An increasing number of financial institutions and fintech companies are coming together to create consortia or shared utility service providers that will identify, design, build and provide emerging technologies like blockchain and the possibility of using decentralized, distributed ledger technology that can be accessed and used by market participants to record information.
Rather than keeping its own record of numerous relevant events about a transaction each bank could instead, using blockchain technology, hold a copy of a ledger that is used to record this information according to a common standard, with every change in the information about a client, ownership to an asset traded or action performed between participants recorded in each copy of the ledger held by those participants. So the potential benefits of using blockchain to ensure that transactions are recorded accurately, that contracts are automatically performed according to their terms and that information about clients has been provided correctly by every market participant are clear. However, there are a number of challenges for any consortium trying to launch this technology to overcome.
Building a Consortium and Establishing the Benefits from Participating in it
Defining the objectives of the consortium and the role that each member will have in its success can be difficult to establish, with each participant often having different and competing interests. While some financial institutions will try to influence the consortium in that way so that the outcome will satisfy their particular standards and legal requirements, others may focus more on the potential financial return resulting from the successful exploitation of the technology. Still others may have joined to obtain a seat at the table. Service providers meanwhile may be interested in creating, marketing and launching the solution as quickly as possible in order to establish themselves as the preeminent players within the industry, to maximize the return on their investment and to expand their business into other areas with or without the partner banks. These differences can often create tension over the direction and operation of the consortium between members. To keep this system functioning properly it is very important to clearly define the rights and obligations of every participant in a memorandum of understanding executed at the start of the project.
Establishing Ownership and Exploitation of the Technology
Agreeing who will own and will be able to exploit the developed technology is critical to the success of any initiative. While the foundations of blockchain and similar technologies may be built on open source software which allows quick and free development, the project consortia will frequently require their members to contribute their own software, materials and know-how to the project, which may result in complex and thorough negotiations between the participants regarding the use of each other’s intellectual property. Otherwise consortium members risk losing control over their intellectual property, with rivals potentially able to use it to develop, monopolize and exploit the technology created from it, to the detriment of the contributing participant and others in the industry and the success of the initiative.
Understanding the Regulatory Environment in which the Technology will Operate
As banks and other financial institutions cannot outsource their responsibilities to regulators, the understanding of how new adapted technological solutions can be used in compliance with the laws and existing regulatory framework is crucial.
For example, while blockchain may allow financial institutions to share, validate and update information about the identities of the ultimate shareholders of common clients, it is important to protect privacy rights of individuals in different countries, such as the right to object to the distribution of information about them and the so called “right to be forgotten”. Similarly, although financial institutions may be willing to share information about the identity of its clients, a bank may not be able to accept any liability to other banks for any inaccuracies in the information it has provided, preventing those other banks from relying on it for anti-money laundering, client onboarding and other compliance purposes.
A Look Ahead
So while there are many potential benefits of using blockchain and other similar technologies in the financial services industry, there are also a number of strategic and legal challenges which the consortia developing them will need to overcome.
A version of this article was first published in Financial IT on 7 December 2016 – https://financialit.net/pdf/view/11782