DLT in Capital Markets [2/6]: KYC / due diligence use case

Within capital markets, the business onboarding process requires careful assessment of a number of criteria to decrease business risk/exposure and to limit the possibility of risk contagion in the investment lifecycle. This due diligence process requires collecting and validating client’s or service provider’s information and has to comply with “know your customer” (KYC) regulation when it comes to investors’ onboarding. It is also important to note that the collected data are evolving over time and therefore part of the same process is re-initiated regularly.

The ISSA’s article “Inherent Risks within the Global Custody Chain” gives an overview of the risks at stake and the types of data to collect from various typical Capital Market actors: custodians, market infrastructures, (institutional) investors, etc.

This KYC/due diligence process generates a significant administrative burden for the onboarding and onboarded parties:

Costly and time-consuming processes:

• The necessity to collect various documents which are not necessarily immediately available at the onboarded client
• Manual processing of the collected information, including validation processes
• Mainly email-based communication

Redundancy of the process:

• The onboarded party needs to go through the same process sharing the same information each time it engages with a service provider

Recurrent process:

• The onboarded and onboarding parties need to update the information on an ongoing basis

The proposed business solution is a DLT platform integrated with (or built as an extension of) a legal entity identity (LEI) register/identity register. The KYC/due diligence information will be stored, validated, and maintained on a shared record according to defined workflows involving both the onboarded and onboarding parties, enforced by smart contracts.

Once the KYC/due diligence process is finalized, the shared record can be made accessible to any other capital market actor willing to engage with the same entity, and could even be integrated with tax automated processes (e.g. related to a financial transaction or income/corporate event), specific disclosure automated processes, or regulatory reporting/oversight activities. Access to the shared record can only be done under strict consent provided by the onboarded company.

As each market, service type, or financial product type has its own specificities and risks, the solution will enable different standardized but customizable data templates and workflows. KYC/due diligence duality may lead to distinguished workflows but running on a (portion of) common data set.

Figure 1 illustrates an implementation supporting the KYC process to onboard investors in the investment industry.

Figure 1: KYC workflow example — transfer agent/ManCo’s KYC process

The benefits such platform can generate are multiple:

For onboarding companies

• Reduced cost, time to revenue, and effort of compliance by leveraging pre-validated data
• Improved due diligence and compliance processes as main KYC/due diligence data validation is performed by independent parties over time
• By building the solution from the LEI register (or equivalent identity ledger), foster a progressive standardization of the KYC/due diligence process by market/market niche/service type
• Higher transparency facilitating client’s due diligence process

For onboarded companies

• Reduced time to investment/hedging opportunities or fundraising opportunities (especially valuable in a context of higher market volatility)
• Control over own data sharing
• Seamless onboarding experience
• Facilitating the communication of any change in own data
• Better management of the risk linked to the service provider

We see this KYC/due diligence solution as a logical next step of the wider LEI implementation and a structural step to create a fluid but risk-controlled access to a high variety of markets. The advantages it generates in terms of cost reduction and customer experience for both the onboarding and onboarded organizations should push its adoption.

The KUBE project led by the fintech ISABEL in consortium with four Belgium banks and implemented with the help of IntellectEU is a good illustration of the above mentioned concept and shows the way for moving-on.