Could the Blockchain solve the collateral conundrum?

As the financial industry continues to tackle the challenge of collateral management it is only natural for a range of solutions to be touted as the ‘savior’ of said troubles.

As the financial industry continues to tackle the challenge of collateral management it is only natural for a range of solutions to be touted as the ‘savior’ of said troubles.

One such phenomenon is blockchain, the cryptographic ledger system stemming from the Bitcoin revolution and heralded by many in the industry as there future of finance.

Blockchain is a chronological order of all Bitcoin transactions recorded in a public ledger in order to keep track of records. It is decentralisted, allows quick transactions and allows people to send Bitcoin in a cheaper way than you can send most currencies.  

So this technology has sparked interest, especially in the banking world. You’d be hard pushed to find a major financial institution that hasn’t begun looking into blockchain technology, while many have made substantial investments. Santander, UBS and Goldman Sachs are just a few who have been public about their blockchain ventures.

Now let’s look at the issues surrounding post-financial crisis collateral requirements. The movement, cost and availability of collateral headlines the market’s worries, so could the transparency, cost efficiency and speed of blockchain technology help?

“The decentralised ledger process and the immediate nature of transaction processing would certainly bring a lot of efficiency to collateral management,” says Philippe Ruault, head of solutions for settlement, clearing and custody, BNP Paribas Securities Services. “We think blockchain has the potential to make processes more efficient and faster.” 

New regulations are forcing major changes and advancements in the collateral world. The requirements for increased margins and the central clearing of OTC derivatives have spurred new technologies and offerings across the market.

The door is open for new solutions and technology providers to capture market share and this has led to much industry discussion and collaboration. So could blockchain be the answer to the industry’s problems?

A study co-authored by Santander this year predicted that blockchain technology could cut $15bn-$20bn a year from banks’ infrastructure costs.

“An interesting application of this could be around enhancing the velocity of movement of securities, enabling financial institutions to mobilise collateral to back up their trades more quickly,” adds Ruault.

“The blockchain comes with additional characteristics such as traceability, or the option to hardwire conditions into transactions, which have interesting applications to the concept of collateral management.”

BNP Paribas is just one of the custodians looking into this technology, others who have been vocal are Deutsche Bank, SIX Securities and also collateral management provider the Depository Trust and Clearing Corporation (DTCC).

“Collateral management is a critical topic now because the volumes of business at stake are huge, new regulations are introducing increasing complexity, and new technologies are on the cusp of disrupting the processes that enable the market,” Ruault continues.

“While this technology is exciting, it is still in its infancy. It is too early to say whether it is scalable enough/cheap enough to be implemented on a wide scale. We have a number of proofs of concept in the works, all centred around how blockchain technology could be integrated into our core infrastructure.

“The idea is to assess how this technology could be integrated into the core infrastructure of a custodian to facilitate the movement of securities and their safety. We are at an exploratory stage - the legal, risk and even technology environments are currently not production ready.”