Major stock exchange completes blockchain trial for replacement settlement system

Australia’s largest Stock Exchange, the Australian Securities Exchange (ASX), recently published its Annual Report, revealing the company’s progress and near-future plans for its blockchain, or Distributed Ledger Technology (DLT), projects.

ASX is one of the world’s leading financial markets, with a total market capitalization of around $1.5 trillion. Employing a team of 530 people, their customers include 6.7 million share owners, 180 participants and, according to the annual report, 2,204 listed companies and issuers.

The company announced in January that it was going to develop solutions for the Australian equity market using blockchain technology. A partnership with Blythe Masters’ Digital Asset Holdings followed shortly after, with an investment of A$14.9 million in the US-based firm.

The exchange has now completed the initial phase of its DLT testing, and their blockchain prototype has “met performance, security and scalability thresholds.” The same technology is now being developed as a potential system to replace its 20-year-old clearing and settlement system.

"We believe that distributed ledger technology has the potential to change the way our market operates end-to-end, reduce risk and costs for our clients, speed-up the settlement process for investors, and support new services for listed companies. It offers a unique opportunity for Australia to be a leader in the assessment of innovative market solutions.”
— – Elmer Funke Kupper, ASX Managing Director and CEO

The current system used by ASX for clearing and settlement services is the Clearing House Electronic Subregister System (CHESS). As of the end of June 2015, CHESS held $1.64 trillion in securities across 1,948,631 account holders and 12,316,496 equity holdings. In addition to providing clearing and settlement, CHESS also electronically registers the share ownership on its secured subregister.

Finding a CHESS replacement has long been a topic of discussion. The Reserve Bank of Australia launched an extensive review of settlement practices following significant delays in the settlement of Australian equities on 29 and 30 January 2008.

A subsequent review of financial market infrastructure regulation, by the Council of Financial Regulators (the Council), raised the issue of competition in clearing and settlement. The Council subsequently invited the Australian Competition and Consumer Commission to work with the Australian Securities and Investments Commission, the Reserve Bank and the Commonwealth Treasury to further develop analysis on the competition aspects of clearing and settlement.

Following the release of a discussion paper in 2013, the Council and Australian Competition & Consumer Commission provided its conclusions and recommendations to the government.

“The Council recommended that a decision on any licence application from an equities clearing facility seeking to compete in the Australian market be deferred for two years, with the ASX required to develop a code of practice with its key stakeholders to ensure transparent and non-discriminatory access to ASX’s infrastructure.”
— – Wayne Swan, former Deputy Prime Minister and Treasurer

The ASX Code of Practice for Clearing and Settlement of Cash Equities in Australia, also known as the Code, came into effect on 9 August 2013. The Code sets out ASX’s commitments to establishing an advisory forum (the Forum) comprising ASX’s senior representatives and a wide range of other industry stakeholders that use ASX’s clearing and settlement services.

The Forum recommended two key strategic initiatives. ASX addressed the first early this year by introducing a T+2 settlement cycle for the cash market. The company is now concentrating its efforts on the second strategic initiative recommended by the Forum, replacing CHESS.

“CHESS continues to serve the Australian equity market remarkably well – and is still the envy of many of our global peers – but as a piece of critical post-trade infrastructure it is around 20 years old, “ ASX Deputy CEO, Peter Hiom, stated earlier this year. “ When we started considering how we might replace CHESS, we came upon blockchain.”

The company recently built a dedicated blockchain showcase space, called “acceler8,” in their Sydney headquarters. “It is one thing to talk about blockchain, but in order to really understand its capabilities, you need to see it in action,” Hiom states. The company’s annual report, released on Thursday, states that a blockchain prototype is working, a "potential replacement for CHESS will be developed through till 2018.”

Committing to the development of a blockchain platform, ASX also revealed a further investment in DAH, to USD $17.4 million (A$24.4 million), citing that DAH is “undertaking a project to develop a potential solution for ASX equity post-trade services currently performed by CHESS.”

“Over the next year, ASX and DAH will be collaborating with intermediaries, issuers, investors and other industry stakeholders, including Government and regulators, to understand the benefits and implications of deploying this technology in ASX’s equity post-trade environment.”
— – Rick Holliday-Smith, ASX Chairman and Dominic Stevens, ASX Managing Director and CEO

The final decision on the company’s post-trade infrastructure will be made in 2017. Only then will a blockchain solution progress into full production. If and when that decision is made, the company will start building its “industrial strength platform that could replace CHESS.”

Although ASX is the largest exchange to attempt a full clearing and settlement system replacement that uses a blockchain, Overstock.com CEO Patrick Byrne’s startup exchange t0 was the first to issue a security, in the form of a ‘crypto-bond’ over a blockchain. T0 was announced in late 2014 and has been open for trading just over a year. However, t0 is starting from scratch and has yet to gain momentum.

In May 2015, Nasdaq started investigating blockchain technology for its Private Market. The testing resulted in an exchange platform named Linq, which was demonstrated at the Money20/20 event in Las Vegas last October. Linq and blockchain technology provider Chain showcased how blockchain technology can “successfully complete and record a private securities transaction.” Nasdaq then claimed that Linq was the “first of its kind” to issue a security over a blockchain.