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Banking on the future of digital assets

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Crypto coins

Jeremy Boot, Senior Product Manager at Temenos, explores the impact of digital assets on the financial industry and how banks must adapt to thrive in the brave new tokenized world

 

The rapid innovation of blockchain tech has led to an explosion of interest in digital assets. Investor enthusiasm has pushed crypto valuations to dizzying heights. The media is awash with new acronyms DeFi, NFTs, CBDCs.

Cutting through the noise, one thing is clear: distributed ledger technology has opened the door to a future where all our assets, both real-world and digital, could become tokenized and recorded on blockchains, completely redefining how we think about value exchange and ownership.

This begs the question; how will this impact the financial industry and how can banks adapt? Let’s look at some of the opportunities.

 

Jeremy Boot

The rise of crypto banks

Crypto assets are a hot topic as a new investment asset class, store of value, or hedge against government money and inflation. The ability to buy small amounts makes crypto financially accessible to all and a natural fit for the younger digital-native generation. Attractive risk-return ratios provide new portfolio allocation options for the wealthy at a period of record stock valuations and negative bond yields.

The digitally savvy may like to buy their crypto on exchanges and self-custody in hardware wallets, but this is out of reach for the masses. They would look to trusted institutions to give them access to these new markets, and a wave of offers led by new FinTechs and Challengers is already available.

This is where traditional banks can move in, building on their experience with securities trading to provide an additional integrated offer. Crypto infrastructure providers are evolving enterprise-grade custody and accessibility to markets using standard protocols such as FIX messaging. Banks can leverage their processes for order lifecycle management between front and back office and integrate crypto custody into their core banking systems.

The crucial advantage banks have, is a deep experience of regulatory compliance, such as with customer risk profiling and controls, allowing them to adapt quickly to the incoming regulatory frameworks that are certain to appear.

 

CBDCs and alternate payment rails

The first Central Bank Digital Currencies are appearing across the globe with many more countries refining their strategy. They seek to facilitate payments, boost their digital economies, and protect against the adoption of alternatives. Central Banks have no interest in managing the end customer directly and do not want to risk disintermediating banks. For these reasons, the standardised approach evolving for retail CBDCs is the two-tier model where traditional institutions remain the interface to the customer.

The emergence of CBDCs represents an opportunity for banks to gain ground on competitors by quickly integrating CBDC accounts into their offerings. By leveraging infrastructure partners at the back to link to the CDBC network and providing mobile apps on the front, they can offer a frictionless experience to their customers. One that facilitates exchange from current accounts to CBDC wallets and with an integrated payments experience.

Alternate payment rails – for example, Stablecoins issued on Ethereum or Lightning payments network on the Bitcoin blockchain – are also key areas to monitor adoption trends and potential for integration.

 

Open banking, new possibilities

Open banking facilitates financial product distribution, allowing institutions to broaden their ecosystems of products adding value to their customers. Digital assets open the door to additional products that could be included.

For example, on SmartContract blockchains we have seen the emergence of DeFi (Decentralised Finance) protocols. Many indeed have dubious levels of decentralisation in their current form, and the ultra-high yields on offer to liquidity providers scream Ponzi. Nevertheless, DeFi offers an exciting glimpse of new automated, non-custodial, and decentralized lending and borrowing models. Aave, one of the pioneers of the DeFi space, recently launched a first permissioned and KYC’d protocol opening the door to regulated financial institutions to tap into this tech, potentially offering new products to their clients to gain passive income in return for providing liquidity with their spare deposits.

For crypto investors holding native assets of proof-of-stake blockchains, staking would be a natural add-on service a bank could provide to their customers. Staking is the process of delegating assets to help secure the network. In return for locking up their tokens the user receives staking rewards. As on-chain economies develop and grow securing networks will become increasingly important. Asset staking could become a new form of standardised capital income generation, alongside bond coupons and stock dividends.

 

Everything tokenised

NFTs (non-fungible tokens) have grabbed the headlines. Though the assets today are primarily digital – CryptoPunk JPEGs and the like – NFTs can also be used for real-world assets. Everything from stocks, collectibles, real estate and more could be tokenized, revolutionizing value ownership and exchange. The underlying blockchain provides a means to exchange value with other participants without having to rely on a centralized party.

Tokenisation opens the door to fractional ownership of assets such as art and real estate, lowering barriers to entry, and bringing in new liquidity to these markets by opening to the masses.

Beyond government CBDCs, non-profit organisations, sports clubs, corporations could issue tokens providing new ways to engage with their communities, encourage participation and loyalty, and distribute value to their network. New creator economies might emerge for digital works of art, metaverse artefacts and objects, non-propriety gaming assets.

Aside the low-value gaming or social tokens, we will need safe places to keep our valuable tokens. This will be essential for security, taxation, inheritance planning and the like.

Enter banks – banks of the future will not only hold our money but become the trusted guardians of the holistic value of our lives.

 

Banks as trusted guardians

The digital asset landscape is evolving fast. Most people will look to their trusted financial institutions to help them manage their new digital financial lives.

Banks can leverage their large customer base and deep regulatory expertise to provide new digital asset services that are trusted, secure, accessible, and compliant.

The good news is that there are infrastructure providers emerging that banks can leverage on their journey. In this way, banks can become primary players in the brave new tokenised world.

 

Banking

Wealth Managers and the Future of Trust: Insights from CFA Institute’s 2022 Investor Trust Study

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Author: Rhodri Preece, CFA, Senior Head of Research, CFA Institute

 

Corporate responsibility is more important than ever. Today, many investors expect more than just profit from their financial decisions; they want easy access to financial products and to be able to express personal values through their investments. Crucial to meeting these new investor expectations is trust in the financial services providers that enable investors to build wealth and realise personal goals. Trust is the bedrock of client relationships and investor confidence.

The 2022 CFA Institute Investor Trust Study – the fifth in a biennial series – found that trust levels in financial services among retail and institutional investors have reached an all-time high. Reflecting the views of 3,588 retail investors and 976 institutional investors across 15 markets globally, the report is a barometer of sentiment and an encouraging indicator of the trust gains in financial services.

Wealth managers may want to know how this trust can be cultivated, and how they can enhance it within their own organisations. I outline three key trends that will shape the future of client trust.

 

THE RISE OF ESG

ESG metrics have risen to prominence in recent years, as investors increasingly look at environmental, social and governance factors when assessing risks and opportunities. These metrics have an impact on investor confidence and their propensity to invest; we find that among retail investors, 31% expect ESG investing to result in higher risk-adjusted returns, while 44% are primarily motivated to invest in ESG strategies because they want to express personal values or invest in companies that have a positive impact on society or the environment.

The Trust Study shows us that ESG is stimulating confidence more broadly. Of those surveyed, 78% of institutional investors said the growth of ESG strategies had improved their trust in financial services. 100% of this group expressed an interest in ESG investing strategies, as did 77% of retail investors.

There are also different priorities within ESG strategies, and our study found a clear divide between which issues were top of mind for retail investors compared to institutional investors. Retail investors were more focused on investments that tackled climate change and clean energy use, while institutional investors placed a greater focus on data protection and privacy, and sustainable supply chain management.

What is clear is that the rise of ESG investing is building trust and creating opportunities for new products.

TECHNOLOGY MULTIPLIES TRUST

Technology has the power to democratise finance. In financial services, technological developments have lowered costs and increased access to markets, thereby levelling the playing field. Allowing easy monitoring of investments, digital platforms and apps are empowering more people than ever to engage in investing. For wealth managers, these digital advancements mean an opportunity for improved connection and communication with investors, a strategy that also enhances trust.

The study shows us that the benefits of technology are being felt, with 50% of retail investors and 87% of institutional investors expressing that increased use of technology increases trust in their financial advisers and asset managers, respectively. Technology is also leading to enhanced transparency, with the majority of retail and institutional investors believing that their adviser or investment firms are very transparent.

It’s worth acknowledging here that a taste for technology-based investing varies across age groups. More than 70% of millennials expressed a preference for technology tools to help navigate their investment strategy over a human advisor. Of the over-65s surveyed, however, just 30% expressed the same choice.

 

THE PULL OF PERSONALISATION

How does an investor’s personal connection to their investments manifest? There are two primary ways. The first is to have an adviser who understands you personally, the second is to have investments that achieve your personal objectives and resonate with what you value.

Among retail investors surveyed for the study, 78% expressed a desire for personalised products or services to help them meet their investing needs. Of these, 68% said they’d pay higher fees for this service.

So, what does personalisation actually look like? The study identifies the top three products of interest among retail investors. They are: direct indexing (investment indexes that are tailored to specific needs); impact funds (those that allow investors to pursue strategies designed to achieve specific real-world outcomes); and personalised research (customised for each investor).

When it comes to this last product, it’s worth noting that choosing advisors with shared values is also becoming more significant. Three-quarters of respondents to the survey said having an adviser that shares one’s values is at least somewhat important to them. Another way a personal connection with clients can be established is through a strong brand, and the proportion of retail investors favouring a brand they can trust over individuals they can count on continues to grow; it reached 55% in the 2022 survey, up from 51% in 2020 and 33% in 2016.

 

TRUST IN THE FUTURE

As the pressure on corporations to demonstrate their trustworthiness increases, investors will also look to financial services to bolster trust. Wealth managers that embrace ESG issues and preferences, enhanced technology tools, and personalisation, can demonstrate their value and build durable client relationships over market cycles.

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2022 ESG Investment Trends

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Jay Mukhey, Senior Director, ESG at Finastra

 

Environmental, Social and Governance (ESG) themes have been front and center throughout the pandemic. While the framework has been surging in popularity for several years, COVID-19 served as a period of reflection causing many companies, investors and other individuals to take these factors seriously. It’s something that we can no longer afford to ignore.

Jay Mukhey

We are witnessing drought, adverse weather patterns, hotter climates, and wildfires with more regularity, raising the profile of the climate crisis. Efforts were renewed at COP26 in Glasgow last November to help address the challenge, with the signing of the Glasgow Climate Pact and agreement of the Paris Rulebook. As a result, we are now seeing record net new inflows into ESG investing and impact.

 

Evaluating ESG criteria

Long gone are the days when ESG issues were at the periphery of a company’s operations. In just a few short years, ESG criteria have become a key metric for investors to evaluate businesses they are considering investing in.

Investor money has poured into funds that consider environmental, social and governance issues. Data from the US SIF Forum for Sustainable and Responsible Investment shows that ESG funds under management have now reached more than $16.6 trillion. It’s not just institutional investors who are embracing ESG, with Bloomberg Intelligence predicting that savers across the world will amass £30.2 trillion in ESG funds by the end of the year.

Due to the multitude of divergent factors that contribute to a company’s success on ESG, it can be tricky to pin down exactly what criteria to measure. Depending on the industry a company operates within, environmental criteria could include everything from energy usage, the disposal of waste and even the treatment of animals.

Social criteria are primarily related to how a company conducts itself in business relationships and with stakeholders. For example, does it treat suppliers fairly? Is the local community considered when the business makes decisions that would impact them? Do they have a statement and policy around modern slavery?

While governance criteria have traditionally been an afterthought, this may be changing. Everything from executive pay to shareholder rights and internal controls are relevant to investors within these criteria.

 

Tracking ESG for competitive advantage

Many experts within the financial services industry point to the power of ESG as a major competitive advantage, if used correctly. It has been noted that increasingly corporations, from big Fortune 500 companies down to small scale-ups, will communicate on their sustainability metrics to grow their business and to attract talent. However, it’s no longer enough to just pay lip service to ESG issues, with abstract commitments increasingly being seen as insufficient. Companies must now quickly progress to concrete objectives that can be measured and tracked.

A wide range of data providers now offer detailed information and tools that can measure ESG performance and effectiveness. Yet major challenges remain around bringing together what is often extremely fragmented data and transforming it into actionable insights.

 

Focus areas for 2022

The ESG criteria that investors measure is by no means stagnant. Complex societal challenges regularly emerge that require the attention of companies. Contributors recognize several topics that demand a sophisticated approach, including the COVID pandemic, diversity challenges and powerful social movements.

Companies operating within the financial services sector face several specific challenges related to ESG, with contributors believing that fintech will also continue to play a central role in finding answers to them.
For example, industry experts expect customers to be more demanding of firms in SME lending when it comes to understanding exactly what impact they are having on the climate. For many financial services firms, 2022 will be the year that they will try to reduce the time it takes to bring ESG products and services to market, such as green loans and mortgages, as well as checking accounts with sustainability and carbon tracking capabilities.

When selecting a service provider, customers are increasingly interested in the ESG credentials of their bank or financial institution. Research from PwC finds that 80% of consumers are more likely to buy from a company that stands up for environmental and governance issues. Consumers are one of the main drivers of ESG and many are putting their money where their mouth is. It’s a trend that’s not going away; financial institutions need to start implementing their strategy for ESG now.

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