Confidence, Transparency, Complexity: This Is How the Buy-Side looks at Digital Assets and ESG Investing

Among those who do hold digital tokens (utility tokens and asset-backed tokens), less than one in ten currently trades more than 80% of their holdings on regulated marketplaces. Overall, respondents estimate that just 54% of their digital token holdings are traded on marketplaces with regulatory oversight.

In other words, almost half of the respondents’ volume of digital tokens is being traded in the dark. The shortage of regulated venues that offer digital tokens could be slowing progress towards greater institutional adoption of digital assets.

If availability on institutional platforms and marketplaces is the main hurdle, then technological advancements, regulatory oversight and sound risk management are the main accelerators of adoption. This includes smart contract standardization, which has a considerable role to play (see graphic below).

Confidence in the way that digital assets (including cryptocurrencies) are traded was consistently cited as a key driver to greater adoption – with over 60% of respondents pointing to a desire for a safer trading environment. This was supported by a belief that a regulated exchange would provide such an environment. A quarter of respondents (25%) said that reduced counterparty risk would be the key driver in their adoption plans; while a fifth (20%) mentioned greater availability of institutional exchange-traded offerings; and another 15% said that regulated venues for trading and listing would help to push their plans forward.

When buy-side companies were asked what they expected from a regulated platform for digital assets, increased transparency was the most common answer. In fact, 42% of respondents identified transparency as the key role such a platform should play (see graphic below). Meanwhile, a third (32%) were explicit that increasing growth potential of the market is where a regulated exchange can make its best contribution. With its unique position, the regulated exchange for digital assets has the capacity to provide visibility, security, liquidity, and ultimately instill confidence in the industry. Echoing the desire for greater confidence, a fifth (21%) attributed the most important role to mitigating counterparty risk.

It’s another indication that it is not necessarily a concern with the digital assets themselves or blockchain technology that is holding buy-side companies back from increasing their current allocation levels. Instead, it is a focus on the potential to increase institutional governance and management of this infrastructure that supports them. There is space here for experienced exchange and market infrastructure operators to make the trading, settlement, and custody of these exciting assets both more accessible, and more secure, underpinned with the appropriate application of blockchain technology.

A majority (55%) of the respondents indicated that they would be more likely to trade digital assets if they were held by a recognized, traditional custodian.

Compared to digital assets, the ESG space is much further along its development curve, which was clearly shown by the level of take-up revealed in the research. The challenges that are felt by buy-side companies are more varied, with several different, equally complex issues to contend with.

Regarding the challenges to overcome when implementing an effective ESG investment strategy, asset managers agreed that all of the following were of almost equal concern (see graphic below): the availability and quality of ESG-related data; complex reporting requirements and impact at portfolio and asset levels; accurately analyzing the ESG credentials of an asset; risk/return considerations at portfolio and asset levels; and talent availability and expertise to assist in decision making.

This represents a broad range of challenges that could prevent ESG investing from reaching the buy-side’s stated growth ambitions. However, it is also an indication of how far the investing principle has come: Respondents understand the space and recognize the various barriers to fully and consistently integrating it into their portfolio.

As a result, companies are demanding more from their technology and data vendors. As volumes rise, the strain on operational and analytical processes will inevitably intensify, resulting in a need for greater automation, quality, and access to expertise.