For some years, distributed ledger technology (DLT) has been touted as a game changer for capital markets, with the potential to disintermediate centralised market infrastructures. By enabling real-time, distributed access to a single source of truth and allowing for the storage of large sets of data against each record, for many, DLT holds the prospect of immediate settlement of transactions and the elimination of various points of reconciliation required along today’s post-trade lifecycle.
Combined with self-executing smart contracts, other processes such as the allocation of trades to funds could in theory be automated and streamlined, or eliminated altogether. All the while, advances in encryption would serve to protect the security and anonymity of transaction data.
Notwithstanding the fact that existing technologies offer many of these benefits today (T+0 settlement, synchronous notification), the arrival of DLT has nonetheless provided an opportunity for centralised market infrastructures such as Central Securities Depositories (CSDs) to reimagine their space, how they function and the potential to disrupt existing operational models.
So, what is the state of play of blockchain in relation to centralised market infrastructures, and what are the future implications for capital markets?
Rob Palatnick, Managing Director and Chief Technology Architect at DTCC, speaks of a fintech revolution, with growth in blockchain along with artificial intelligence (AI), automation and cloud computing – together signalling a sea change in financial market technology over the next decade. At the same time, however, he warns of the need for a careful assessment of the risks and rewards of new technology implementations during this time.
“In my mind, at least from a centralised market infrastructure perspective, blockchain is still a teenager. It needs to be tested before it matures,” Palatnick noted when I caught up with him recently at SIBOS in Sydney.
Alongside the maturing of these technologies, Palatnick also envisages the development of greater partnership ecosystems, with focused technology players and innovators augmenting existing institutions and infrastructures’ capabilities and business models.
“It will take time for the technology and supporting structures to be rolled out, and for appropriate standards and necessary governance models to be fully developed,” he said.
One key test for DLT is DTCC’s initiative to re-platform its Trade Information Warehouse (TIW). The TIW manages lifecycle events for 98% of the world’s credit derivatives, including payment calculations and settlement. Working with IBM, Axoni and R3, DTCC is currently transitioning the TIW from its existing mainframe-based platform to DLT and cloud. Industry testing with fifteen of the largest global banks is underway, which could enable the go-live of one of the world’s largest DLT deployments as early as next year.
“This is a prime opportunity to test the technology, to test governance models, to test out rules and permissioning around the technology within a defined market,” adds Palatnick. “DTCC is working closely with market participants to get this right, for benefits in the form of efficiencies and lower costs to industry to be realised.”
Ask when we might expect DTCC to look at moving settlement of US equities to DLT, however, and Rob becomes more circumspect. He notes the scale of the US market, and points to a recent benchmark study commissioned by DTCC to assess DLT-type technologies’ ability to handle the typical peak daily trading volumes of US equities that DTCC handles today. These stand at more than 100 million trades per day.
While the results of this recent study, conducted by Accenture with support from Digital Asset and R3, prove DLT’s performance can scale, the research only tested basic workflows. Additional work is needed for DTCC to determine if the technology can also meet the resiliency, security, operational needs and regulatory requirements of its existing clearing and settlement system at these volumes.
Hearts and Minds
In Australia, on the other hand, the Australian Securities Exchange (ASX) is moving confidently towards replacing CHESS – its 25-year-old equities clearing and settlement platform – with DLT provided by Digital Asset, the technology company headed by CEO Blythe Masters. Scheduled for deployment in 2021, the project comes after two and a half years of careful due diligence by the ASX board and management.
Speaking on a panel at SIBOS, ASX Executive General Manager for Equity Post-trade Services Cliff Richards spoke of a ‘hearts and minds’ challenge, noting the difficulty at times to focus local industry discussion on the benefits of the change, such as lower reconciliation costs, rather than the technology itself.
One of the key principles guiding ASX’s replacement of CHESS is that the new platform must provide issuers and investors “greater control over, and enhanced confidence in, their market activities through timely, secure and simplified access to the register of holders (for issuers), financial assets (end investors) and associated information.”
At the same time, ASX aims to accommodate potential future needs and promote further industry innovation through new levels of functionality, open standards and flexible technology.
To minimise disruption to the market, ASX will offer two modes of connectivity with the new platform. Users may choose to connect by sending and receiving messages in a similar way as they do today, or they may choose to operate a DLT node and interact directly. The change is expected to take place over a single weekend, during which cutover from CHESS to the new system will take place. Daily equity volumes processed by ASX typically range between 1.3-1.4 million trades per day.
In the longer term, however, ASX and Digital Asset envisage an ecosystem in which third parties are able to develop ancillary applications based on Digital Asset’s DAML coding language, such as managing rights issues and offering financial data-related services. Speaking at a morning briefing targeting locals and international peers during SIBOS, Masters and Richards spoke of DLT having the potential to be as transformative as the Internet.
In addition to the prospect of a single source of truth in order to lower reconciliation costs and enable more timely transaction processing, Richards even hinted at a role for ASX which places it at the centre of an even broader national ecosystem in which listed entities and other corporates might develop new applications of blockchain technology off the back of ASX’s platform to solve broader economic problems such as supply chain management. “We are just at the start, we are still shifting people’s minds,” Richards said in a separate SIBOS panel.
Privately, however, some local market participants seem wary, fretting about who will ultimately bear the cost of the new system, what the migration will mean in practice, and who will benefit from any new efficiencies. Indeed, this highlights a conundrum market infrastructures face: whereas historically they have been required first and foremost to provide stable operating environments at the lowest cost, recent technology advancements mean infrastructures are facing up to questions about whether there are in fact better ways of supporting and enabling capital markets.
There is also a prospect that, in some cases, these developments by centralised market infrastructures could instead disrupt the business models of other traditional service providers, such as custodians. For example, layered beneficial ownership data on a distributed ledger could potentially negate some custody and sub-custody arrangements, while other data management and analysis opportunities might open up different commercial opportunities for this segment.
DTCC’s TIW and ASX’s CHESS replacement projects are arguably two of the most advanced DLT projects in capital markets today. That the two centralised infrastructures are taking different approaches to the scale and pace of DLT adoption, speaks in part to key differences in each market.
Not only is the US a larger market – where DLT’s perceived scale limitations were a contributing factor to DTCC’s decision to focus on credit derivatives as its first major test of the technology, rather than equities post trade – but the Australian equities market is more vertically integrated than most markets, where multiple national and/or regional exchanges may exist separate to the CSD. Australia is also a fully dematerialised equities market.
Notwithstanding, both examples portend a future in which DLT starts to play a greater role in the provision of services by market infrastructures. Rather than disintermediating centralised infrastructure, however, it appears more likely that DLT will be used primarily within existing centralised ecosystems to support them.
Other market infrastructures in the region exploring DLT include Hong Kong Exchanges and Clearing (HKEX), which announced last month it is consulting on a Digital Asset-built prototype to address operational challenges relating to northbound investment into China via Stock Connect. In fund distribution and management, Calastone announced earlier this week it will move its 1700-strong client base to a DLT-based platform in May 2019. In Europe, Deutsche Börse has taken a minority stake in HQLAX, targeting the fragmented securities lending market and collateral liquidity.
While each is taking a different strategic approach to DLT, centralised market infrastructures increasingly seem likely to play a key role in maintaining these platforms and their governance, and permissioning access to them.
Longer term, however, successful global adoption of DLT and related technologies will be reliant upon harmonised standards and, most likely, interoperability between platforms. Other factors will include sanctioning by regulators and, of course, user acceptance.