The role of digital and data as an enabler for the custody industry

Digital assets are not homogenous, but comprise of crypto-currencies – now a USD1.6 trillion market¹, together with stable coins, central bank digital currencies [CBDCs] and security tokens. CBDCs – a type of digital money issued by central banks – are attracting interest from custodians. Unlike crypto-currencies which tend to be volatile, the value of CBDCs are pegged to a country’s fiat currency. To their detractors, however, the benefits of CBDCs are hard to gauge - especially because so many people already have access to efficient digital payment channels. Nonetheless, James Pomeroy, global economist at HSBC, argued the cost savings which CBDCs could generate – through the elimination of payment fees, for example – would be significant. “Over time, payment fees could go down to zero, which would provide a huge uplift to economic activity,” he said. Pomeroy added that a number of Central Banks including those in China, Sweden and the Bahamas are all now developing CBDC pilots.

Appetite for security tokens, a fractionalised digital representation of an underlying asset (i.e. a bond, equity, real estate), is also on the rise. One of the primary benefits of tokenisation is that it makes illiquid assets more accessible to investors as their fractional nature means the minimum investment thresholds are lower than conventional assets, noted Paul Clark, Global Head of Digital & Data, Securities Services at HSBC. “Tokenisation will ultimately make illiquid markets, such as private assets, far more liquid. Arguably, tokenisation is a continuation of dematerialisation,” said Chris Jones, Global Head of Technology Strategy, Markets and Securities Services at HSBC. In response to client demand, providers such as HSBC are looking to develop digital custody solutions.

Underpinning trading in digital assets are technologies such as DLT and self-executing smart contracts, both of which have the potential to drive widespread efficiencies in capital markets. “DLT lends itself to multi-party workflows, while smart contracts ensure business processes function in a consistent way across the entire value chain,” said Rajeev Tummala, Director of Digital and Data, Securities Services, HSBC. In addition, providers are also trialling AI and machine learning tools across post-trade – using them to spot potential settlement fails at clients, for instance. However, AI is not without its challenges. In order for AI and machine learning tools to thrive, Janice Ku, Director of Digital and Data, Securities Services, HSBC, stressed that the meta data being fed into these technologies needed improvement. Demand for APIs has also skyrocketed, with Ku saying there had been a 600 per cent increase last year in clients using the HSBC Custody API. However, she highlighted that many customers still did not have the technology systems and infrastructure in place to fully utilise APIs.

While new technologies can unlock all sorts of potential, it can also expose firms to new risks. “Five years ago, digital was not at the top of people’s agenda. Now, the ability to innovate with new digital and data solutions is a key criterion in most RFPs, and we can expect interest in cyber-defences to follow that trend moving forward” said Clark. “Clients want to know about how effective our cyber-defences are, and the protections we put in place to safeguard client data. This is an issue we take very seriously, as do many of our peers,” added Jones. It is also essential that providers future-proof their systems against cyber-threats which have yet to fully emerge. Jones said advancements in areas such as quantum computing could theoretically result in bad actors overriding existing cyber-security encryptions leading to potentially devastating hacks. In response, technologists are analysing whether some sort of quantum-enabled encryption device could be leveraged to counteract this future cyber-risk. “We are still a long way from seeing quantum computers in the office let-alone hacking credit card transactions, but it is good to have an eye on the day after tomorrow,” added Jones.

Many of the new technologies now emerging could be enormously beneficial for the industry at a time when margins are facing growing pressure. However, some technologies do still require finessing, while their risk implications need to be better understood if they are to flourish moving forward.