Blockchain – Progression in securities markets?
Blockchain solutions for payments seem about a dime a dozen. BNY Mellon’s Tom Casteleyn explains the latest DLT trends impacting securities.
Blockchain or Distributed Ledger Technology (DLT) solutions in the payments world seem about a dime a dozen at the moment. But less is heard about bringing blockchain to the securities industry, even though current securities post-trade processing holds a large amount of inherent risk. Of course, the generic promises DLT brings regarding cost savings and efficiency gains whilst reducing risk remain the same across both industries. But is blockchain technology a viable solution for the securities markets? Does the industry want to move forward with DLT and, if so, how will this progress from use case to business case? What are the challenges to overcome and what opportunities lie ahead? These issues were discussed at the ‘Blockchain – From use case to business case in securities markets’ session at Sibos in Toronto this year, and SWIFT interviewed Tom Casteleyn, Head of Product Management for Custody, Cash and FX, from BNY Mellon to provide an overview of key topics and concerns going forward.
Blockchain and Securities: Areas of potential change
Whereas the life cycle in payments really only consists of a transaction and balance, followed by the payment or debit of interest, the complete lifecycle of a security is a much more complex business involving a variety of different elements including income, tax withholding, corporate actions and voting (including proxy voting). On a purely transactional basis, the placement of payments on the blockchain, as opposed to securities, is much more straightforward.
In terms of the securities industry, however, there is a broad agreement that blockchain can provide scope for potential change in two main areas, including:
- Improvement of current post-trading processing: This involves applying DLT technology to one small part of the overall post-trade process, evaluating any potential efficiencies and eventually evolving from use case, to proof of concept, to business case. Examination is underway, for example, of how corporate action notification or voting (including proxy voting) can be undertaken on the blockchain.
- Transfer of non-automated, non-centralised assets: There are two approaches to dealing with assets on DLT; (a) the creation of a digital or crypto-asset that only exists on the distributed ledger (such as with Bitcoin or other cryptocurrencies), or (b) a tokenised version of assets that exist simultaneously in the real world. Once tokens of assets are placed on DLT, the whole post-trade chain can then be mimicked on the blockchain, from instructions, to settling, to servicing of the assets. Accordingly, much of today’s focus is on building out a life-cycle on blockchain for the types of assets that currently exist within a non-centralised system, such as gold trading, trading of loans or trade finance activities.
“The benefits of blockchain come to fruition when there are multiple parties working together on a process that is today relatively non-automated, for example, within a chain where the information needs to be shared with multiple parties and there is no current, logical, automated protocol in usage,” explained Casteleyn. “A blockchain solution would work well, therefore, in areas such as corporate action notification or voting, including proxy voting, because each of these involve extremely cumbersome manual processes that by nature carry a lot of inherent risk.”
A blockchain solution would work well, therefore, in areas such as corporate action notification or voting, including proxy voting, because each of these involve extremely cumbersome manual processes that by nature carry a lot of inherent risk.
Tom Casteleyn, Head of Product Management for Custody, Cash and FX, from BNY Mellon
Challenges: Transition and timing
One of the biggest challenges facing the industry in widespread uptake of DLT in securities processing is moving from a promising proof of concept to the next stage of production-quality implementation. The current transition period means that, unless every player in the transaction chain of that particular process has joined the DLT, both legacy systems and new DLT infrastructure would need to coexist side-by-side, meaning any benefits from DLT would not be truly realised and cost of operating could even increase. The main challenge, therefore, is not with how the end-state looks, but how to move from today’s position to that end-state. Questions arise, for example, of how long that transition will take, and will the benefits of the end-state make up for all the increased costs and build-out of running two parallels for an unknown length of time?
“On paper, the identified benefits could be huge and there are some industry studies that have come up with quite incredible numbers. But all of these assume that we will directly move from the world that we're in today to a world where the entirety of that process is put on DLT,” elaborated Castelyn. “The problem is, not what the end-state will look like, but what the intermediate state looks like while we are moving away from the current ecosystem to that end-state. Indeed that end-state may never be completely reached.”
The increased costs and build-out involved with running two parallel infrastructures in this transition phase pose many difficulties, including:
- Having the bandwidth to work on a new system: Building out a complete new infrastructure requires significant investment over a long-term time horizon, added to the fact that much of the focus of late has been on other priorities, such as adapting to the new regulatory agenda.
- Creation of a viable business case: Ensuring that the business cases work, and within an acceptable timeframe.
- Cultural element: Blockchain by necessity means that you have to deal with a consortia of other institutions, yet there needs to be one party who is willing to be a bit of trailblazer to get things truly moving. Because the post-trade industry is well-known as being conservative and slow-moving (with good reason, because it is dealing with so much risk within a finely-balanced ecosystem), it is not easy to take up the role of trailblazer, convincing others (including the regulators) to follow your lead.
- Regulatory element: During the Sibos sessions there was general agreement that any industry move would need to be done in conjunction with the regulator, meaning that the regulator would de facto determine the pace of change.
“One point that keeps arising during the blockchain conversations at Sibos is the parallel between implementing DLT systems with the completion of the European securities settlement engine TARGET2. This was a project that required the build-out of a new technology platform by a large group of interested parties (including participants, CSDs, and national central banks), as well as agreement on a common set of standards,” said Casteleyn. “TARGET2 securities is here today and has largely fulfilled its mandate, but it has taken ten years to do so, even though it was being driven by the European Central Bank and supported by regulation. So even in that scenario, where the right ingredients of push and pull existed together, it still ten years down the line from when the technology and legal framework were already in existence. If that is a proxy of how hard it will be to implement DLT, then we are in for a long process.”
The benefits that blockchain can bring to the post-trade securities industry could mean the introduction of efficiencies into today’s system laden with cumbersome, manual processes and a great deal of inherent risk. The ecosystem that we have today in terms of recording and processing assets has evolved over many years. The securities laws and regulations will have to continue to evolve in lockstep with the industry itself, as well as the role of technology solutions, so as to come up with some viable alternatives - not an easy process.
The consensus at Sibos was that we are still at least 3-5 years away from a big industry change. But that does not mean that DLT technology is not proving itself in more discreet and defined parts of securities post-trade processing, such as gold or corporate loans. Progress is being made on implementation of DLT no doubt, but we should remember that this will be at the pace of the post-trade securities industry, rather than the pace of a FinTech startup.