time we cannot know where the markets are going to be, or what is going to be the next big development. We speak to our clients on a daily basis in order to respond to what they are currently trying to achieve. Without their input we could not develop our software."
Nevertheless, as part of the future development of the alternatives industry, Roger Woolman, Principal Solutions Consultant, Asset Management & Alternatives at SS&C Advent believes it will become more self-servicing.
"In other words, investors servicing themselves through mobile devices. Fund administrators too will want their asset manager clients to become self-servicing and configuring their own reports and views on the data. We have the foundation in place to support such a future vision," remarks Woolman.
Mobile technology will continue to be a part of SS&C Advent's next generation roadmap.
Woolman states: "If we are going to create a self-servicing environment we've got to make sure that our solutions are all consistent and mobile. Not just to enable clients to look at reports or statements but to actually trace the flows of capital and provide look-through capabilities on positions and risk exposure, etc.
"Next generation Geneva will include technology to allow the servicing of information in a more rapid, mobile manner. We're also introducing workflow tools that will sit above a number of Advent systems, including Geneva, as well as non-Advent products that clients are using. Being able to service workflow processes across a client's organisation will be an important element."
On the convergence trend within alternatives, Braun says that this is something he is discussing with his clients every day.
He cautions that the end investor wants to see one report that looks the same regardless of whether the manager is investing in listed securities, real estate debt, private equity, etc.
"Therefore, you need to have a consistent and coherent data layer and reporting engine in order to properly report to the end investor, and indeed to the regulator. The whole transparency agenda has totally changed in recent years and this is where finTech can help," says Braun.
The more that alternative fund managers – and their appointed service providers – operate not just in siloed areas (hedge funds, private equity) but across all alternatives, the more that robust data governance frameworks will be needed to properly source and take ownership of the vast amounts of data being reported to investors, regulators, and indeed ratings agencies and distribution platforms.
In a recent Northern Trust/Economist Intelligence Unit survey, it revealed that among asset managers who said they had a data strategy, only 27 per cent felt it was entirely successful in helping them meet their current challenges and opportunities.
Even fewer (13 per cent) felt their strategy was entirely flexible in supporting future challenges and needs.
"Unless you can sit down with a professional – and not a consultant whose primary interest is to draw the process out – and decide where your weaknesses are, it's going to remain a problem. Consultants, in general, are either looking at a unique problem i.e. I am going to fix the PRIIPs problem for you, rather than fix the core long-term issue of how to make a company more efficient with a robust data governance process," says Godfrey.
He says that one of the key considerations of a data governance framework is knowing who the product manager is that owns the data for a particular product range.
"It's just about having control over the source of the data and knowing who has the responsibility for this. So document this first and foremost. Secondly, where does that data need to go? Where is it important from a regulatory perspective? What contracts are necessary from a legal perspective? What market data needs to be made available to those buying the funds or advising on the funds? What client communication needs to be conveyed?
"Once those two things have been determined, one can ascertain where is the overlap in data required for each of the required outputs. Having built that governance framework, the rest depends on the asset manager's choice of technology," explains Godfrey.
What this illustrates is that whilst there are myriad fintech solutions and tools being developed within the funds industry, fund managers have to get their ducks in a row from a data management perspective. Using the latest flash bang technology becomes a redundant exercise if their fund data is poorly managed, organised, and monitored.
It is easy for fund managers to be seduced by technology. The trick is knowing where to use it to deliver the best outcome for the organisation.
"No single player of the fund industry value chain can afford to close its eyes to the emergence of new technologies without compromising their competitiveness," concludes Picard.