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Leading clearing houses join London Stock Exchange in exploring the Blockchain

A new working group has been quietly set up to explore post-trade distributed ledger technology, and it includes three of the leading clearinghouses; the heads of an industry that the blockchain appears to make completely obsolete.

A new blockchain working group has reportedly been created to explore how blockchain technology could transform the way security trades are cleared, settled and recorded. This group, working under the name ‘Post Trade Distributed Ledger Working Group,’ was created by one of the world’s largest exchanges, major banks and leading trading services firms.

The group will be lead by a steering committee, according to people familiar with the initiative, and three meetings have already taken place over the past few months, the first of which was hosted by the London Stock Exchange (LSE).

LSE“We believe that driving innovation and developing new products using this exciting new technology will significantly reduce risk and margin requirements while delivering the opportunity for deeper regulatory oversight.”
— – London Stock Exchange

The group states a belief that the blockchain has the potential ”to drive change across the capital markets industry,” according to the Group’s spokesperson. “In particular, it can help with risk management in pre- and post-trade.”

“The technology needs to be developed in a considered and rigorous manner, in partnership with clients, to provide the right service and benefit to them. Given our long experience in post-trade, our group has significant technical expertise to bring to the discussion.”
— – London Stock Exchange Spokesperson

This is not the first time financial institutions have expressed an interest in using blockchain technology to improve their business models. Earlier this year, 25 leading banks partnered with New York-based startup R3 CEV, including banking giants Société Générale and UBS. The R3 project seeks “to establish consistent standards and protocols for the technology in order to facilitate broader adoption and gain a network effect.”

David Rutter“We have placed an emphasis on working with the market from day one, and our partners recognise that a collaborative model is the best way to quickly, efficiently and cost-effectively deliver these new technologies to global financial markets.”
— – David Rutter, R3 CEO

This new working group claims to offer a different perspective, as it has a “broader range of members” and is not a “commercial venture.”

While R3’s partners are all banks, the working group has a diverse mix of members from various steps in the securities settlement process, which should provide a deeper understanding of how exactly the blockchain can help with settlement, clearing and reporting processes.

The participating firms include the London Stock Exchange (LSE) and it’s Clearing House (LCH Clearnet), Belgium-based securities settlement specialist Euroclear, and leading derivatives marketplace and clearinghouse CME Group. Joining them are the French and Swiss megabanks, Société Générale, and UBS.

LCH Clearnet is a European-based leading multi-asset class, independent clearinghouse that serves major international exchanges, in Europe, UK, Asia and the US, as well as a range of OTC markets. The company’s principal activity is the provision of Central Counterparty Clearing House (CCP) facilities and related services to clearing members.

Risk AwardMajority owned by the LSE Group, the company was named Risk Magazine’s 2015 and 2014 Clearing House of the Year, after winning for the first time in 2012. A significant part of what they do can automatically be done using blockchain technology, and is already done for bitcoin and bitcoin-based securities.

Joining in them is CME Group, one of the world’s leading and most diverse derivatives marketplace, which also operates CME Clearing, one of the world’s leading central counterparty clearing providers. The company offers clearing and settlement services across asset classes for exchange-traded contracts and over-the-counter derivatives transactions.

The company was named ‘North America Exchange of the Year’ and ‘Clearinghouse of the Year’ by Global Capital, a new Euromoney Institutional Investor publication.

This is not the first time CME Group has been reported as interested in blockchain technology, there are blockchain-based alternatives to nearly everything they do too.

Euroclear provides post-trade services, making it equally at risk for blockchain disruption. They currently connect over 2,000 financial market participants across the globe, specializing in the settlement of securities transactions as well as the safekeeping and asset servicing of these securities. As a leading international Central Securities Depository (CSD), Euroclear’s depositories cover more than 65% of European blue-chip equities and 50% of outstanding European domestic debt.

As blockchain technology gains in popularity, an increasing number of market participants are exploring initiatives in securities settlement, bypassing the need for a centralized ledger. Financial trades such as bonds, stocks or derivatives, could be transferred via the blockchain, circumventing clearing houses and settling in minutes, rather multiple days as they are currently.

This tiny settlement time has sparked interests from many financial institutions, including the number two stock exchange by market capitalization, Nasdaq. The exchange has many initiatives, including using the blockchain to settle trades on its private market and proxy voting.

UBS has also been actively exploring the blockchain in a variety of ways, both independently and as part R3 CEV. It is not surprising that the Swiss megabank has also joined this new working group. The bank has its own research lab in London devoted to studying the application of blockchain technology, including the idea of creating a settlement coin.

In response to the growing popularity of virtual currencies such as bitcoin, the European Central Securities Depositories Association (ESCDA) called for evidence of investments using virtual currency or distributed ledger technology, in April. While acknowledging that some of its members, including Nasdaq, saw potential benefits, ESCDA concluded that there are numerous risks, and most of the work at CSD level still remains “exploratory.”

European Central Securities Depositories Association“The threat to existing business models of securities, exchanges, CCPs and CSDs, is only secondary, and will probably only materialise if virtual currency players remain largely unregulated, i.e. if regulators allow these players to make use of a lighter regulatory regime to compete with existing securities infrastructure providers.”
— – European Central Securities Depositories Association

Surprisingly, while focusing more on the risks, ESCDA has also stated that the increase in popularity of virtual currencies can actually benefit CSDs and other securities infrastructures in some cases.

The Association cited an example from May, Nasdaq OMX Stockholm provided a certificate for trading which tracks the performance of bitcoin but traded in a traditional currency, the Swedish Krona. This instrument was the Bitcoin Tracker One, the predecessor of the newer, similar product, Bitcoin Tracker EUR. ESCDA stated that Euroclear Sweden settled this certificate like any other security.

As for the role of CSDs, in the event of the blockchain technology being used for settlement, the Association believes there is currently no good replacement for the traditional ways of settlement.

“In the absence of a ‘central register’ of investors, information on the holders of virtual currency assets is stored as part of the blockchain. This is not directly comparable to the notary and registration functions performed by CSDs, which are essential to maintain the integrity of the issue.”

While understanding that individual "miners" are collectively responsible for validating transaction data, ESCDA asserted that “there is no legal entity bearing responsibility for reconciling individual holdings with the number of total assets having been issued.” There is no management of potential discrepancies, which could “present a serious weakness in terms of investor protection.”

“The ‘safekeeping’ of virtual currency assets is done through accounts maintained in IT servers, without any ‘depositary’ entity being responsible for the central maintenance of these accounts. In this context, the protection afforded to investor assets by CSDs’ liability regime does not apply.”

Over in the US, the Depository Trust & Clearing Corporation (DTCC), a post-trade, clearing and settlement services company, has also been keeping an eye on blockchain technology. Michael Bodson, DTCC President and CEO explained that there are challenges to leveraging this new technology on a large scale, such as “guaranteeing strong investor protection rules, resiliency of systems, transparency, liquidity and proven capacity for processing very high volumes.”

Michael Bodson“The technology is intriguing and we are actively evaluating potential applications related to post-trade processing, but we cannot lose sight of the fact that market infrastructures have developed in order to not only lower costs but also to protect the stability and integrity of the marketplace and the system as a whole.”
— – Michael Bodson, DTCC President and CEO

Independently, the SWIFT Institute has also been investigating the blockchain’s impact on securities transactions. Swift, whose membership includes more than 10,800 banking organisations, securities institutions, and corporate customers in over 200 countries, recognized that the idea behind using the blockchain is the opposite of the current post-trade clearing and transaction model.

SWIFT Logo“In the securities transaction lifecycle, post-trade clearing and settlement is slow and expensive, involving many actors including global and local / sub custodians, central counterparties (CCPs) and central securities depositories (CSDs)… Blockchain and the distributed ledger have the ability to securely and transparently move securities in seconds or minutes, with automatic clearing and settlement upon trade execution.”
— – The SWIFT Institute

More and more of the companies and organizations who seem most likely to be disrupted by Bitcoin are trying to understand it. Only time will tell who will be left standing.


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