CSDs forced to defend their existence in a DLT world

Joseph Lubin describes CSDs as “conceptual construct” that can take a decentralised form, forcing Euroclear to defend their role.

By Jonathan Watkins

The founder of Ethereum doesn’t see the need for central securities depositories (CSDs) to exist in their current format in a financial system based on distributed ledger technology (DLT).

There is a broad consensus amongst the post-trade industry that blockchain technology will revolutionise the custody and clearing world and could radically change how assets are maintained and stored by custodians and CSDs.

A decentralised DLT system could, for example, remove the need for a market infrastructure provider to hold a security, or token in its own physical or electronic vault, while also potentially allowing real-time settlement.

While the full disintermediation of market infrastructures has been played down in recent years as start-up FinTechs look to partner with incumbents, there remains some debate about the future roles of certain players.

“A CSD is a conceptual construct and has a physical manifestation because that’s what we know how to build,” said Joseph Lubin, founder of ConsenSys and widely known as one of the founders of Ethereum. “It can continue to exist as a conceptual or logical construct, but it can take on a decentralised implementation. Global financial institutions can get together, define a protocol and build that system, but there doesn’t need to be a central physical clearing house or implementation of a central database; it can be realised as a series of nodes on a decentralised network.”

Recognising the threat of blockchain to their current services, CSDs across the world have been working together and with regulators to develop blockchain technology in the post-trade sector and establish their future role.

We exist for a reason

Some believe the involvement of CSDs in a governance and operational role could help increase trust of investors, and raise the quality of the ecosystem infrastructure underpinning these new asset classes. CSDs could become a ‘custodian of the code’ ultimately playing a similar role in ensuring safety and oversight within the system.

Pushing back at Lubin’s suggestion, Walter Verbeke, global head of business model and innovation at Euroclear SA/NV, said that ultimately the market looks to CSDs for safety and efficiency, something investors need to feel comfortable, even in a DLT world.

“As a CSD we are not a service company, we were created by the market,” said Verbeke. “A capital market has inherent risks: counterparty risk, liquidity risk, there’s credit risk, settlement, legal risk, there are so many risks but they are not inherent to securities as compared to another asset class, they are not inherent to a market infrastructure be it a trading venue, clearing venue or settlement venue, they are inherent to the capital markets.”

“Capital markets have created CSDs to mitigate some of those risks…In a distributed world you need to organise around roles, and controls and governance systems and ensure the same type of safe and efficient environment.”

In a world where securities and other assets become tokenised, some have argued that an intermediary will still need to issue them and create rules.

Natural remit

Verbeke said that CSDs are aware that some duties will fall to them and others won’t.

“Some of those roles will fall into our natural infrastructure and we have made our mind up that other stuff is out of our league,” he added. “Our natural remit could be anything around safety, notary role, when you want someone to say ‘this is yours’.”

A new white paper from Deutsche Bank this week highlighted that Europe’s data protection laws and the incoming CSD Regulation (CSDR) might also have a significant impact on the implementation of DLT in the post-trade area.

“CSDR mandates that the ultimate record of ownership of securities is to be maintained by a CSD. Only allowing CSDs to issue or process securities transactions clearing restricts the use of blockchain for this purpose,” Polina Evstifeeva, head of regulatory strategy, GTB chief digital office, Deutsche Bank told Global Custodian.

The core value of blockchain is that it is decentralised and transparent, but the white paper outlines these values could also conflict with data protection laws, which focus on the importance of allowing personal data to be removed or edited.

However, the white paper does not rule out the implementation of blockchain by CSDs, and rather suggests the technology can be implemented through a hybrid model in which the CSD can either operate a blockchain platform itself to perform the book entry role, or it can continue to perform this role off-chain, with the third-party blockchain platform accessing those records held by the CSD via an API (application programme interface).