As a wave of new technologies crashes into traditional business models, banks are asking what needs to be done now and how relevant is it to the business. On the topic of blockchain, or distributed ledger systems, it’s a question of when, not if, said panelists at the Association for Financial Markets in Europe’s (AFME) annual European liquidity conference.
One speaker described distributed ledger technology as a simple data architecture. It allows for a decentralized view of common data, which banks have been “historically bad” at leading to ‘multiple inefficient processes’ like settlement, for example. Blockchain, however, gives “one source of the truth”, updated and near real time, and could be used to create collateral or securities ledgers, for example.
“As soon as we agree to transact at the execution layer, that ledger would be updated fairly promptly, hopefully. And you can imagine, therefore, that all those post trade processes within the bank, and even custodial services, would be challenged or even redundant,” he said. In the case of a collateral ledger, it would be possible to have a common, shared view about where collateral sits, who owns it, and whether there’s permission to rehypothecate, for example.
Over the next couple of years, he predicts that both tier one and tier two banks will continue to invest in what is currently an “eclectic mix” of blockchain research – from specific niche solutions to post trade reform on a significant scale. Strategy is being determined as well. Banks are asking themselves – do we want to be leaders? Providers? Is this a pure P&L play? Or do we just want to be part of a consortium and keep our fingers on the pulse?
Parallel to this will be initial proposals around market standards, which he said might be in part a “defensive play” from CSDs and custodians: “You can see how this technology could potentially erode some of those providers…(of) settlements and custody. But there would be a role where they could be a central guarantor, or register, or just policing the whole blockchain construction.”
“There is probably a role for some sort of market structure like master key holder, owner, register, that could administer access controls and decipher the keys for the benefit of the market, but also as an extra regulatory window if you will,” he added.
Still, it’s going to take time, he said. Part of the waiting game has to do with a history of banks not playing well together when trying to come to terms with a new utility-like structure. Another part is a question mark over how regulators might handle it. One source from a major bank said: “From a purely technological view, absolutely, that’s a one- to two-year view. But (not) from an implementation into the financial markets (view), especially (where) a lot of government agencies have a big say – and they are the slow ones.”
As a case in point, he noted the ‘tonnes’ of data regulators are currently figuring out what to do with in the post Trade Repository regulation era: “The DTCC data was completely useless.” Another panelist agreed that there are many regulatory questions yet to be addressed, but it’s going to happen quicker than people realize.
The only way that banks can extinguish liabilities among themselves is by transfer of gross time real settlement services or some interbank money, the panelist explained. In FX, there’s CLS, which can take up to 24 hours. A blockchain, on the other hand, can “demonstrably” do that same thing in five seconds: “Just figure how different the world would be if we could settle transactions in five seconds?”
Sceptics would say that such realities won’t exist for other kinds of financial products, like swaps, which can take years to settle. Right now, banks will have ledgers for FX, bonds and equities, for example – all marginally different. But the moment standardization takes hold, assets can be swapped really easily: “The ability to change the liquidity positions of major banks is going to be a gigantic cost savings, I think you will be able to see some really changes come down that pipe.”
The analogy, the panelist said, is to remember what happened to world trade after the shipping container was invented: “That’s going to be a revolution, and that’s why I think it’s going to happen much quicker.”
