I have just read an excellent paper, produced by Euroclear in conjunction with Slaughter and May, about blockchain settlement. I also have attended several meetings where, after an initial wave of untrammelled enthusiasm, the participants started to question the expectations they had attributed initially to this development.
I suspect that we are coming to an era of reality. I do believe, though, that we are at the cusp of a technological revolution within the post trade world which will allow us to reengineer the entire value chain. I suspect it will involve more application outsourcing and the emergence of a commercially viable solution to the distributed ledger. I would also envision increased use of artificial intelligence and smart contracts to fully automate the bulk of processing which is rule based. We should also see the convergence of conflicting market message standards or instrument identifiers and, above all, much more process harmonisation.
The big question is where to find the catalysts for such change. On the basis that cash is king, it appears logical to use the buy side buyer power, be it fund managers paying Bloomberg or Reuters, brokers paying Exchanges or securities services firms paying CSD’s to mandate a preferred champion for the different initiatives needed. Time is of the essence because the cost and revenue trends across the investment business are inexorably pointing to a squeeze on net revenue or, potentially in a serious market downturn, substantial financial operating losses even among the larger market players.
And we only have to look at an initiative like blockchain to appreciate the complexity of the task ahead. We can either have costly conflicting solutions or a dominant cost effective one.
The problem I see with many of the blockchain initiatives is that most are sponsored by a part of the securities field rather than being inclusive of the different parties in the entire value chain. After all, a single incidence of a securities transaction creates a blockchain and that needs to be reconciled to different views. The various interested parties may see it as a block trade, part of the fill of a larger block, a block to be attributed across a variety of holders, part of a larger portfolio holding in the security line in question or perhaps they will need to distinguish between its traded and settled value. Some may regard the ledger as their position in a security line, others as part of their wider investment portfolio and agents as part of their omnibus client holdings. Some may see it as a value to be traded. Other may view it as a value to generate cash and information flows, be it corporate actions, dividends, proxy voting and so on.
One of the scary aspects of blockchain in the post trade space is that it looks like a tax lot accounting surrogate, a transaction based item of information. We need some help to find how it will align with the view from the trading book, the portfolio or the custodian omnibus account.
But that is not the only open issue. We have a standards challenge. Reconciling BIC or RIC codes with ISINs is a need if the blockchain crosses over from the trading desk to the post trade world. Ensuring we have a global standard is another with SWIFT being the logical catalyst for many global OECD investors and intermediaries. However, there are other segments of the market, with powerful voices, who feel alien to SWIFT. And can SWIFT, the message standard as distinct from the network, operate under ISO rules with the speed of delivery that will be needed?And reporting, which fits logically to blockchain, will need agreement from regulators. And despite warm words and genuine encouragement from some, the bulk of that sector appears unlikely to adopt the new technology until it is much more of a proven and tested animal. Reporting between consenting commercial entities must though surely move to single ledger more quickly to eliminate the tedious, time consuming and high risk reconciliations and that search for the truth that mars the current landscape.
The Euroclear paper I mentioned also raised some interesting legal issues. At the operational level, they highlighted the need to coordinate a blockchain securities account and a Central Bank cash account if we are to retain Delivery versus Payment. Some Central Banks, among them the Bank of England, are being supportive about disruptive technologies. Others are quieter. And not only do we have the technical challenge around alignment of two blockchains in settlement, we will also have the control issue for Central Banks are loath to allow third parties the transfer rights over cash, their cherished financial tool. And blockchain creates further legal issues. How does one create finality in a blockchain? It is not clear what the legal status of a Blockchain will be as transactions can, and most likely will, be multijurisdictional. And PRIMA rules cannot prevail as the concept of blockchain does not accommodate the concept of a relevant intermediary. The cross border angle, raises further issues around interoperability, which is the mantra of the systemically concerned regulator and sits badly on the blockchain model.
For Blockchain to work, there are two approaches. There could be a multi local multi-functional approach. Or there could be a global approach which will avoid us creating a new spaghetti junction of Blockchain and associated applications or functions.
The prize is great enough for sensible solutions could eliminate perhaps half our costs. The challenge is great enough to need a new approach. The solution needs a powerful sponsor. It has to be a sponsor that can gain the confidence of global players, infrastructure, regulators and more. And, unlike much of the G20 work, which followed core common principles up to a point but differed on detail, this challenge needs common detail as well.
Faced with the challenges, the reality may well be that we will have multiple false starts, material duplicative effort and a barrier to true reengineering. Pragmatically, we need a powerful new entrant with a deep pocket, a true disrupter to bring the industry from its semi-automated mid-20th century structure to one more fitting for the 21st century!