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UBS Prototyping Settlement Coin To Revolutionize Trade Between Banks

UBS Prototyping Settlement Coin To Revolutionize Trade Between Banks

The Swiss megabank is reportedly working on a currency backed altcoin, in an attempt to reduce settlement times. The move could potentially make the banking industry far more efficient.

The current process of trade settlement is slow, inefficient and expensive, but Swiss banking giant UBS may have a solution using blockchain technology. UBS is reportedly working on its own digital currency, referred to as a “utility settlement coin.”

“The development of this coin could be a key element in ensuring widespread adoption of blockchain-based platforms in the financial market”
— – Oliver Bussmann, UBS Chief Information Officer

The current process involves a number of intermediaries verifying each step of the process. Customers initially place orders with their brokers, who then execute them on an exchange. The funds then go through a clearing and settlement process, before finally being registered in a Central Bank account.

In the United States most markets settle in three days, T+3. In Europe most markets settle in two days, T+2. The move to T+2, during 2014, was so successful that other markets are considering doing the same in order to benefit from a harmonized settlement cycle.

Following the move, the Association for Financial Markets in Europe published a study on the positive impacts of implementing T+2, “The shortened settlement cycle of T+2 will contribute to increased efficiency and reduced risk in post trade.”

British multinational banking and financial services company, HSBC, stated that “T+2 will help foster a reduction of counterparty risk by moving trades more quickly to settlement, enabling capital to be freed up faster for reinvestment and reducing credit and counterparty exposure.”

“The move to T+2 and a shorter settlement cycle would mitigate counterparty risk for all industry participants.”
— – HSBC

In April, the US Depository Trust & Clearing Corporation (DTCC), a financial services company providing clearing and settlement services, recommended shortening the US trade settlement cycle, “After considerable industry input and discussion, along with in-depth due diligence that included risk and cost-benefit studies”

The DTCC revealed that there is demand for shorter settlement cycle among both institutional and retail investors,“Investment managers often request shortened settlements for portfolio securities to align the sale of portfolio assets with mutual fund share redemption transactions. Retail clients request shortened settlements to meet the demands of large purchases and tax payments.”

The corporation further recommended that there should be an investigation into the industry’s readiness and demand for a future move to a one-day settlement time, T+1. The industry looked into this possibility thirteen years ago, but the initiative was abandoned due to “competing priorities.”

Many financial authorities and institutions have also concluded that while shortening the settlement cycle would reduce risk, moving to T+1 would not achieve the same effect as moving to T+2.

“T+1 would not work due to the high use of paper and low levels of straight-through processing in the industry.”
— – Harmonisation of Settlement Cycles Working Group

According to UBS, its prototype coin will be linked to real-world currencies and connected to central bank accounts, meaning that within seconds after a trade the funds would be registered at a Central Bank.

Research by international management consulting firm, Oliver Wyman, states that the cost of clearing, settling and managing post-trade processes ranges between $65 billion and $80 billion a year globally. This cost can be  substantially reduced by using a distributed ledger system, according to a joint report from Oliver Wyman and Santander InnoVentures

“Our analysis suggests that distributed ledger technology could reduce banks’ infrastructure costs attributable to cross-border payments, securities trading and regulatory compliance by between $15-20 billion per annum by 2022.”
— –  Santander InnoVentures and Oliver Wyman Consultancy

Last October UBS Chief Information Officer, Oliver Bussmann, told Financial News that the blockchain had the potential “not only change the way we do payments but it will change the whole trading and settlement topic.” He further described the technology as having the biggest potential to disrupt financial services, and trigger “massive” simplification in banking processes and cost structure.

UBS has been exploring blockchain technologies for some time, and according to Bussmann, 20 to 25 potential uses for blockchain technology in finance have already been identified. “The limitation is scale. [The blockchain] still can’t handle the volumes that we handle in our traditional business,” Bussmann explained.

The bank is not the only company exploring blockchain technology solutions. Overstock.om CEO Patrick Byrne announced his new company in August, T0, designed to facilitate simultaneous stock market transactions. The UK High Street banking giant, Barclay’s, has also been exploring the technology in its labs in London.

UBS hopes that its new coin will be used to settle transactions on institutional financial platforms, which should also be built on blockchain technology. The bank plans to work with market participants such as buy-side firms, regulators, and market structure providers to create an industry-wide product. "Obviously we need to collaborate with other parties around the market in the space, with the regulators, with the central banks, to take this forward," explained Hyder Jaffrey, e-commerce commercial director, UBS Investment Bank.

The new digital coin is being developed in the bank’s cryptocurrency research lab, which opened in April. Located in Level39, of Londons’ Canary Wharf, the technology lab is tasked to explore how blockchain technology can be adapted to process financial transactions in a more efficient and cost-effective way.

The finer details are being developed in collaboration with London-based blockchain startup Clearmatics, which develops blockchain-based software to enable clearing and settlement of financial transactions. The company uses what it calls a Decentralized Clearing Network (DCN) to implement distributed ledger and smart contract concepts.

“Clearmatics’ mission is to offer to the financial communities an intelligent platform that, while offering permission-less innovation on contracts and execution, will allow participants to run their post-trade processing the most safely, secure and clear way.”
— – Clearmatics

Supporting FinTech innovation has become an important part of the UK’s Government strategy. In March, the UK Government announced that it was launching a new research initiative, committing £10M to support research into digital currency technology.

“The application of decentralised technology to this platform of digital information could have far-reaching implications, other industries whose products were digitised have been reshaped by new technology. The impact of the distributed ledger on the financial industry could be much wider than payments.” – Bank of England

However, some Bitcoin enthusiasts have expressed doubts over this implementation of blockchain technology. “It could end up being very similar to centralized payments networks we have right now, without the benefit of the network effect of bitcoin,” stated Jon Matonis, a founding director of the Bitcoin Foundation

Toby Coppel, a co-founder and partner at Mosaic Ventures, also has concerns about the system being employed, “There are question marks around the strength of the cryptography to come out of new private blockchains.”

The settlement coin is just the latest initiative from the UBS lab in London. The team there is also working on a prototype for a “smart bond” platform, built on the Ethereum blockchain. All projects from the lab are ongoing, but UBS executives stated that the prototype has already proven the technology’s potential.

“Fostering an open and collaborative environment between banks, start-ups and the investor community is essential to ensure we focus on promoting synergies between us, accelerate innovation opportunities and create real value for the industry."
— – Oliver Bussmann

Since the UBS utility settlement coin is still in the concept stage, it remains to be seen how successful it will be at improving the trade settlement process. The bank said that more detailed information on the project would be disclosed at the end of 2015. Regardless of the outcome, this move demonstrates that there are parties working together to use blockchain technologies to improve the current systems.


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