Deloitte releases blockchain use case report exploring the impact of blockchain on various financial sectors (full report download)

Through the amount of money that financial institutions are investing in blockchain technology and the experiments they are conducting, research organizations are gaining a better understanding of what the future financial services infrastructure will look like. Accounting firm Deloitte and the World Economic Forum (WEF) have taken a pragmatic approach to determine how blockchain, or distributed ledger technology (DLT), can help financial companies.

A joint research report, “Financial Infrastructure of the Future: How Blockchain Can Reshape Financial Services”, was recently released, exploring how DLT can transform processes such as liquidity management, regulatory compliance and internal/external reconciliation. The authors of the report include Bob Contri, Deloitte Global Financial Services Industry Leader, and Rob Galaski, Deloitte Banking and Securities Leader.

DLT has received more than $1.4 billion in investment in the past three years and has applied for 2,500 patents. It is expected that 80% of banks will launch DLT-related projects in 2017.

The research paper states that despite its potential, DLT is not a panacea but a tool that can shape the foundation of financial services infrastructure along with other tools such as cloud analytics, cognitive computing and robotics.

However, DLT still faces many challenges. Its regulatory environment is uncertain, standards are only just beginning to be created, and the legal framework does not yet exist.

Upgrading financial infrastructure through DLT will take a lot of time and investment.

The financial sectors to which DLT is applicable include payments, insurance, deposits and withdrawals, market supply, capital financing and investment management.

What does blockchain bring to the financial industry?

Distributed Ledger (DLT) is a technology that allows institutions to transfer assets between each other in a way that does not require intermediaries to trust each other. DLT brings transparency, immutable records and autonomous enforcement of business regulations.

DLT makes it easier to verify that partners are complying with their obligations. Dispute resolution becomes simpler and audit trails can be created.

Other benefits of DLT include: DLT can bring usable digital identities; DLT solutions can be scalable; and data sources using DLT cannot be corrupted.

Using DLT, various institutions can coordinate and resolve disputes between institutions. Lending companies have greater visibility into their assets.

Key Survey Findings

DLT brings efficiency and simplicity. DLT eliminates much of the human involvement in the settlement and dispute resolution process while also reducing locked-in capital.

The benefits of DLT depend on the business problem. For compliance, DLT provides greater accuracy and faster reporting through automated and immutable data sources.

Digital identities, digital licenses and other capabilities can broaden the appeal of DLT. Digital systems can be integrated with DLT-based infrastructure to verify that counterparties and consumers are who they say they are. Benefits include more accurate and faster AML and KYC processes.

DLT is one of many technologies that could reshape the infrastructure of financial services. Other technologies that could also bring about this change include robotics, machine learning, biometrics and cognitive, quantum computing and cloud computing.

The importance of industry collaboration

The research report points out that all the most critical DLT applications require industry collaboration to achieve. Replacing existing financial infrastructure is a large project, and DLT implementation will be delayed in highly regulated industries.

The current execution of contracts is full of bureaucracy and is based on the assumption that the counterparties cannot be trusted. DLT infrastructure provides a degree of autonomy that eliminates the need for trust. DLT will disrupt today's business models. The immutability of DLT infrastructure eliminates information silos so that everyone uses the same information.

Here are some key financial services use cases:

Global Payments

The current global payment transfer fee costs are very high. In the second quarter of 2016, the average fee was 7.6% of the remittance amount. With DLT, the digital identity document of the remittance sender can verify the identity information. The smart contract containing the remittance data delivers the funds to the institution of the remittance recipient and notifies the regulator. The liquidity provider on the ledger is responsible for currency conversion.

DLT makes small payments more affordable by removing much of the manual effort in the money transfer process.

Commercial Property and Casualty Claims Processing

DLT automated claims processing can reduce fraud and improve the assessment process by using historical claims data. Loss and claims processing is one of the causes of friction, accounting for 11% of insurance companies’ premiums.

DLT can simplify the claims process through the use of smart contracts or smart assets. Business rules encoded in smart contracts eliminate the need for loss adjusters to review every claim.

Syndicated Loans

Syndicated loans can help spread the risk that institutions face when they lend too much to a single client. These types of loans are huge, with $1.8 trillion in syndicated loans in the U.S. in 2015. If the back-end operations of this business were simpler, the market would attract more participants. Selecting members is labor-intensive, as is certifying whether borrowers are qualified. Verifying settlement funds requires investors to wait three days before they can get their money.

DLT record keeping can streamline this process. Bookkeepers use the digital identities of borrowers to complete KYC and investors to identify those with appropriate capital and risk tolerance. Smart contracts perform due diligence and automate parts of underwriting and credit decisions.

Trade Finance

Trade finance fills the gap between exporters, who need payment security before shipment, and importers, who know their goods have been shipped once they have been paid.

DLT can improve import and export efficiency by providing simplified access to trade documents, faster settlement and greater capital efficiency.

The global trade finance industry has already seen blockchain applications.

$18 trillion of trade each year is tied to some form of finance; guarantee, insurance or credit. The process is very lengthy. The import bank must review the importer's agreement and send the information to the correspondent bank. The export bank must then conduct an AML check using the Exim Bank's financials.

With DLT, the purchase agreement between the buyer and seller is written in code, and the smart contract is responsible for automatically executing the terms of the agreement. Documents on the ledger allow the parties involved to conduct due diligence on credit decisions, track the location of goods and conduct AML checks.

Coco Bonds

A convertible bond is a hybrid security that combines features of debt and equity. Investors receive dividends until the principal is repaid, but once a certain threshold is exceeded, the bond converts into equity, saving the issuer the remaining coupons and the cost of having to repay the security. That threshold could be a bank's capital ratio.

The market for these bonds is largely untested. DLT can address these issues by embedding regulation into business processes. When a bank issues a bond, it creates a token with information about the loan. When the bank updates its capital ratio, the results become part of this tokenized record. If the capital ratio exceeds the conversion threshold, the smart contract notifies the regulator and bank management.

Automated compliance

By making financial data available to auditors, organizations can eliminate error-prone manual work, reduce costs and increase trust in their financial health.

Inspectors can use DLT to access the data they need for the audit. After completing the audit report, the auditor stores it on the ledger for review. The smart contract then transfers the information in the report to the reporting tool.

Proxy voting

As a method of distributing proxy statements and counting votes, DLT can increase retail investor participation and automate vote verification, and can enable personalized analysis. When someone buys stock in a company, the stock transaction is recorded on the ledger.

When the company completes a proxy statement, a smart contract notifies owners and regulators. Shareholders’ votes appear on the ledger as tokenized assets. Another smart contract matches shareholder votes with ownership records to determine validity.

Asset re-mortgage

Rehypothecation, when an institution uses a borrower's collateral to pledge its own transactions, is known as a secondary transaction, which is very difficult to manage. If the institution confuses the ownership of the assets, the risk to the trading partners will increase. Therefore, regulators will limit which institutions can rehypothecate. However, without a way to track the transaction history, it is impossible to implement.

DLT can mitigate the risk of asset rehypothecation by creating an immutable history of asset transactions. When an asset is traded, the smart contract broadcasts the transaction information. If an asset reaches the regulatory rehypothecation limit, trading will stop.

After the equity transaction

Equity post-trade processing allows buyers and sellers to exchange transaction information, changing ownership records and assets. This process begins once the exchange confirms that the trade has occurred.

Applying DLT and smart contracts to post-trade activities can eliminate the need for middlemen, minimize operational risks and provide a faster settlement.

Central securities depositories work with custodian banks to match trades and verify investors’ credentials.

The central counterparty clearing house transfers the securities to the correct custodian - the person who stores the assets in an account. This process takes one to three days.

DLT can significantly speed up this process. Once the exchange confirms the transaction, the custodian bank sends its part of the transaction information to the ledger, and the smart contract verifies this information and matches it with the rest of the transaction information. Once the assets are securely stored, the smart contract will start the service process and notify the custodian and investors in real time.

All of the different use cases covered in the report involve a shared library and the elimination of one or more intermediaries from the value chain.

The industry must work with industry leaders to identify areas where DLT can demonstrate real promise or increase the risk of disintermediation.

Business use cases can be developed as successful experiments. From these experiments, we may be able to create a plan to commercialize these solutions, as well as identify barriers to scaling.