Distributed Ledger Technology and the Future of the Custodian

By Lisa Iagatta, Vice Chair, ISITC North America and Director of Account Management for Investment Services at Fiserv

Distributed Ledger Technology (DLT) is something we have been discussing regularly with our membership over the last couple of years.

While bitcoin is one of the most well-known use cases for distributed ledger and blockchain technology, when you look at the reality for large enterprise financial services companies, the economic motivation is not about creating a digital currency, but about leveraging the underlying technology to make the financial infrastructure more efficient.

The discussion around DLT can run in many different directions when it comes to the actual impact it will have on the industry. How DLT will change the custodian model, for example, is a frequent topic of discussion at our committee meetings and events and one that we aim to explore further. Custodians, in addition to representing a core component of our membership, are a foundational piece of the financial services ecosystem.

The role of the custodian is tried and true, and has always made up a significant piece of the revenue pie for banks and other institutions over the years. It’s a model that works and that we trust. In heavily regulated markets such as financial services, custodians play an important role.

Some would argue that the true North Star potential for DLT is to eventually create a completely open-public access system for the holding and trading of securities, which would end any need for custodians. However, considering the complexity of capital markets, and the trillions of dollars at stake, we take a more pragmatic or cautious outlook.

In the open-public versus private-permissioned ledger debate, the financial services industry has shown bias toward the latter, which allows institutions to experiment with the technology to increase operational efficiencies internally. For custodians, who take in, reconcile and report on huge amounts of data on a daily basis, implementing a permissioned enterprise ledger would lead to significantly increased efficiencies. As we look forward to the prospect of T+1 down the road, DLT has the potential to help custodians keep pace.

Looking farther into the future, when custodians have conquered the permissioned enterprise ledger, the next step in further increasing efficiency is connecting these systems with one another in the ecosystem. Instead of the open-public system mentioned earlier, the goal here is to work on creating a private system.

Another separate situation our custodian constituents are watching very closely is the growing cryptocurrency investment activity at the retail investor level; particularly, if and when institutional investments start pouring into crypto assets, whether digital currencies like bitcoin, or crypto securities such as the controversial Initial Coin Offering (ICO). In this situation, the custodians find their typical role altered. Instead of actually holding the security or asset, they will in theory become a keeper of the keys. The big challenge here with private key management is that the custodian is responsible for assets that are natively issued on a separate network. Cybersecurity immediately rises to the top of conversation in this scenario, and is something we will continue to discuss as the trend continues.

In our view, DLT will absolutely affect how one performs custody (e.g., keeper of the key vs. CSD participant). We look at DLT as a way for custodians to evolve their businesses to remain an integral part of our capital markets.

As an association helping to shape the future of capital markets, our aim is to keep a close eye on these emerging technologies, continue to educate our membership, and develop standards that allow organizations to optimize the operational benefits. When it comes to a topic like DLT, it’s safe to say our work is just beginning.