Alex Powell is a Senior Financial Services Professional working in Capital Markets, Exchanges, Asset Management and Asset Servicing Sectors. He has served as a Partner at Accenture and Ernst & Young and has line management experience as a former COO for HSBC Securities Services. He is currently advising an early stage FinTech start-up. Alex has written a guest blog on behalf of the JM Group which looks at the application of blockchain technology in financial markets. Part 1 focuses on payments and post-trading processing. Blockchain in Financial Markets
Over the past couple of years there has been considerable activity in financial services examining and applying blockchain technology, or sometimes described as Distributed Ledger Technology (DLT). This activity does not yet live up to the media hype, but nonetheless the industry has gone from thinking that blockchain is the same as Bitcoin to a general acceptance and understanding that this new technology will form an important part in the technology arms cabinet. Furthermore, there is considerable investment in blockchain for real world applications in regulated markets. I am interested in the real world applications in Financial Services for blockchain and have been working with one of the more established blockchain technology companies for some time, deploying and considering use-cases in financial services.
What is blockchain technology?
But first to get everyone on the same page if you are not so familiar with what blockchain actually is. Blockchain is a chain of transactions which is agreed by a wide group of participants and which is recorded in a replicated and distributed manner. A blockchains integrity hinges on strong cryptography that validates and chains together blocks of transactions, making it infeasibly difficult to tamper with any individual transaction record without being detected.
Source: Financial Times
So where are the applications in financial services?
Each firm in each industry sector is reviewing what could happen and here is my synopsis of what they are saying, and importantly what I am actually seeing and hearing about. Here I shall cover payments and post-trade processing, the first areas which have sparked interest and where huge cost savings will lie from deploying blockchain technologies.
Many banks have looked at the wholesale payments space. Some (e.g. Unicredit) are working with Ripple Labs who use a DLT at the core of their international payments offering. BNY Mellon, Deutsche Bank, Santander and UBS the latter of which first disclosed its work on a so-called "settlement coin" last year are hoping to launch a commercial-grade blockchain system by 2018, with blockchain start-up Clearmatics. The settlement coin will be used as the cash payment leg of a securities settlement transaction. Santander introduced a pilot payment system amongst staff in July 2016. Central banks are also looking at using blockchain for central bank money. The Bank of England has openly discussed and explored issuing a digital currency using blockchain, while the People's Bank of China is reportedly investigating the idea and the Swedish central bank, the Riksbank, may also look at this. And lets not forget the crypto-currencies. Bitcoin is widely used as a means for payment, though I am not aware that it is used in the wholesale markets. Bitcoin is so established, that exchanges are compiling indices and listing futures contracts on Bitcoins e.g. CME CF Bitcoin Real Time Index (BRTI).
securities settlement A blockchain provides a shared ledger which is well suited to the transfer of title of assets. A good application of blockchain technology is to the settlement (exchange of ownership) of securities and derivatives following trading. There is a lot going on in the securities settlement space, most notably many proofs of concepts by banks, Central Securities Depositories and exchanges; a launch by the Nasdaq stock exchange (Nasdaq Private Market); an initiative with good funding SETL and Digital Asset Holdings who are working with the Australian Securities Exchange . The benefits of changing the existing securities settlement systems provided by the Central Securities Depository (CSD) and Target 2 Securities to a blockchain based environment would be enormous. Benefits include near instantaneous settlement rather than T+2/3, the removal of the need for clearing and reduction in reconciliation costs. However, the barriers to adoption are very high and it is not something a single institution can do on their own. Therefore banks are looking at other smaller areas that can produce a result internally or with a limited number of participants or clients. Derivatives processing This year, the Depository Trust & Clearing Corporation (DTCC) announced that it has selected IBM, Axoni and R3 to create a blockchainÂ framework to improve the derivatives post-trade lifecycle. It looks like it may eventually replace the DTCCs current Trade Information Warehouse (TIW). It is developed with input from Barclays, Citi, Credit Suisse, Deutsche Bank, J.P. Morgan, UBS, Wells Fargo, IHS Markit and Intercontinental Exchange. It will build on Axonis AxCore distributed ledger protocol which will be submitted to the Hyperledger consortium when the solution goes live, anticipated in early 2018. Clearmatics and OpenGamma demonstrated a proof-of-concept showing how two counterparts can collectively value, in real-time, a portfolio of FX swaps using blockchain technology adapted from the Ethereum codebase. Asset servicing Banks are looking for smaller areas where they could deploy blockchain technology on post-trade areas in support of settlement, which is a much larger topic. I have come across use cases such as proxy voting (which would have to bring together different market participants: custodians, issuing agents) and syndicated loans administration. Collateral management Current collateral models will be severely impacted by blockchain settlement existing cash and collateral management models will no longer be required because trade and settlement could be practically instantaneous. The need for collateral could almost be eliminated. But this is a huge step which requires real time gross settlement across all securities, which would be a fundamental shift away from current operations.
Depositories and transfer agents are looking into how issuance could be made directly onto a blockchain. Stock transfer and Registrar Company Computershare and British start-up firm SETL have teamed up on a project to create an immutable record of securities ownership using blockchain technology in Australia. Corporate actions could be integrated into a securities ledger on a blockchain and then execution of the action could happen via a smartcontract which updates everyone's shareholding. And as everyone is using the same shared ledger, custodians, investors and the company registrar do not have to update their own system.
Part 2 of Alex's blog continues next week.
Contact: firstname.lastname@example.org or https://uk.linkedin.com/in/alexapowell References: DTCC Embracing Disruption (post-trade focused) http://www.dtcc.com/news/2016/january/25/blockchain-white-paper Euroclear and Oliver Wyman Blockchain in Capital Markets (excellent input from Euroclear experts) https://www.google.co.uk/url?sa=t&rct=j&q=&esrc=s&source=web&cd=4&cad=rja&uact=8&ved=0ahUKEwjTmraC663RAhXMExoKHaMyCwwQFgguMAM&url=http%3A%2F%2Fwww.oliverwyman.com%2Fcontent%2Fdam%2Foliver-wyman%2Fglobal%2Fen%2F2016%2Ffeb%2FBlockChain-In-Capital-Markets.pdf&usg=AFQjCNECjxE2iaAlqj20WhbOyyOvcxZgzA Santander Innoventures Fintech 2.0 https://www.google.co.uk/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0ahUKEwi7n7ar7K3RAhXKmBoKHRcfBV4QFgggMAE&url=http%3A%2F%2Fsantanderinnoventures.com%2Ffintech2%2F&usg=AFQjCNEHKQm-EsDY-nL2juhLWWLaxdmEoA ESMA Discussion Paper: The Distributed Ledger Technology Applied to Securities Markets https://www.esma.europa.eu/sites/default/files/library/2016-773_dp_dlt.pdf