Blockchain allows the same information to be shared by different players in real-time and cannot be modified without the consent of all – it is as simple as that. When it comes to the capital market, most articles on this topic explore how to use this technology to solve the problem of real-time reconciliations between banks, counterparts, CSDs (central securities depositories), and CCPs (central counterparties). But is this really the problem that banks need to solve today? Will it bring profitability back to their capital market business, or could distributed ledger technology be the better solution?
A Solution Falling Short?
Imposing a standard in blockchain on the market, obtaining regulators’ blessings and deploying the technology within the ecosystem could take years (anywhere between 5 to 10 years, even). The TARGET2-Securities platform, for example, started in 2008 and was supposed to be implemented in 2015 in France, Germany, Italy and Spain. Eight years on and they’re still working on it.
Aren’t there more pressing problems? Banks’ trading margins are shrinking. Their trading infrastructure is mostly outdated, complex, very expensive to maintain, and reduces competitiveness. Executives are asked to lower their spending on operations and technology. Don’t these problems seem familiar?
Defining the real problem is the first step towards solving it. This is how the trading infrastructure in the capital market generally looks now (although this is not representative of all systems and locations):
It is characterised by high support costs due to the sheer amount of inter-connectivity in the model, high failure or error rates, end-to-end testing being very difficult, the cost of upgrades being very high, and the cost of ownership being high due to complex connectivity to external environments.
So it is important to stake a step back and look at one of the major challenges in the capital market: reducing the cost of operations and technology. When it comes to reducing the cost of infrastructure in the capital markets, the idea of having one system that does it all is a utopia. And whatever solution there is out there, experience showed that its TCO (total cost of ownership) is prohibitive.
What Can Be Done?
“R3CEV, the largest blockchain consortium of banks and technology firms including multi-billion dollar institutions such as Barclays, Credit Suisse, Bank of America, Citibank and HSBC, has seemingly admitted defeat and moved on from blockchain technology development.”
Ralph Merkle, Cryptography Expert
The market used blockchain and distributed ledgers (DLT) for a long time referring to the same thing in capital markets and promising a revolution. Now, after R3CEV’s announcement, the market is effectively saying it inadvertently misled people, that these are two different things, and that it meant at least for capital markets to use other distributed ledgers instead of blockchain technology. In other words, the market admitted that blockchain technology is not ready to solve the challenges faced by capital markets.
They are, however, insisting that distributed ledger technology can. But how exactly? Until now, no one is approaching it in such a way that a solution can emerge quickly. Every article and experiment looks promising for about 8 to 10 years from now. By then, who knows what other technology will be revolutionising capital markets.
Why It’s Still Delayed
- Players need to agree on one standard (and there are difficulties in competitors agreeing on one standard).
- Regulators in different countries would need to adopt this standard.
- Financial institutions have to re-architect their infrastructure in order to meet it.
- Software vendors have to revamp their solutions in order to comply.
The objective is to have a practical solution using distributed ledger technology (DLT) to reduce the capital markets’ operating costs in the coming 2-3 years – rather than in a 10-year time frame.
Distributed Ledger Technology: A Lasting Solution?
When a trade event is to be recorded, in real-time, the following departments are made aware of the event: risk, collateral, treasury, back-office, finance, compliance, credit and audit. If the event creates an issue within any of these departments, then the corresponding department rejects it and the event is cancelled or put on hold.
That is what all these expensive, heterogeneous and complex interfaces between the systems of the trading infrastructure are trying to achieve.
Using distributed ledger technology internally has huge benefits for financial institutions, including:
- No need to wait for one global standard;
- No need for regulators to approve everything;
- The cost of maintaining complex interfaces between systems is reduced;
- The cost of internal reconciliations is reduced.
What if, instead of banks joining forces, the major vendors in capital markets (such as Murex, Misys, Calypso and FIS) joined forces and created a DLT layer that can cross-communicate with their solutions. It is known for a fact that the majority of banks use a combination of these solutions – mainly Murex in front-office and risk, with Calypso in back-office.
This would confer several advantages:
- There would be no need for cross-country green lights from legislators
- No need to select a standard from hundreds of companies fighting to impose one
- No need for complete re-architecting of infrastructure.
If these vendors agree to create a consortium and find a common distributed ledger technology solution instead of fighting, at least in this space, financial institutions will follow and cost reduction will be quasi-immediate.
Combining the above with a standard target operating model (TOM) for post-trade operations will allow further cost reductions. This can be done today – there is no need to wait ten years until a standard emerges and regulators sign off on it.