Know your customer: Blockchain’s perfect use case
Could the decentralised nature of blockchain technology reinvent KYC utilities of the past? Sanne Wass investigates.
While tech enthusiasts often prophesy blockchain as the solution to all the world’s problems, there is one use case where trade financiers in particular hope it will be the next big game-changer: know your customer.
KYC regulation came into sharp global focus after the 2008 financial crisis and is rightly an important measure to fight financial crime. But ask any banker and they would more often than not point to this requirement as the number one culprit slowing down business.
It’s a job that is extremely inefficient and mired by time-consuming and labour-intensive manual processes and the duplication of efforts. The figures speak for themselves: some major financial institutions spend up to US$500mn annually on KYC and customer due diligence, according to Thomson Reuters. Its 2017 survey found that the average corporation spends 26 days a year to provide KYC regulatory information, up from 23 days in 2016.
The KYC utility emerged as a solution to ease the burden: a shared service or repository in which multiple institutions can manage and share due diligence information.
In theory, these utilities eliminate the high level of duplication currently happening in the market. The model saves each bank having to reach out to its clients to gather the information individually, and saves customers who have already provided their information to a participating member from having to supply it again.
A range of players are already pursuing this strategy. In the correspondent banking space, Accuity’s Bankers Almanac Due Diligence Repository has been providing “a single, central source of the primary documents required to conduct due diligence checks on your correspondent banks” since 2004. Today the utility includes 23,000 banks and has over 630,000 documents available.
A more recent competitor, Swift, entered this space in 2015 with the launch of its KYC Registry. Of Swift’s 11,000 members, 7,000 have correspondent banking activities and are therefore the target of the registry. Around 5,000 have joined so far.
Meanwhile, other firms have explored a similar KYC concept for sectors such as retail and corporates. IHS Markit’s KYC.com, for example, provides banks with KYC information on corporates, asset managers and hedge funds. Thomson Reuters has a similar offering.
Regional solutions are also emerging. In July, the African Export-Import Bank launched its customer due diligence platform, called Mansa. Focused on Africa specifically, it hopes to “end the subjective evaluation of customers and eliminate the perceived, and often unfair, risk in trading with African counterparties”.
It followed the announcement in June by five Nordic banks – DNB Bank, Danske Bank, Nordea, Handelsbanken and SEB – that they, too, are developing an “efficient, common, secure and cost-effective utility” to simplify customer onboarding and information exchange.
Blockchain’s new proposition
But despite a lot of activity in this space, many KYC utilities struggle to gain industry-wide uptake and become an integrated part of bankers’ due diligence processes. According to the ICC’s global trade survey 2018, over one-third of banks do not use a KYC utility due to cost, operational considerations and the challenge of complex technical integration.
Others deem existing utilities inflexible and, in light of new technologies, a model that may well go extinct sooner rather than later.
“Past attempts to create KYC utilities have focused on centralised repositories of data, managed by third-party vendors acting as an intermediary between banks and their customers, which can in turn create significant inefficiencies,” Abbas Ali, director of partner solutions at blockchain firm R3, tells GTR. “These utilities also force standardised KYC policies upon their customers and the one-size-fits-all model does not work for competitive financial institutions.”
Enter blockchain. Promoters of this new, decentralised technology say it can provide a modern and more viable way forward for a truly global, efficient and secure KYC utility.
As opposed to centralised solutions, this new technology eliminates third-party data aggregators and centralised repositories of data. Instead, it utilises the power of the distributed, immutable ledger to drive greater operational efficiency through a digital process flow and a streamlined way to access real-time up-to-date customer data. Through blockchain, any participant in a network will, with the right permission, be able to view a record, and the blockchain will give them full transparency on how information is entered, by whom and when it was verified.
“Blockchain’s immutability used as a new verification mechanism, and its peer-to-peer nature enabling greater data privacy, are two of the native features that have attracted many in the KYC sector to blockchain,” says Tim Coates, US blockchain lead at Synechron, an information technology and consulting company.
He made the comment in July when announcing that the firm had trialled a global KYC utility on the Corda blockchain platform, together with R3 and 39 banks, firms and regulators.
Thanks to blockchain, the parties involved in the trial say they are now “reworking the KYC utilities of the past”. Their solution works as a “self-sovereign” model, allowing corporate customers to create and control their own identities, including relevant documentation. In a post-GDPR world, this data sovereignty is key.
Through this model, Ali explains, they are giving participants “much more control over their own identity and how it is managed”, allowing for “direct, bilateral relationships between a bank and its customer”.
“Historically, the KYC problem has only been addressed from the perspective of the banks,” he says. “That’s been one of the issues in adoption: no one actually took the end-user, the corporate’s pain points, into account.”
The new model is one that has drawn attention from banks everywhere: according to Ali, R3 has seen increased demand from its ecosystem (which today includes more than 200 members and partners globally) for exactly that type of utility. He says its clients simply believe centralised solutions will “seize to exist”.
“We think there is a limited role for someone providing an intermediary service in that solution and that it can be enhanced and made more efficient with technology,” he says. “Our prediction is that in the next five years, the industry will move towards decentralised solutions for customer identification and onboarding. Traditional utility models will need to adapt to changing market dynamics.”
A commercial advantage
R3 and Synechron believe that the use of blockchain technology will make their solution more appealing to the industry than previous utilities. Their latest trial was the third in a series of pilots that the two have conducted for a KYC solution on Corda. The previous pilots ran under the names Leia 1 and 2.
“The feedback has been extremely positive, and if you need evidence of that you can just look at the numbers of banks that participated in each of our successive projects. The first was 13, the second was 14 plus six observing members, and the third was 39 organisations,” Ali says.
Each pilot, he adds, clearly demonstrated the efficiencies blockchain can bring to the process. “We estimate the onboarding time for a large corporate, which can take up to a month or more as per the most recent Thomson Reuters KYC survey, will be reduced by over 50%. That means a bank can start doing business, opening accounts, issuing credit to their customers in just a week or two as opposed to four.”
R3 is not alone in the ambition to bring blockchain-based KYC utilities to a market in dire need of a revamped solution. A number of fintech startups, such as Cambridge Blockchain and Tradle, are each working on similar applications.
Tradle, a firm founded in 2014 and based in New York, is currently rolling its KYC platform out in production in New Zealand with its first customer, after having tested it with seven financial institutions in proofs of concepts and pilots. While Tradle’s platform caters to a broad range of sectors, the startup will start to focus on the trade finance space when it kicks off pilots with a big African bank shortly.
Speaking to GTR, Gene Vayngrib, CEO and co-founder of Tradle, says he is convinced that a decentralised model can make the trade finance sector more agile and significantly speed up the time it takes to set up a deal.
The main goal, he adds, is to help banks turn compliance pain into a commercial advantage for the banks, which can now serve their customers better.
“The majority of the conversation in trade finance is that KYC is such a pain and that it’s stopping business,” he explains. “The way we approach it is: it’s a commercial advantage. The information is sitting in a silo and we are taking it out of the silo and making it available for commercial business. Now two companies that are KYC’d by different banks can engage in trade much faster.”
Threatening existing players?
Meanwhile, the idea of a blockchain-based KYC solution is met with cautious interest from established players. Bart Claeys, Swift’s head of the KYC registry, tells GTR that KYC “seems like the perfect use case for distributed ledger technology”, but argues that it doesn’t yet solve the real issues faced by banks today. The challenge, he says, is that blockchain initiatives have thus far been driven mainly by technology rather than compliance.
“For us, at this stage, I haven’t yet seen the value addition of the distributed ledger technology (DLT) related initiatives compared to what we have in our centralised solution,” he says, bringing up a widely expressed scepticism in the industry: can technology alone get banks onboard and make them want to work together towards better KYC?
“In my view, a lot of these initiatives have been initiated from a technology perspective, yet today little has been said around the level of acceptance from a compliance perspective within the banks. Ultimately, be it a DLT-based or centralised utility, you will be required to have the backing and support from the compliance side within each of the banks,” he says.
He emphasises that Swift is “not just a technology provider” but a trusted third party that has played a crucial role in standardising the information provided to the registry – addressing the challenge faced by financial institutions that KYC lacks a global standard.
Plus, he says, Swift is also providing an additional quality label on the information submitted. “One piece I find very instrumental for a centralised solution and for the whole KYC concept is the notion of information verification. We check every KYC profile that a bank is submitting onto the registry for completeness, accuracy, consistency and validity. And we report the quality of this information back to all of the participants looking at the information,” he says.
Whether blockchain will in fact mean the end to centralised solutions is impossible to say at this point. Theoretically speaking, there is no doubt blockchain and KYC could be a good match – and Swift believes this too. Claeys says the firm is following the blockchain initiatives in the market “very closely”, but also hints at other technologies, such as APIs, as a possible way to make the registry more efficient.
Perhaps the question is rather how long it will take before the technology can provide a real alternative to the centralised options that we see today.
So far, at least according to Swift itself, its registry is proving successful in its current, centralised form: not only are more banks signing up; they are also putting in efforts to institutionalise it in their business processes.
As Thomson Reuters sums up in a recent report on blockchain-enabled KYC solutions, blockchain may “conceptually” provide “the perfect platform to deliver an automated, secure, trustworthy KYC solution”. But, in itself it “cannot solve all the industry challenges surrounding KYC”.
Referring to challenges around governance, accessibility to the infrastructure and trust in the technology, it concludes: “The hurdles which would prevent such a platform from achieving success are similar in nature to those faced by the managed service providers in this space. In short, lessons need to be learned if we are to avoid a false dawn.”
R3 and Synechron’s KYC trial in short
- The four-day collaborative trial took place in May and saw the completion of more than 300 transactions on an application designed and built by Synechron on R3’s Corda blockchain platform.
- It enabled the 39 participants, which included the likes of ABN Amro, BNP Paribas, Deutsche Bank, ING and Société Générale as well as regulators and central banks, to communicate and manage test customer KYC data across the network.
- Operated as a so-called “self-sovereign” model, corporate customers can create and control their own identities, including relevant documentation. Banks can request access to the data, whilst customers can approve requests and revoke access. Any updates that are made become automatically visible to banks with permission to access the data.
- The project is among several KYC applications that are currently being tested on Corda, with R3 expecting to see its first product implementations by early 2019.