Market PerspectivesTransforming to a Digital Economy

Irfan Ahmad, APAC Product Lead, State Street Digital

Garry West, Senior Manager, Media & Communications,  Australian Institution of Superannuation Trustees

Garry [00:00:02] Hello and welcome to our podcast on Digital Assets and the Digital Transformation. I'm Garry West, Senior Manager, Media and Communications with AIST. I'm joined by Irfan Ahmed, Product Lead for State Street Digital in Asia Pacific. And today we'll be discussing the key opportunities presented by digital assets. An update on where we are on the journey towards digitalizing our economy, how regulations are catching up and the evolving role of the custodian. Irfan. Thanks for joining.

Irfan [00:00:34] Thanks, Garry, and thanks for having me on today.

Garry [00:00:36] Diving straight into the discussion, can you give us an overview of the opportunities that are being presented by Digital Assets?

Irfan [00:00:43] It's a great question and a great way to kick off the conversation. We see digitalization opening up brand new set of opportunities for market participants across the board. Firstly, it's important to point out that Digital Assets go a lot wider than just crypto. We look at Digital Assets as a way of reimagining the financial infrastructure of today. Cryptocurrencies are a component of that, and so is tokenization. Underpinning all of this is Blockchain technology and smart contracts. The conversation around blockchain technology and financial markets is mainly been centered around cryptocurrency and its rise as an asset class. We expect blockchain technology to cause a dramatic shift across all sectors of our industry, including asset owners and asset managers. For asset managers, this not only means incorporating new asset classes into portfolio models, but more importantly, it means taking advantage of blockchain to reduce costs in areas such as IT, labour and compliance. Ultimately, the opportunities are the goodness that will come out from an infrastructure perspective - providing more security, more transparency, more efficiency, and more productivity to benefit the entire industry.

Garry [00:01:50] Thanks, Irfan, it's interesting to hear you say the conversation around blockchain has been centered around cryptocurrency, so perhaps we can pick up on some of the lesser known use cases and how these are helping to shape digital infrastructure.

Irfan [00:02:05] So in the past, technological innovation in finance often meant developing new layers on top of old ones, creating a patchwork, if you will, of systems and processes. That won't be the case with blockchain though, as it's an entirely new infrastructure, which is likely to occur as tokenization transforms traditional assets into digital ones. So the question is what is tokenization? It's the ability to standardize and create a digital version of any kind of asset, whether that be a building, artwork, intellectual property or anything that could conceivably have a value or potential market. Anything can be represented on blockchain and with that comes the ability to fractionalize it and make the asset more accessible to a broader range of investors. To give you a few examples of use cases in financial services, we can talk about fractionalization. As the name suggests, assets can be split into fractional amounts, which in turn lowers the barriers of investment and offers greater investor diversification and targeted portfolio construction. Data in and of itself can be stored and accessed securely on the blockchain, providing credible, immutable insights to investors or members of the chain. Having a single shared book of records also brings with it a significant reduction in reconciliation that might take place up and down the investment lifecycle. Accredited investors will be able to access more private investments. Eventually, the market for private assets will be democratized, and they will be easily accessible to a wide and diverse set of investors. So as you can see, the advantages of tokenization go beyond simply digitizing the asset itself. We see institutional investors across Asia-Pacific, including Australia, exploring business use cases for digitizing assets, and regulators are keeping pace of this, bringing in new regulations, guidelines, which protect end investors, whilst also encouraging innovation more broadly.

Garry [00:04:00] That's a great segue into regulation and the role of the regulator, so how have regulators responded to developments in the digital economy and from an institutional perspective, what do they need to consider when investing in this asset class?

Irfan [00:04:15] It's a great question, Garry. It's certainly an area that our clients have been questioning and showing a lot of interest in, looking back Bitcoin began the crypto revolution back in 2008 as a response to the global financial crisis and reliance on banks to execute financial transactions. As institutional investors interest has swelled, questions around regulatory treatment of such assets become more prominent. Until recently, there's been a lack of regulatory transparency. In October last year, the Australian Securities and Investments Commission released guidelines on crypto-asset related investment products. This was a significant step and provided clarity for issuers and market operators on how to bring crypto asset-exchange traded products (ETPs) to market. Since then, a number of crypto-asset related products have been launched and are available in Australia to Australian retail investors. In March this year, the Australian Treasury issued a consultation paper for a proposed new regulatory framework for crypto-asset, secondary service providers or CASSPs, to seek feedback on defining the scope of services and categorizing crypto-asset. In most other jurisdictions, regulators have approached crypto-assets regulation by first trying to identify whether a crypto-asset would be classified as a type of instrument that is already regulated, therefore bringing them into the regulatory framework that exists today. While nearly all regulators have determined that crypto-assets are not currencies, there's still not much consensus beyond that.

Garry [00:05:49] I'm interested to hear about some of the conversations that you're having with clients and in particular superannuation funds. How quickly will digital assets move more into the mainstream of a Super funds' Portfolio Holding?

Irfan [00:06:01] We see Australia at an inflection point. Institutional investors in particular are now getting up to speed with their obligations whether that's regulatory reporting on tax requirements, looking at the operational complexities of bringing these types of assets into their portfolios and in terms of that aspect, they're looking at how effectively they can hold these assets alongside their traditional portfolio. At the same time, the regulatory clarity that has come through over the last 6 to 12 months has been positive, showing an increased openness to engage. So those two things together point to an increased maturity and willingness to move the conversation forward.

Garry [00:06:36] So super funds are now starting to look at digital assets, but how long do you think it will be before they're comfortable investing members' retirement savings in them, and particularly in crypto-assets?

Irfan [00:06:46] So that's an important distinction to make, so superannuation funds' interest in cryptocurrencies and that of promise of tokenized assets might bring to otherwise illiquid assets, including real estate and private equity, are two different things. The World Economic Forum indicates in a prediction made several years ago now that the market for tokenized instruments would be in the region of about $24 trillion by the year 2027. Given that we're only five years away from that prediction and we've begun to see policy change as well as market infrastructure developments, there's a need for supers to keep an eye towards the future, whilst of course ensuring that they maintain an appropriate line of sight on the risk weighted opportunities the crypto-assets might provide. Ultimately, crypto-assets are seen by many to be a largely speculative asset class, and as such, any investment into this space needs careful consideration that takes into account investors' preference for risk mitigation and the potential for return.

Garry [00:07:41] There's certainly a lot to consider here and keeping on top of these changes will be a task for many. Shifting now into your role as a custodian and how that is changing as we moved into the future, how do you safe-keep a digital asset?

Irfan [00:07:55] I guess a good starting point would be defining what custody of a digital asset actually is. Essentially the concept of digital asset custody relates to the safekeeping of a private key, and private keys are encrypted digital code and are used to store and manage and transfer ownership of the digital asset. So the technology used to control and manage these private keys is really important and what we refer to as digital custody. Now, looking at the role of the custodian in this context, I think there are few important considerations and developments taking place. The custodian industry today has been shaped by regulatory developments created over decades. We see paper securities moving to electronic securities and then other developments, including central securities depositories or CSDs. This enabled investors to access assets through the use of intermediaries. Through the introduction of digital assets, we are seeing greater levels of decentralization with peer-to-peer exchange of value. Now the impact of all this change is requiring State Street and other global custodians to reimagine the meaning of custody and essentially what the role of the custodian will be in this context. So what needs to be considered? Firstly, how do you segregate assets from proprietary assets and achieve this through the use of private keys? Asset owners in particular will have to ensure that their custodians can manage effective control over these assets through ensuring that nobody has access to these private cryptographic keys and control the digital assets. Also, with the use of DLT or Distributed Ledger Technology that utilize digital wallets. What will replace securities accounts in jurisdictions that require you to book transactions into an account to transfer ownership. At State Street,we've partnered with key fintech firms to support our clients' growth ambitions. As an example of that, we've entered into a licensing agreement with a company called Cooper.co, a software provider of digital asset custody and trading infrastructure. By doing this, we're able to deliver a digital solution, as well as looking at the additional layer of integration and protection for our clients that they have come to know with traditional custody. Clients have come to expect an increased speed and velocity of moving data and assets around, and we are happy to be at the forefront of that change and solutioning to those rapidly changing needs.

Garry [00:10:11] There's certainly some momentum building here. Before we finish up, I wonder whether we can take everything we spoke about today and summarize that into what this means for markets, assets and money in the future.

Irfan [00:10:25] What I would say is that we have a long-standing belief that the rapid technological developments that are emerging across our industry are affording us the opportunity to reimagine the financial infrastructure of tomorrow. And this, in turn, provides a huge opportunity for all market participants. For markets, we observe the potential around an offering for synchronized and standard offerings, which would improve the efficacy and efficiency of markets. For assets, this will broaden and diversify the offerings and clients and create a new paradigm for portfolio construction. For money, as concepts of central bank digital currency move into the real world, the ability to settle tokenized assets in real-time will become a reality and untrap liquidity that was previously tied into T+2 settlement cycles. The convergence of technology and regulation and the way in which we bridge the divide between the old and new will help define what financial market infrastructure of tomorrow will look like. We are very bullish about the future and we're excited to be bringing our clients on the journey with us.

Garry [00:11:23] We'll finish up there, Irfan, thank you for your perspectives today and thank you for listening. You can find a range of market insights and thought leadership online at statestreet.com/ideas. We look forward to sharing more insights with you in our next edition.