Today New City Initiative is comprised of 43 leading independent asset management firms from the UK and the Continent, managing approximately £500 billion and employing several thousand people.
Published by Charles Gubert
The temptation to invest in digital assets such as cryptocurrencies and initial coin offerings (not to be misconstrued with Blockchain, which is the technology that supports trading in those very same digital assets) is a growing one for some asset managers whose revenues from traditional equities and fixed income are becoming increasingly depleted. While some asset managers see crypto-investing as a tool to attract interest from younger clients, an investor pool which many providers have found difficult to onboard, others see it as a purely speculative tool with little or no value.
The volatile returns available through digital assets are well-documented, as are its violent price swings, whose erratic daily movements often exceed the basic risk thresholds put in place at most regulated fund managers. Ripple’s price, for example, rose by 1200% at the end of 2017, while Bitcoin grew by 200%, only to fall precipitously since. Unlike conventional securities, digital assets remain something of a black box financial instrument, whose gyrating prices are dictated by broadly inexplicable variables.
For pension funds and insurers seeking out regular, predictable income streams, digital assets do not strike a chord. This, however, has not prevented a small band of pioneering, unconstrained fund houses – overwhelmingly hedge funds - from investing in digital assets with mixed results. Most regulated institutional managers are naturally less enamoured, preferring to stick with their tried and tested investment formulas, and for good reason.
The global regulatory response to the growth of these unconventional instruments has been haphazard, and arguably quite random. Unlike OTCs where global regulation is broadly synchronised, the market response to crypto-assets has been fragmented and confused. Some markets have decided to ban or heavily curtail digital assets, whereas others are not passing any legislation until they know more about the instruments’ modus operandi.
This absence of regulation and oversight from Central Banks and market authorities means there is extremely little in the way of protection for managers insuring them against losses and fraudulent behaviour. As these assets are not securities, there is no legal requirement for beneficial owners to be reimbursed for any loss of private keys held in custody as they are not covered by regulations such as AIFMD or UCITS V.
Ensuring that assets are kept safely with credit-worthy, well-regulated financial institutions and protected against external threats is an elementary requirement for anyone managing money. While the traditional custody market is well-developed, the existing safekeeping arrangements for digital assets’ private keys – at least at crypto-exchanges - can best be described as primitive and amateur.
Crypto-exchanges have repeatedly been hacked or compromised by cyber-criminals, with billions of dollars recorded stolen from such infrastructures over the last few years. While a handful of technologists are launching crypto-custody products for the institutional market, their solutions are untested, and none of these companies will have the balance sheet security and protections offered by a conventional banking provider.
Some bank custodians – conscious that their own business model is under cost-pressures – are in the early stages of developing crypto-custody products. They do – however – remain a minority, as client demand for such solutions has not yet reached critical mass. Unless the AUM of crypto-funds ramps up dramatically, the number of traditional custodians willing to provide the necessary services and infrastructure supporting digital assets will be limited.
Another hindrance is that digital asset transactions are conducted anonymously, meaning managers may find it difficult to ascertain if they are breaching sanctions or violating money-laundering or terror financing provisions. Given the chastening fines levied on banks recently for breaking sanctions or abetting money laundering, fund managers would be well- advised to avoid partaking in any transactions which put them at heightened regulatory risk.
It is possible – in the short-term – that some investors will ask their managers about whether they intend to diversify into digital assets given all of the recent hype and excitement. Until there is a more sizeable range of mature custody solutions and greater clarity and oversight from regulators about their treatment of digital assets, fund managers should exert patience and avoid rushing into these new instruments.