JOURNAL #51: WEALTH & ASSET MANAGEMENT

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WEALTH MANAGEMENT IN THE AGE OF DIGITAL ASSETS: HOW FINANCIAL ADVISORS CAN FIND OPPORTUNITIES AMONGST DISRUPTION

JAMES McDONALD | TYLER SALATHE
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FRONT OFFICE EFFICIENCY: IMPROVING BUSINESS DEVELOPMENT AND INCREASING SALES

INGO RAUSER | TOBIAS WEHRLI

 

JUERGEN RAHMEL | Chief Digital Officer, HSBC Germany

Artificial intelligence (AI) and machine learning (ML) are gaining more and more traction in finance and asset management. But AI/ML is a complex tool that requires specific skills to be created, trained, and interpreted well for a given task. In this paper, we discuss some of the context parameters to be considered in order to apply AI beneficially in financial settings. We explore a matrix of use-cases, following the lifecycle of asset management and structured by the type of underlying AI technology. As AI requires human setup and interpretation, we briefly review the role of us ‘humans-in-the-loop’ of AI implementations. Finally, the emerging field of asset tokenization promises to disrupt the conventional markets and market practices, opening up for a new field of AI applications to tackle the new way of trading and servicing securities. The AI game is on in asset management. Not to play is not an option.

 

TEODORO D. COCCA | Professor, Chair for Wealth and Asset Management, University of Linz, and Adjunct Professor, Swiss Finance Institute

This article uses empirically collected data in Switzerland, Germany, and Austria to illustrate how the share of digital clients in wealth management has evolved since 2012. Using this data, we try to determine the relationship between client characteristics and the preference for bank-centric or open ecosystems. We find that a clear majority of clients seem to lean toward an open digital wealth management ecosystem as opposed to a bank-centric one.

 

YUTA TAKANASHI | Senior Fellow, Georgetown University
SHIN’ICHIRO MATSUO | Research Professor, Georgetown University
JOHN JACOBS | Executive Director, Center for Financial Markets & Policy, Georgetown University
ERIC BURGER | Research Professor, Georgetown University
CLARE SULLIVAN | Visiting Professor, Georgetown Law Center, Georgetown University
JAMES ANGEL | Associate Professor, Georgetown University
TATSUYA SAITO | Assistant Manager, Center of FinTech, Corporate Planning Division, Mitsubishi UFJ Trust and Banking Corporation
TOSHIKI HASHIRISAKA | Senior Manager, Center of FinTech, Corporate Planning Division, Mitsubishi UFJ Trust and Banking Corporation
HIROTOSHI SATO | Vice President, Digital Transformation Division, MUFG Bank, Ltd.

Tokenization is expected to improve the way people trade various types of assets by using technologies, such as blockchain and smart contracts. However, it is important to understand how it is similar to, and different from, traditional securitization mechanisms in order to evaluate tokenization as an asset mobilization mechanism.

This paper establishes evaluation criteria, such as bankruptcy remote, legal certainty of transactions, transparency, liquidity, and finality, and applies them to both securitization and tokenization. We find several areas where tokenization could improve securitization as well as areas in which tokenization itself needs improving. While tokenization could increase certain aspects of transparency, such as traceability, enhanced liquidity, and reduced settlement risks, in certain cases investor protection is not enough.

We discuss the ways in which practices of tokenization could be enhanced in order to ensure investor protection, especially focusing on bankruptcy remote, perfection of transactions against third parties, disclosure, ratings, and finality. These additional practices could increase costs and complexities of tokenization, but they are necessary to ensure that there are adequate levels of investor protection, which is a prerequisite for an asset mobilization mechanism.

 

JET LALI | Chief Digital Officer, State Street Global Advisors

For a company to be successful in its digital transformation, leaders will need to understand what digital can deliver for their businesses and have a hand in driving that change themselves. Digital transformation is more than an IT solution, it is a firm wide event. Executives will need to comprehend the value of data and deeply understand what artificial intelligence can and cannot do for them. For those who get this right, the prize will be to unlock the information advantage for their businesses and for the very best, it will be digital supremacy and domination of their sector. This paper will explore the key areas of digital transformation, provide insights into how digital will disrupt our industry in the coming decade, and offer insights into how best to prepare for the change ahead.

 

DANIEL NEVZAT | Manager, Government Relations and Public Policy Practice, Norton Rose Fulbright LLP
IMOGEN GARNER | Partner, Financial Services Group, and Head, Buy-side Regulatory Practice, Norton Rose Fulbright LLP

There has been a shift in thinking among industry stakeholders, policymakers, and regulators alike towards viewing environmental, social and governance (ESG) issues as financial risks that can have a material impact on investment performance. This has resulted in legislative and regulatory changes in the U.K. and the E.U., seeking to clarify that ESG issues are financially material, which may in turn impact the interpretation of investment managers’ fiduciary duties, tortious and contractual duties, as well as their regulatory duties.

This article will discuss the duties of investment managers, consider how ESG issues interact with those duties, and explore how recent legislative and regulatory changes may impact the applicable legal liability regime.

 

PANOS SERETIS | Head of ESG Research - EMEA, MSCI
ZOLTAN NAGY | Executive Director, Equity Core Research, MSCI
RIC MARSHALL | Executive Director, ESG Research team, MSCI

Recent studies by MSCI ESG Research LLC have shown historical positive links between environmental, social, and governance considerations and corporate financial performance. Because investors might still question whether ESG historically added value in emerging markets, where companies’ consideration of ESG risks is a more recent phenomenon, we compared the performance of four ESG indexes to their MSCI emerging-market parent. Overall, we found that despite emerging-market companies’ tending to have lower MSCI ESG Ratings than global peers on average, ESG characteristics measured by MSCI ESG Ratings had contributed to performance overall.

 

INGO RAUSER | Senior Partner, Capco Switzerland
TOBIAS WEHRLI | Senior Consultant, Capco Switzerland

This article looks at front office efficiency and analyzes how it represents a critical success factor for private banking organizations, especially for business development and sales. We address the levers for optimizing front office efficiency from an organizational point of view as well as different options for an efficient front office set-up.

To this end, three specific cases from previous project work with leading international private banking institutions help illustrate the relevant aspects for optimizing front office efficiency:

- Case one: International bank creates a centralized client service team

Case two: International bank introduces three functional support teams – online banking service, client service, and client due diligence advisory specialist

Case three: International bank introduces a client lifecycle management team

The conclusion provides the most important take-aways for actionable next steps.

 

EOIN MURRAY | Head of Investment, Hermes Investment Management

We need to rethink our economic model – and the new one needs to be premised on stewardship in the broadest sense of the word. Action is required on the part of all participants in the economic system, with the investment industry, as the turntable of capital, having a key role to play. This paper will focus in part on climate risk, more specifically on the ‘putative’ tail risks represented by climate tipping points. It will also consider recent developments in the fixed income markets to see if a market- and climate-friendly innovation can be found to provide the direction and pace of change that we need.

 

SAKIS KOTSANTONIS | Co-Founder and Managing Partner, KKS Advisors
GEORGE SERAFEIM | Charles M. Williams Professor of Business Administration, Harvard Business School, and a Co-Founder, KKS Advisors

Human capital development (HCD) is a key consideration for most companies, but only recently have investors focused on understanding the risks and opportunities related to human capital with the emergence of environmental, social, and governance (ESG) investment frameworks and impact investing.

We argue that the importance of human capital is likely to be magnified in an environment of rapid technological change, where the future of work is uncertain and that existing frameworks for measuring and evaluating HCD might not be fit for purpose. Against this backdrop, we derive an HCD metric that focuses on outcomes rather than inputs; demonstrate that even in the current disclosure landscape one could measure with reasonable accuracy this metric for thousands of companies; and provide exploratory evidence on its relationship with employee productivity. Moreover, we develop an estimate of probability of automation of job tasks for each sub-industry and show the relationship between this probability to elements of our HCD metric and other human capital characteristics. Finally, we outline an investor engagement framework to improve the disclosure landscape related to HCD and to empower effective investment stewardship.

 

MICHAEL LEWIS | Head of ESG Thematic Research, DWS Group GmbH & Co. KGaA
CARSTEN KEIL | Head of ESG Engine & Solutions, DWS Group GmbH & Co. KGaA

There have been significant advancements in addressing climate transition risk from an investment portfolio perspective in recent years. This has been warranted given the shortcomings of carbon foot-printing as a proxy for climate risk. The challenge for investors has been to understand the increasing variety of climate transition risk methodologies available in the marketplace, followed by the subsequent incorporation of climate risk into the investment process.

By combining the various techniques offered by multiple data providers, DWS aims to capture risk across multiple dimensions that incorporate carbon intensity metrics, carbon pricing scenarios, and climate-related opportunities. This ability to identify climate risks and opportunities at a security, sub-sector, and sector level basis allows us to optimize a portfolio that not only reduces climate transition risk, but also tilts investments towards entities that promote the low carbon transition.

 

ARON SZAPIRO | Head of Policy Research, Morningstar
ANDY PETTIT | Director of Policy Research, EMEA, Morningstar

The publication of a Sustainable Finance Action Plan in March 2018 marked the European Commission’s formal launch of a major project to leverage financial markets to address sustainability challenges. The Commission had previously identified an annual funding gap of between €175 billion and €290 billion to meet its envisaged target of a 50 percent cut in greenhouse gas emissions by 2030.

To plug the gap, the broad series of steps set out in the Action Plan ultimately seeks to induce behavioral change to reorient capital flows and mainstream sustainability in risk management. In this paper, we examine how the plan uses traditional regulatory tools to achieve these goals, and the challenges and opportunities in doing so.

We find that changing fiduciary and suitability standards are the most coercive tactics, but enforcement and implementation will determine the degree to which these approaches cause the investment industry to consider and cater to investors’ ESG preferences. Further, new disclosure regulations will have a profound impact on the information investors have and, if they are enforced and effective, make it much easier for them to express their sustainability preferences through their investments.

 

LUKE O’LEARY | Associate, White & Case LLP
MINDY HAUMAN | Professional Support Counsel, White & Case LLP

In the age of big data and globalization, regulation is increasing in both scope and scale. Much of the recent regulation in the E.U. has focused on ESG investments and compliance, with a focus on increased data reporting requirements to promote transparency. This suite of regulations will pose a real challenge to financial market participants. This article focuses on some of the recent E.U. regulations regarding ESG investment, examines how it will impact the market, and proposes a solution to the challenge.

Integrating data analytics into the regulatory and business framework will enable artificial intelligence and machine learning to assist companies and investors with compliance. It will also assist in providing a reliable, objective standard to promote comparability. Finally, this article will discuss how the implementation of some E.U. legislations have enabled fintech businesses with ESG goals to disrupt financial markets.

 

CHRISTOPH MERKLE | Associate Professor, Aarhus University

Robo-advisors can replace financial advisors and asset managers at low costs. However, human managers and advisors will survive. This is predominantly because although robo-advisors primarily appeal to a clientele of already financially sophisticated investors, they lack some of the qualities people look for in a ‘money doctor’, and their business models have not yet stood the test of time. While a general algorithm aversion is absent in the financial domain, even tech-savvy millennials do not particularly favor robo-advisors. As new survey data shows, investors view algorithms as an aid to human managers rather than competitors. A hybrid model with humans and robos working together, as already implemented by some financial institutions, might be the future of delegated investment.

 

ROBERT C. MERTON | Distinguished Professor of Finance, Nobel Laureate – Economics 1997, MIT Sloan School of Management
ARUN S. MURALIDHAR | Co-founder and Client Portfolio Manager, AlphaEngine Global Investment Solutions LLC

There is a looming retirement crisis, as individuals are increasingly being asked to take responsibility for their own retirement planning and a majority of these individuals are financially unsophisticated. They cannot perform basic compounding calculations and do not understand the impact of inflation, both critical aspects of retirement planning. Yet, these individuals are being tasked with the responsibility for three complex, interconnected decisions: 

How much to save

How to invest (with many additional decisions), and

How to decumulate one’s portfolio at retirement.

Compounding these challenges, current financial instruments and products (e.g. T-Bills, TIPs, or Target Date Funds) are risky because they focus on the wrong goal – wealth at retirement, as opposed to how much retirement income can be guaranteed to support pre-retirement standard-of-living. Moreover, annuities are complex, costly, and illiquid and seldom used. Without financial innovation and a change in the metric for measuring retirement success, many individuals will retire poor – a financially and socially undesirable outcome for any country. 

This paper presents an easy, quick and efficient solution for countries to address all these challenges and improve retirement security by creating and issuing an innovative new bond – SeLFIES (Standard-of-Living indexed, Forward-starting, Income-only Securities). 

- The SeLFIES bond is a single, liquid, low-cost, low-risk instrument, easy-to-understand for even the most financially unsophisticated individual, because it embeds accumulation, decumulation,compounding and inflation-adjustments. 

SeLFIES is good for governments too, as the bond lowers the risk of individuals retiring poor, improves balance sheet management, and funds infrastructure. 

SeLFIES can ensure longevity risk protection and hedge standard-of-living risk, a key unmanaged risk globally today, and has the potential to become the “currency of retirement”.

 

 

CAITLIN McERLANE | Partner, Financial Services Regulatory, Baker & McKenzie LLP

In March 2018, the European Commission published an ambitious Action Plan on Sustainable Finance, which proved to be the first step in a series of regulatory reforms aimed at fundamentally reorienting capital flows towards sustainable investment and managing perceived financial risks stemming from climate change. While the resulting reform framework is sprawling in nature, and adds to a disparate set of pre-existing regulations, the overall design forms a blueprint that will touch almost every aspect of the financial services industry and profoundly alter the language of sustainable investment.

In this article, we will examine the major features of the reform project and how the new regulatory architecture will impact financial institutions based in the E.U. and further afield, alongside the question of how the reforms will flow through to commercial companies.

 

ANTOINE BOUVERET | Senior economist, European Securities and Markets ity
MASSIMO FERRARI | Economist – Markets and Investors Team, European Securities and Markets ity
STEFFEN KERN | Chief Economist and Head of Risk Analysis, European Securities and Markets ity

The asset management industry has grown significantly in recent years – in Europe alone assets under management have more than doubled in the last decade – and, as a result, is attracting heightened attention for its systemic implications. Alternative investments, including hedge funds and private equity, form a significant part of that industry. In the E.U., the Alternative Investment Fund Manager Directive (AIFMD) provides a dedicated regulatory framework for these alternative investment funds. This article presents a comprehensive mapping of the €6 trillion E.U. AIF market, and an overview of the indicators ESMA applies to assess industry-level risks.

 

PASCAL R. NÄGELI | Managing Partner, i.AM Innovation Lab AG

This article looks at the major challenges asset managers face and what they need to do to stay relevant. Most asset managers will contend that the environment in which they are operating is changing rapidly, and that they need to adapt. It is true that technology is evolving and that they need to keep abreast of how it impacts the industry, however, having the latest technology will not be enough. To be successful, asset managers need to better manage their corporate cultures, have a rigorous focus on clients, and update their business models.


 

MD MAMUNUR RASHID | Senior Research Fellow, Consumer and Organizational Data Analytics (CODA) Research Centre, King’s College London
STUART J. BARNES | Chair in Marketing, Consumer and Organizational Data Analytics (CODA) Research Centre, King’s College London
MD ABDUR RAHMAN | Associate Professor, Department of Cyber Security and Forensic Computing, University of Prince Mugrin

The insurance industry continually struggles to identify the validity and justification of insurance claims, which put service providers and clients in a complicated trust relationship. The complexity is not only concerned with people who are involved in fraudulent claims, but due to the nature of certain businesses, genuine claims are often handled with a mindset of potential fraud.

The current insurance business model is largely a traditional, paper-based, error-prone claiming mechanism. Current practices comprise complex and costly processes, often resolved by the involvement of the legal administrators. The overall process also has a multi-point authentication issue, as it needs to maintain an immutable ledger, which is distributed and validated among different parties.

Recently, technology has made evolutionary advancements in the area of distributed ledgers. In this paper, we present a novel architecture that will allow a massive amount of heterogeneous data to be used for insurance claims evidence. Our framework leverages the state-of-the-art networking technology and both blockchain and off-chain decentralized repositories. The framework also employs explainable artificial intelligence for bringing trust within the reasoning and deep learning algorithms and helping in different ecosystems of the insurance industries. Our solution uses advanced technologies in the insurance industry that could potentially enhance transparency, trust, and automation in handling insurance claims.

 

JAMES McDONALD | Senior Consultant, Capco
TYLER SALATHE | Senior Consultant, Capco

The advent of digital assets has led to the creation of new financial products with the ability to fundamentally change where and how wealth is invested. For wealth managers, the new asset class and varying products present both a challenge and opportunity. On one hand, digital assets allow retail investors to personally invest in tokenized alternative assets with minimal capital, diminishing the need for a financial advisor or broker. On the other hand, new product classes such as cryptocurrencies and security tokens can be added to wealth managers’ existing portfolios as means to diversify holdings and corner an increasingly demanded market of blockchain-based assets.

This paper should be viewed as a starting point for wealth managers who are concerned about potential business disruptors or growth opportunities associated with digital assets. We will review and discuss the significance for wealth managers of the following:

- Cryptocurrencies

- Stablecoins

- Initial coin offerings

- Security token offerings

We will also focus on an increasingly popular application of security token offerings, termed tokenization, and discuss how wealth managers may use tokenized products to supplement portfolio offerings.

While the full effect of digital assets to a wealth manager’s business is still yet to be determined, forward thinking financial advisors will need to be prepared for this asset class marketplace in order to avoid potential disruption. Financial advisors should take proactive strategic steps, such as enhancing their digital capabilities or upskilling their staff on the benefits of digital assets, to ensure that they are well equipped to serve their clients’ changing needs.