Custody faces a looming identity crisis as finance morphs further into digital form, according to a new State Street paper.
The article, included in the first ominbus report published by the recently formed State Street Digital, says traditional custodial practices will come under pressure as the digital asset transition continues apace.
Penned by Swen Werner and Irfan Ahmad – State Street Digital head of custody and APAC product lead, respectively – the paper says as digital finance “is becoming to big too ignore” custodians must adapt quickly.
“It has been said of the custodial business that if the fund manager is the chief architect of the investment process, the custodian serves as the engineer that ensures all the systems are working properly.
“How does one take care of the maintenance and plumbing, however, when the edifice is in the process of being constructed? This is the challenge the custodial industry takes today as it relates to the fast-changing world of digital finance.”
For example, Werner and Ahmad argue that the “reimagining” of the industry would require custodians to segregate assets based on private cryptographic keys while also safely transferring ownership via distributed ledger technology (also known as ‘blockchain’) across multiple jurisdictions with different legal protocols.
Other asset-servicing duties supplied by custodians might also be upended by a digital asset revolution such as verifying fund net asset values.
“In a crypto environment – where there are multiple exchanges but limited standardization around trading – how might one determine what is a good reference price? We have recently seen regulatory discomfort around this scenario,” the report says.
And while fintech firms might be pushing the boundaries, the State Street Digital duo argue that highly regulated incumbent “at-scale” custodians command “a distinct competitive advantage in the space as clients look to participate in the new digital economy”.
“The emerging shape of digital custody, however, will be about far more than the question of who holds the private key.”
In addition to the custody conundrum, the inaugural State Street ‘Digital digest’ publication tackles issues such as crypto-volatility and the allure of instant settlement offered by a ‘tokenised’ economy.
“One of the major attractions of tokenization is the promise it holds to transform any asset into a digital one that could be traded instantaneously,” the report says.
Recycling a survey carried out last October, the new State Street Digital report also highlights a worrying excess of enthusiasm for the nouveau asset class over “basic understanding” among investors.
For example, over 80 per cent of investors in the survey expected to increase allocations to digital assets in the medium-term but “very few have expert-level knowledge” about them.
“While long-term investors recognize that digital finance promises to usher in the financial services industry’s most transformative change since the commercialization of the internet, widespread education is sorely needed to counteract rumor, myth and conjecture in the space,” the report says.
State Street launched the specialist digital division last June, appointing Nadine Chakar to run the show. Chakar was previously head of operations for the asset and wealth management arm of US insurance giant, Manulife.