The global banking industry is changing as rapidly and decisively as it can keep up with the technologies. And one technology that is emerging fast is that of blockchains, which some believe will do for transactions what the internet did for information.
By Annie Gray
Commercial blockchain solutions are rapidly being adopted throughout banking and financial markets, dramatically faster than initially expected, according to two new IBM studies. The studies found that 15 percent of global banks and 14 percent of financial market institutions interviewed by IBM intend to implement full-scale, commercial blockchain solutions in 2017. The studies say that mass adoption isn’t that far behind with roughly 65 percent of banks expecting to have blockchain solutions in production in the next three years.
So, what is blockchain?
IBM’s head of blockchain for Australia and New Zealand, Michael Aaron, says that blockchain is a protocol that comes from the world of mathematical algorithms. Essentially it is highly secure shared ledgers where participants write transactions in near real-time to an unbreakable chain that becomes a permanent record of an asset or transaction.
He says it is the ability to share a ledger and parties agree to lock that transaction down and it can’t be changed. Within a business network you can share the ledger which improves the process and flow between the participants.
It’s like a digital database that each person participating can work on and update. He sees it as protocol or standard to enable businesses to automate their business network.
Aaron explains that IBM, for instance, has a lot of suppliers and if there is a dispute over any link in the finance or supply chain, it could take up to 44 days to address. But with blockchain, each of the participants can see their records and the shared record (whether it be agreement around the terms and conditions of the sale, the type of sales tax, etc) and there
is no dispute. Resolution has gone from
44 days to one day.
In a nutshell, says Aaron, it’s reducing any friction within supply chains or business networks that might slow
“Everyone is in agreement of what is in that shared ledger.”
In trade finance, there are many participants and mechanisms to enable trust such as letters of credit, bills of lading. Blockchain has the potential to reduce the number of mechanisms and change the role of some participants in the business network in how they enable trust.
It means players can trust each other directly because they are seeing the same information throughout the life cycle and that makes them more efficient.
At the end of the day there are four benefits:
- Reducing disputes, which reduces costs.
- Reduced risk as it can’t be tampered with.
- Closed shared record keeping increases trust within the business network.
- It’s a ’tool’ to be able to reengineer practices within a business network.
Another benefit might be in the provenance of goods. Aaron said in China, where food safety is hugely important, Walmart is working with IBM with blockchain and the internet of things piloting the tracking of pork from the pig farm through to the slaughterhouse to Walmart. In South America it is being used in areas where the title to land has been unclear for decades and in New Zealand it could be used for food provenance too, in organic food or our highly sought after Manuka honey.
The application of blockchain technology to trade finance is being investigated by a major Proof of Concept with banks, the Port Authority of Singapore and the Monetary Authority of Singapore.
In Japan, the Japanese Stock Exchange is looking at certain kinds of post trade settlement.
Aaron sees blockchain as being transformational in allowing business networks to increase their efficiency and bringing trust to a business network.
A media release on the banking studies, conducted by the IBM Institute for Business Value, says more than 70 percent of banking “trailblazers” surveyed, or early adopters, are prioritising blockchain efforts in order to break down current barriers to creating new business models and reaching new markets.
“These trailblazers are better positioned to defend themselves against competitors, including those untraditional disruptors like startup non-banks. For financial markets institutions, seven out of 10 trailblazers surveyed are focusing their blockchain efforts on four areas: clearing and settlement, wholesale payments, equity and debt issuance, and reference data.”
It also says that trailblazers expect the benefits from blockchain technology to impact several business areas, including reference data (83 percent), retail payments (80 percent) and consumer lending (79 percent).
“When asked which blockchain-based new business models could emerge, 80 percent of banks surveyed identified trade finance, corporate lending and reference data as having the greatest potential.”
The release says that says outside of early adopters, banks feel there are many barriers to success when adopting blockchain. According to those surveyed, the top barriers to success include regulatory constraints (56 percent), immature technology (54 percent) and lack of clear return on investment (52 percent).
The IBM study, Leading the Pack in Blockchain Banking: Trailblazers Set the Pace (1) is based on a survey of 200 global banks. A second IBM study, Blockchain Rewires Financial Markets: Trailblazers Take the Lead (2), is based on a survey of 200 global financial markets institutions.
For currency markets, it seems like volatility and uncertainty is the new normal. Between the Swiss Franc crash last year, the Brexit-sparked 12 percent fall in the British pound over a single afternoon and even the New Zealand dollar’s flash crash in late August 2015, we’re peering around corners looking for the next event to derail the global economy, according to Phillip Lindberg, foreign exchange manager at OM Financial.
He says this means New Zealand businesses need a prudent approach to foreign exchange risk management if they’re going to get anywhere and that hedging FX could be one way to save the day.
“If you are lucky enough to operate in a market where you can pass through any costs to your consumers, then you probably do not need to consider hedging,” Lindberg says, adding that companies with a product that moves in line with the exchange rate might also be able to avoid hedging.
“However, if you operate in a market with competitors that have a hedging strategy and you do not, it could potentially put you at a competitive disadvantage if your bottom line is being eroded by the value of the New Zealand dollar.
“Whether you are an exporter that is distributing products into international markets, or a manufacturer that imports materials for production, the value of the dollar can wreak havoc on your bottom line.”
Recently, the value of the dollar has meant that importers have performed well, while exporters have felt the pinch. Even though it has been relatively stable in 2016, Lindberg says that when you’re on the wrong side of a 15 percent range, it’s going to be painful. However, it is possible to take advantage of New Zealand’s current status as an appealing investment option to make a significant benefit to your business’s bottom line.
“Where companies or individuals often get it wrong is by how they strategically approach their business management. The issue should be ‘how’ to hedge, as opposed to ‘should’ I hedge.”
Common hedging mistakes
A common approach to hedging is by using forward exchange contracts that allow you to lock in a price today for conversion at a future date. However, Lindberg notes that many companies don’t do this the right way.
“The mistake that is often made is preferring the use of forward foreign exchange contracts for 100 percent of your exposure.
“The hedging approach of using only forward contracts can expose a company to a number of risks – if orders get cancelled, or product is lower than forecast, or the price of the underlying fluctuates from that assumed, then there is the potential to leave the company in a position of being over-covered.
“When this happens, the company is either forced to close their foreign exchange positions out at current market rates or roll their positions – potentially at a loss – forward to a future date. Either outcome is less than desirable.”
Another approach to managing foreign exchange is the ‘do nothing’ approach, whereby companies only exchange currency at market rates.
“This exposes the company to all the vagaries of the markets,” Lindberg says.
“Interestingly enough, both of these approaches are often cited by companies which say they do not want to take a view on the market. It is difficult to see a more aggressive market view than locking in your entire FX risk through forwards, or putting your head in the sand and hoping.”
So if these open up your risk, what is the right way to hedge?
“A more balanced approach to hedging is starting with a risk neutral stance of being 50 percent hedged, and 50 percent unhedged. From that point you can build a hedging strategy that combines forward foreign exchange contracts and foreign exchange options to provide surety, but also allow flexibility to benefit from future foreign exchange moves.”
Lindberg, who has been involved in foreign exchange markets globally for the past 30 years, is still surprised by people’s aversion to using foreign exchange options because they are deemed too expensive.
“We are conditioned to paying premiums to insure our houses, our cars, and even our health.
“Foreign exchange risk should be no different, and when combined with traditional hedging techniques, can provide a flexible way to protect and enhance cash flows.”
In times of volatility, it is important to be able to protect your bottom line and keep the business growing. Hedging FX – done the right way – can set you on the path to financial stability, no matter what happens in global currency markets, he says. (content supplied)