First mover advantage

The Australian Securities Exchange (ASX) has been the first adopter of blockchain technology for its equity post-trade infrastructure. Will this move resonate with other clearing houses, and is this the time to embrace blockchain?

Blockchain had its first major foray into the clearing and settlement process with the announcement last December that the Australian Securities Exchange (ASX) will replace its legacy CHESS equity clearing platform with distributed ledger technology (DLT) developed by Digital Asset. Full deployment is set to go live by 2021 but participants are already taking note.

While Digital Asset’s technology has not yet been proven to scale, the potential benefits are many. According to ASX, the technology should provide greater market efficiencies through better record keeping, reduced reconciliation, more timely transactions and enhanced data quality.

“The changes ahead will lead to innovation in new products being available to investors opening up further offerings and the potential for further offshore investment into Australia,” says Johann Palychata, head of blockchain, BNP Paribas Securities Services, which is an investor in Digital Asset and consulted on the ASX project.

“This will provide the opportunity to challenge the inefficiencies in the end-to-end value chain and the removal of redundant processes making the market a lot more streamlined, efficient and flexible, especially in terms of timings and ability to change.”

Palychata believes the project could set off “a wave of similar projects elsewhere if the promises of the new technology are confirmed.”

A legitimate claim?

Beyond improving efficiencies—therefore reducing cost—proponents believe that the implementation of blockchain could enable central counterparties (CCPs) to develop new revenue generation opportunities.

“The immediate benefits of DLT to the mitigation of system risk, and the reduction of costs associated with the reconciliation process are just the beginning,” says Chris Church, chief business development officer of Digital Asset. “As DLT solutions move into production, we could start to see market operators and participants examining revenue generating opportunities, such as the creation of new products and services, which are only possible because of shortened trade processing and settlement times.”

Church says that Digital Asset is working with several other central security depositories (CSDs) and CCPs on deploying more blockchain projects. It is the “single source of truth” that blockchain provides which, he hopes, will reduce systemic risk. The push to blockchain is also likely to come from investors using central clearing houses.

Palychata says institutional investor interest will grow when they have analysed how the new system could allow them to optimise their trading strategies and funding models, and how they can interact with exchanges to provide them with the available data in the quickest timeframe.

The idea of cost reduction through an improvement in efficiency makes sense, but it has to be balanced with considerations of implementation expenditure.

Significant costs

According to Suresh Kandula, director of technology at Sapient Global Markets, the initial costs of ASX’s DLT implementation are likely to be significant. “If I have to compare this to equivalent North American platforms and what it would take to modernise those, it would be between three to five years and it could cost up to $150 million, possibly more,” says Kandula.

“That figure does not include all the settlement banks, intermediary technology platforms and whole set of ecosystem of vendors to make changes to their own platforms, supporting newer interfaces and messaging standards. For example, as part of this project ASX is considering ISO2022 along with replacing or augmenting more expensive SWIFT messaging.”

Furthermore, there is a likelihood of continued external costs. “Because blockchain is based on open source, it can be less expensive,” says Monica Summerville, senior analyst at Tabb Group. “However, a lack of in-house expertise raises risks as the entity is more reliant on its outside providers, whether these are suppliers or consultants.”

EuroCCP, the European equities clearing house, is currently looking at new approaches to solving post-trade inefficiencies with the use of DLT. Diana Chan, chief executive at EuroCCP, says the cost of DLT is likely to be similar to other technology integration.

“Our experience is that it is neither costlier nor cheaper than any other integration,” she says. “We have a modern development environment and blockchain services can be integrated in the same environment that we use for our regular IT development.”

The company is still in the early stages of blockchain analysis but, says Chan, the hype around DLT has spurred FinTech innovation and is worth looking at. In future, she believes that DLT could be used to solve current post-trade inefficiencies, such as improving the collateral transfer process.

Large and complex project

“One area in which blockchain seems promising is voting rights and annual general meetings—as it is a well-defined problem with limited automation today, there is a potential business case to apply blockchain to these processes,” says Chan. “It will be interesting to see how this solution will evolve. With regards to post-trade processes the same applies, if there is a problem to solve and a business case for it, blockchain might be the solution.”

The Depository Trust and Clearing Corporation (DTCC) has been looking at using blockchain for specific parts of its post-trade business for some time now. DTCC announced last year that it was working to build a DLT solution for its credit derivatives post-trade processing business based on its existing Trade Information Warehouse (TIW) capabilities.

The initiative, one of the industry’s largest and most complex DLT moves to date, had been expected to launch in early 2018. However, this has now been put back to 2019. The delay is related to increased testing and development of the project—implementation of nascent technologies cannot be rushed, by all accounts. Yet, despite the time extension, DTCC remains confident that the implementation of DLT should boost efficiencies.

According to Jennifer Peve, DTCC managing director of solutions business development and the office of FinTech strategy, DLT has the potential to address the limitations of existing post-trade processes by streamlining and simplifying the siloed design of the financial industry’s infrastructure.

“There are several key features that make this technology a potentially attractive option to improve existing processes, including the fact that standard rules exist for securities transaction validation and replication, immutable linkage to transaction history and auditability,” says Peve.

Infinite possibilities

But it is not a panacea. While at a conceptual level, the function of netting and clearing could be carried out using DLT, the cost and risk considerations of the ledger model need to be balanced against the existing efficiencies of current infrastructure, which for many is highly robust and cost-efficient, says Peve. Indeed, the application of blockchain technology to clearing and settlement will need to mature in order to meet the requisite volume demands and efficiencies delivered by the current model, she adds.

EuroCCP’s Chan agrees and says there is a long way to go before blockchain becomes universally adopted in the clearing and settlement world. “It is not likely to become the go-to solution for clearing and settlement in the foreseeable future,” she says.

ASX’s trailblazing venture—and indeed DTCC’s when it is completed—appears to be more relevant to help larger clearing intermediaries looking to streamline post-trade processing right now, if not all the way to settlement. Kandula says that progress is likely to be incremental and will apply to bits and pieces of post-trade processing starting “two-plus years from now” taking at least five years and more to be ubiquitous.

“The [DTCC] TIW project aims for automated record keeping, lifecycle events, and payment management for more than $11 trillion of cleared and bilateral credit derivatives,” says Kandula. “It will be a stretch to imagine that the entire post-trade lifecycle would be using blockchain technology, but, it will be an evolutionary process.”

Full blockchain implementation is perhaps more pertinent for those with ageing or legacy clearing and settlement technology.

“It especially makes sense where the current infrastructure reaches obsolescence or in areas that lack market infrastructure,” says Palychata. “For instance, we are also investigating use cases for derivative contracts or non-listed instruments that do not benefit today from the same level of automation than listed products.”

As with any new hyped technology, there is also the further challenge of harmonisation with regulatory standards. “It’s unlikely blockchain will completely decentralise clearing and settlement in the near future, as there are many political, legal and structural issues to address,” says Summerville.

“But what I do expect to see is more centralised structures applying DLT technology. Eventually, I imagine that as DLT technology evolves and is used more widely in other industries, the market will become more comfortable with the concept of decentralisation, and with some current DLT technology issues addressed, the clearing and settlement will eventually be seen as essentially redundant.”

DTCC’s Peve agrees: “We believe it is too early to predict the extent to which DLT can be applied to clearing and settlement. Any market infrastructure provider looking to apply DLT to an existing process should collaborate and implement best practices to prevent technology silos from being created, which could lead to the same reconciliation and interoperability issues experienced today.”

The future of clearing is open to infinite possibilities but it will require patience to get there.