A single language of technology deemed crucial to future of financial industry
Custody and asset-servicing firms are hoping that the ongoing development of technologies such as blockchain and artificial intelligence will not only drive efficiencies but also serve as a catalyst to have all market participants speak the same transactional language.
That's important, sources said, as technological advances in the back and middle office might not reach their full potential if counterparties aren't communicating in the same way.
"Wouldn't it be nice to have one language to communicate across all counterparties? AI might be able to facilitate that," said Tom Howat, chief technology officer at GAM Systematic Cantab, the quantitative alternatives and long-only securities unit of GAM Investment Management AG, London.
Added Peter B. Cherecwich, executive vice president and president of corporate and institutional services at Northern Trust Corp., Chicago: "There's no reason the vast majority of asset servicing can't be automated, but that will require the standardization of data, reporting protocols and agreement on language."
Sources said the hope in the industry is that those in asset servicing find a single standardized language protocol similar to what the global banking industry did with the Society for Worldwide Interbank Financial Telecommunication, or SWIFT, a Brussels-based bank cooperative created in 1974 that operates the world's largest bank messaging system.
"Who will be the SWIFT of blockchain?" asked Wayne Riches, director of strategy and solution management, at financial technology developer Fidelity National Information Services Inc., London. "We don't know, everyone's still looking to see who will be the leader in blockchain in the future. Once that happens, the top players will need to get together to decide" on protocol standardization. He said that's how SWIFT was created.
"It depends on what blockchain will be used for," Mr. Riches said. "That's where there are use cases. More broadly than that, we're not at the implementation stage yet. It's naive to think everyone will initially pick one system at the start."
No standardization so far
To date, early AI advances haven't led to such standardization. Indeed, the development of technology has been done more on a company-by-company basis, meaning that counterparties can speak a plethora of languages through codes and need to understand them as well.
"We have 116 different ways of talking with our counterparties, which is completely insane. And 21 of those are for the same counterparty!" said Mr. Howat of GAM. "We've tried to eliminate the overlap with new codes, but for every market participant, you get layers of code."
The FIX Trading Community, an industry non-profit standards organization for global multiasset trading, "has addressed the way computers talk to each other to place an order," Mr. Howat said, but has not standardized how those computers communicate. "Our system supports 28 different dialects of FIX," he said. "So much for being standardized. FIX itself is too permissive. You're allowed to do too much stuff with it. Future things (with AI) might have to be more prescriptive."
The complexity of the asset servicing business — particularly as custodians have outsourced more back-office administrative functions to third parties — has made the need for standardization even more important, said Lesley Keefe, executive director, Americas asset management advisory leader, at EY in Boston.
"Five or six years ago, it was rare to outsource fund accounting," Ms. Keefe said. "Back-office systems are aligned to company structure. As they extended the product line, they had to evolve the back-office process. The minute they did that, it went from a clean hub-and-spoke system to multiple data systems. That's where outsourcing really caught fire. Firms have been trying to solve the data problem for a decade, and that's been passed on to fund administrators, so they've become a big part of the solution in the back office. Now asset managers are saying, 'Now I have to look at the middle office,' which has become the Grand Central Station of data. How can asset servicers fix this problem, a standardization problem? That's where we are today. Now it's a critical issue."
More than just convenience
That lack of standardization isn't just a matter of convenience, Mr. Howat said; it affects the end investor as well in a variety of ways, potentially in execution quality and the potential for reporting and documentation errors on settlements, among other things.
"The lack of standardization is a drag on the investor," Mr. Howat said. "It's just better if that drag is reduced. We've developed tools to deal with this now that have meant creating millions of lines of code. There's some drag from that. Then there are the emails about problems with operations. There is a drag from that. Anything to remove that drag would make both operations and investments work better."
Mr. Howat said he doesn't think anyone is studying the incorporation of standardization into industrywide AI development, and without it, he worries that further AI development will mean yet even more counterparty codes to understand. "Maybe people could talk about it at a conference, even just on the side, about finding a single way to do this," Mr. Howat said. "Otherwise AI is just adding yet another way to do this all. Now we'll have 117 ways of doing things."
For custodians, said Northern Trust's Mr. Cherecwich, standardization will be part and parcel of new technologies that will more broadly require changes in custodians' infrastructure.
"Real time information can be optimized using machine learning and AI, but to some degree this requires a change in infrastructure," Mr. Cherecwich said. "That's the bottom line for all major custodians, to ultimately enable them to unlock revenue streams and make things more efficient with potentially lower cost."
Change is coming
Willa Cohen Bruckner, partner, financial services, at the law firm of Alston & Bird LLP, New York, agreed that advances in technology will generate the change in infrastructure, particularly in derivatives trading and settlement processes, but said large brokerage firms will be the ones in control of the development.
"Right now, technology will drive the infrastructure change," Ms. Bruckner said. "Right now, everyone is on the blockchain bandwagon. That's people recognizing the use and efficiency of blockchain. When the mechanisms for incorporating technology take hold, once that all happens with greater standardization, the big players will be controlling it. That's how it's happened with documentation, with less individualized negotiation with counterparties."
Mr. Cherecwich also said the promise of streamlined settlements through blockchain will require some form of protocol standardization. "When it comes to blockchain, for example, that could lead to T-plus-zero (or immediate trade) settlement. But different platforms, different language, different terms won't work in blockchain. Blockchain itself really is about matching and having an immutable record. So if blockchain helps further the cause of standardization, that would help the market."
Such development, while attractive to asset servicing as a whole, will require companies using the new technology to get their internal infrastructure up to speed first, Mr. Riches of FIS said.
"If you take one step further back, a lot comes down to data and process," Mr. Riches said. "Blockchain is still out there, but there's more focus now on robotics and machine learning. When we talk with firms, they say they have to get their internal processes right. They have to go back to basics first. That's the first rung on the development ladder. If they get that right, then they can move on."
Said Josh Sutton, CEO of Agorai, a Singapore-based artificial intelligence open-access software marketplace: "It comes down to individual drivers on a firm-by-firm basis. As one company lowers their cost by doing this, more will do this. There's a large human-capital regime in the back office. AI will drive individual changes. If there is seen to be a tangible industry benefit, the industry will reach a single conclusion, much as the banking industry did with SWIFT."
Another driver of the use of standardization could be its endorsement by major players in the industry, sources said. That's what happened with SWIFT, which was created by the world's seven largest banks, and that kind of endorsement is driving current efforts to standardize derivatives protocols. Ms. Bruckner cited work by the International Swaps and Derivatives Association Inc., New York, to create a common domain model for a standardized digital representation of events and actions in a derivatives trade, expressed in a machine-readable format for all new technologies.
"ISDA is its members," Ms. Bruckner said. "Its most important members are its large brokers. (The common domain model) lays the groundwork; if dealers say they're going to do it, it's going to carry a lot of weight. When ISDA comes up with the wording, they get input from its members so when it goes out in the world, it has more clout because big brokers have bought into it."
Countering vested interests
Cooperation among major players in the industry isn't a given, said Matthew Seymour, CEO, risk analytics and reporting provider RiskFirst Group Ltd., London. "The biggest challenge is the vested interest of financial services market participants," Mr. Seymour said. "Accepting AI will require some to change their businesses. Right now, the collection of data is a real gold mine for some companies. Their concern about maintaining or growing their data businesses, at the same time as AI and blockchain, will make data more accessible to everyone, will make the adoption of new technology more measured while firms assess how this will affect their business models. It's not just technology adapting to business, but business adapting to technology."
Yet another potential driver of standardization is whether the market ultimately will decide what protocols to choose, similar to the development of video technologies that began with VHS vs. Beta and evolved to today's streaming services, said Richard Sandor, chairman and CEO of the American Financial Exchange LLC, Chicago. The exchange is an electronic trading venue for regional and community banks and non-bank financial institutions to lend and borrow short-term funds.
"If you look at the sorting out of technology, the market is likely to take the lead," Mr. Sandor said. "You might have some uniform standards, but you might have banks with different custody services. They might want to tailor the technology and language to their specific business model — trading, FX, etc. They might all find that a single technology might not be in their customers' interest. They might want it customized. Maybe customizing custodial services to their customers may be cost-effective as a sector. Perhaps standardization is the optimal solution, but the market has to sort out uniformity vs. cost-effectiveness of custodial and collateral functions. We need to pay attention to what the market says first."