Industry should ‘be cautious’ about Blockchain impact

Blockchain has the potential to disrupt certain facets of capital markets, but its overall impact should not be overestimated, according to panellists speaking at the Discover 2015 Conference, hosted by BNY Mellon Pershing in London.

Financial institutions such as custodian banks and market infrastructures have become excited of late about Blockchain, a sequential transaction database, which is in effect a digitised distributed ledger obviating the need for a centralised ledger. It is also the technology that underpins the Bitcoin cryptocurrency.

A report by GreySpark Partners, a consultancy – “The Blockchain: Capital Markets Use Cases” – said Blockchain could be used in payments and remittances, know-your-client (KYC) and anti-money laundering (AML) checks, digitised financial instruments, regulatory reporting, clearing and settlement and reconciliation.

“Blockchain does have the potential to remove market infrastructures like central counterparty clearing houses (CCPs) and central securities depositories (CSDs) but whether the industry and regulators allow this to happen is another question. It will be interesting to see if financial services’ organisations embrace Blockchain, but I do not expect to see substantial changes until well into the next decade,” said Alan Philpot, managing principal at Capco, a consultancy.

However, the Australia Securities Exchange (ASX) is currently in the process of replacing its existing clearing and settlement system – the Clearing House Electronic Sub-register System (CHESS), and Blockchain is one of the options, a point made by Scott Coey, managing director and head of broker dealer services EMEA at BNY Mellon Pershing. ASX executives have said Blockchain could cut administrative costs and reduce the risk of error. Furthermore, Blockchain should be safer as it is a distributed ledger and not centralised.

A handful of regulators have also quietly endorsed Blockchain. The Securities and Exchange Commission (SEC) acknowledged that Blockchain’s transparency and recordkeeping could make it easier for regulators to spot build ups of systemic risk. If financial transactions are recorded on Blockchain and easily accessible to regulators, it would negate the requirement for firms to report such information to regulators in highly forensic reports.

It would also reduce the risk that regulators get inundated with regulatory reports, something which market participants argue could result in the authorities failing to spot risk build-ups due to information overload.

“The challenge regulators will face with Blockchain is that if a problem did arise with the technology underpinning it, there would be nobody to punish as it is a distributed system. This is an issue that would need to be addressed,” said Virginie O’Shea, senior analyst at Aite Group.

Such disintermediation is unlikely to be welcomed by service providers, many of whom could find themselves being rendered obsolete. However, O’Shea is doubtful this will become an issue anytime soon.

“Disintermediation by Blockchain could be something service providers have to deal with in 20 years’ time. But will Blockchain replace clearing and settlement for equities in five years? No. If we look at advances in financial technology versus the rest of the financial services industry, then there is a dis-connect. Financial services moves slowly. If we adopt Blockchain, data standards will have to be set and settlement times will have to migrate from T+2 or T+3 into real-time. Given the billions of euros which the European Central Bank (ECB) has spent on Target2Securities (T2S), this is unlikely to happen anytime soon. Building the internal infrastructure to make Blockchain a reality is going to be a very costly proposition,” she said.

Nonetheless, market participants’ attitudes to Blockchain do need to change. One of the issues is that there is often confusion between Blockchain and Bitcoin.

A number of banks including HSBC, Morgan Stanley, Citi, Societe Generale, BNY Mellon and Bank of America Merrill Lynch have joined a consortium headed by financial technology firm R3 exploring a framework for using Blockchain in capital markets. However, Philpot said he did not envisage a workable Blockchain framework in the near term.