Fund distribution is an increasingly pressing concern for investment managers. Firms must grapple with new regulations such as the second Markets in Financial Instruments Directive (MiFID II), geopolitical issues including Brexit and market fragmentation, as well as technological trends like digitalization and Direct-to-Consumer models. This is all set against a backdrop in which passive funds with minimal operational overheads are outpacing their active competitors in attracting new investment. Furthermore, prospective investors such as pension funds and banks are forcing a race to the bottom on fees and appointing fewer — but larger — managers.
AllianceBlock aims to improve the efficiency of the fund distribution process to provide better client service while reducing the resource burden for managers.
The exact issues faced in fund distribution can depend on where an investment manager is based, where they distribute products and the type of products they sell. However, much of the established investment management space face the same general issues.
The first is investor expectations. Investors expect far more from their managers than they did even when compared to as recently as five years ago. This is driven by widespread and improved technology in adjacent sectors such as retail banking.
The second concern is a regulatory one. Regulations have stiffened since the financial crisis, with penalties becoming more severe. This does not just affect the manager’s core business activities, such as only distributing products in approved jurisdictions, but also, for example, in the preservation and security of user data. Furthermore, even units such as the European Union which have worked to standardize and align regulations can see distribution channels vary greatly. German investors, for example, tend to invest in different fund structures to the likes of those based in the UK.
The third problem involves efficiencies. Fees have continued to be eroded as a result of increased competition, industry consolidation, and the rise of passive and exchange-traded funds (ETFs), while the likes of MiFID II have ensured that there has to be transparency and justification on fees.
Investment managers also face the issue of future changes to fund distribution.
In Europe, for example, the most common model of fund distribution is the Business to Business to Consumer (B2B2C) model. This sees five intermediaries between the investor and fund manager, including the likes of distributors, clearing houses, and custodians. Fund managers use this model because it gives them access to a broad range of investors; they employ third parties to sell their funds for them. However, these intermediaries:
- Bring additional fees;
- Increase inefficiencies as processes such as KYC are repeated by multiple entities; and
- Distance the manager from their end investors.
Retail investors also invest differently in different jurisdictions. While Swiss funds may be distributed mainly through private banks, countries like the UK see far greater usage of Independent Financial Advisors or fund platforms. Markets like the US, however, employ a Direct to Consumer model far more often. Instead of the multiple intermediaries, a fund platform sits in between the investor and manager. This fund platform handles many of the tasks that are covered by the multiple entities of the B2B2C model.
This Direct to Consumer model is expected to become more widely adopted, with an industry survey in 2017 finding that 57% of respondents believed that online fund platforms would become dominant against traditional channels.
What is missing, however, is a model which uses open APIs that allows third-party developer participation, while also easing the regulatory and resource burden that managers currently bear.
Furthermore, there remains significant challenges in bridging the gap between decentralized finance and traditional finance. Financial institutions are largely excluded from offering investors access to DeFi. Fund distribution is one of the issues.
The challenge is to provide a platform which:
- Simplifies much of the regulatory and documentation burden investment managers currently face
- Drives greater efficiencies throughout the distribution process
- Allows managers to understand their distribution partners and retain control over data
- Is future proofed to allow for changing fund distribution models
- Ultimately enables fund managers to distribute funds in their chosen global jurisdictions in an improved manner
- Can act as a bridge between TradFi and DeFi to allow more firms and investors access to both worlds
1. Simplifying the regulatory burdenAllianceBlock simplifies the regulatory burden that investment managers face globally. This is addressed more fully in our case study on cross border activity. However, to summarize, the AllianceBlock Protocol comprises three layers. One of these is the Cross-Border Regulatory Compliance Layer (CBRCL) which ensures that product and fund distribution, as well as marketing compliance, is simplified by making authorized issuances and trades available only to relevant issuers and investors. Regulators are an important participant in the Open Finance platform we are creating, and they will be able to code regulation into the platform at the layer-level, meaning that firms are unable not to adhere to its logic.
2. Drives greater efficienciesThe protocol also works to drive efficiencies through the distribution process. For example, institutions will be able to perform Know Your Customer (KYC) and Anti-Money Laundering (AML) verifications faster and at a fraction of the existing cost. A consortium of validators (approved by the regulators and other stakeholders such as the institutions themselves) perform verification individually. Only when they arrive at consensus will the verified data be committed to the Data Layer. If the institution has not approved the validators to handle their KYC, then they will still be able to do the verification process themselves or through an authorized partner. Collected data is stored in the protocol’s Data Layer, which holds information involving KYC, due diligence, transactional data, and ownership records of digitized securities. This Data Governance Layer ensures that data is collected, processed, and disseminated in a compliant way with regulatory requirements such as GDPR. By doing so, we also ease the burden of adhering to such data protection regulations. Further details on how this information will be securely held can be found in our whitepaper.
3. A more efficient fund platformIn a traditional fund distribution model, all intermediaries between the investor and fund manager can operate independently. Many may only communicate with the next chain in the link. When they do communicate, it is likely through email correspondence, or, for certain operations, even fax or post. This creates inefficiencies.
AllianceBlock seeks to create a fund protocol which hosts all of the required activities on one platform. This allows for greater operational transparency and efficiency. KYC is far from the only process that can be completed on the platform. Book-keeping entities such as depositories and digital custodians can more easily maintain records of transactions. Data processors benefit from the clarity in data governance and privacy. Issuer-investor entities can issue digitized assets to approved investors with faster processing times and cheaper transaction costs.
4. Future proofing
We do not know what new regulations may come into force, which investment channels people may ultimately prefer, nor what new firms will enter the industry. However, with the AllianceBlock protocol, we can code in new regulations as they change. Any regulated investor can be onboarded, while the protocol can be adapted to new forms of technology that may change the fund management process. It is also backwards compatible, and easy for existing institutions to plug in.
5. Enable managers to concentrate on their fund activities
The AllianceBlock protocol seeks to remove the responsibilities emphasized and allow fund managers to concentrate on what they should be doing; generating outperformance for their investors.
ALBT tokens are the backbone of the AllianceBlock ecosystem. ALBT token is a multi-purpose utility token designed to be facilitated across various AllianceBlock platform features. The token is the main medium of exchange for services and assets on the platform. Investors, institutions, and fund managers will pay in ALBT for a variety of services. Investment funds integrated with AllianceBlock will cover the network costs with ALBT tokens when distributing assets from a fund, account, or individual security to an investor.
ALBT token will be utilized to cover network fees for the following services:
Distributions From Mutual Funds — allocation of capital gains, dividend, or interest income generated by the fund for the investors
Stock and Bond Distributions — distribution of payment of interest, principal, or dividend to the shareholders or bondholders regularly
Investment Trust Distributions — distribution of the income generated from an investment trust
Retirement Account Distributions — Distributions from a traditional individual retirement account or retirement plans
Exchange of assets — upsized, reduce and rebalance of the investment bucket
Algorithmic investment advice — An automated advisory platform generating algorithmic trading strategies and intelligent investment advices
Communication with legacy systems — transmitting data via APIs to the external legacy systems
Administrate trade lifecycle — operational transactions regarding trade order, settlement, payment and post trade services
Custody — holding securities on behalf of the client
The fund distribution process is ripe for disruption. The challenge firms have is how they cope with an increasingly digitised process. Do they partner with a technology firm? Do they build out the infrastructure themselves? Do they acquire companies along the wider distribution chain? Or, do they participate in an open and digitised ecosystem, in which they can benefit from having all elements of the chain in one place operating on a platform which enables greater automation and reduces both duplication of effort and regulatory burden?
It is the latter which we believe offers the greatest potential for fund distribution moving forward. Distribution is far from the only part of fund management operations we are looking to improve, but it is an important one, especially as fund managers look to generate alpha in a congested marketplace that will only become more competitive. Through this, we further our vision to bridge the two worlds of TradFi and DeFi, unlocking trillions of dollars in capital in the process.