The user-owned and user-governed Euroclear group provides settlement and related services for bond, equity, fund and derivative transactions. As a leading international Central Securities Depositary (CSD), covering Belgium, Finland, France, Ireland, the Netherlands, Sweden and the United Kingdom, Euroclear's depositories cover more than 65% of European blue-chip equities and 50% of European domestic debt outstanding.
The organization released a straightforward, easily-understood report today, that was co-authored by management consulting firm Oliver Wyman. 'Blockchain in Capital Markets: The Prize and the Journey,' aims to help leaders in capital markets to understand the potential of the technology, lay out the paths for its adoption, and present the decisions that are required from capital markets firms today.
The 24-page report describes what an ideal market structure would look like, citing “access to efficient, well-architected blockchain technologies.”
Blockchains would eliminate the need for data normalization, internal system reconciliation, and exposure or obligation conflicts, while offering transparency and “many other improvements.”
“The prize on offer is a world where all capital market participants work from common datasets, in near real time and where supporting operations are either streamlined or made redundant.”
- Ben Shepherd, Partner in the Strategic IT and Operations practice at Oliver Wyman
While illustrating several benefits of a market built on blockchains, the report emphasized that “huge investment” is needed, not only to create the infrastructure and tools, but also to convince participants to join a network.
The report also outlines where cost savings can be made. The internal costs of operations and IT systems can be reduced, as can the fees paid to external service providers.
“IT and operations expenditure in capital markets is currently close to USD100-150 billion per year among banks. On top of that, post-trade and securities servicing fees are in the region of USD100 billion.”
- Oliver Wyman
Suggesting that a move towards a blockchain-based capital market should be “a step-by-step adoption rather than a big bang reorganisation,” the report states that the legacy system is “too big, complex and important” for an accelerated overhaul.
The authors outline a two phase transition, beginning with small, standalone use cases utilizing new blockchains. The second phase is larger-scale use cases, predominantly processing and monitoring assets on blockchains.
“There is currently a frenetic level of activity across the industry in developing use cases,” the report claims. While successful applications will naturally attract customers and create new ecosystems, collaboration may also lead to blockchain adoption.
R3 CEV has already made considerable efforts, and achieved considerable success, in creating a banking collaboration, while the Post Trade Distributed Ledger initiative is also attracting members. Euroclear reportedly joined the working group in November 2015, along with the London Stock Exchange, LCH Clearnet, and the CME Group.
Regulation may also play a role, as it has done with the implementation of TARGET2 Securities (T2S) in Eurozone settlements. The new European securities settlement engine aims to offer centralised settlements for central banks, across all European securities markets. The platform will enable CSDs to increase their competitiveness, eventually. The project was started in 2008, and migration is due for completion in early 2017.
The Euroclear report provides seven suggestions for how the industry could start adopting the technology now, stating that the “wait-and-see approach” may be unwise.
“The industry needs to take a collective view on the potential of the technology [...] The market must embrace this potential, show patience with this development and invest in various innovative solutions to bring it to bear.”
- Jo Van de Velde, Managing Director and Head of Product Management at Euroclear
Proof of concept for definite use cases are needed first and foremost, then service providers need to gain an understanding of the benefits, before industry-wide engagement could develop. Initial solutions can then be deployed with more startups and funding. Finally, regulators and supervisory bodies should be engaged to address legal measures.
As for the adoption timeline, today Bitcoin is a first-generation application of blockchain technology. The report states that over the next 12 to 24 months, capital market startups with limited use cases will evolve, as well as proposals for market standards, followed by niche applications that will “define new markets that do not exist today.”
“After a 3 to 5 year period, it is possible that substantial applications will start to be used by the majority of large players in an important market,” the report reads, attributing the expansion from “the growth of initial niche successes, or from second generation ideas emerging from previous failures.” However, the authors do not see mass adoption taking place for over 10 years.
An independent survey from the World Economic Forum (WEF), published last October, showed that leaders and experts in several fields expect bitcoin and the blockchain adoption to intensify in 2027, which is on par with the time frame suggested by the Euroclear/Oliver Wyman report.
Meanwhile, Gartner's 2015 Hype Cycle for Emerging Technologies separately predicts that cryptocurrencies and cryptocurrency exchanges will reach a plateau of productivity in two to five years.
Euroclear and Oliver Wyman also see some hurdles obstructing blockchain adoption in capital markets, besides the investment needed to develop applications and run implementation programs.
“Adoption of blockchain technology will be reliant upon aligning industry standards,” is a recurring sentiment in the report. The need for a central authority that could maintain a single universal database for all participants is often highlighted, “essentially an expansion of the role taken by a Central Securities Depository (CSD) in a traditional infrastructure.”
This is not the first time Euroclear has expressed the need for a central authority to develop a universal standard. In July 2015, Euroclear responded to the European Securities and Markets Authority (ESMA) call for evidence on “Investment using virtual currency or distributed ledger technology.”
“Global authorities, including ESMA, should consider developing a specific set of principles, rules and regulations to deal with DLT for securities holdings and transactions, or review and modify existing laws and regulations.”
However, in this report with Oliver Wyman, Euroclear called the capital market industry “unaccustomed to cooperation,” and warns that “a common barrier cited for some innovations is how to agree on a lead provider to hold central responsibility and power in an essentially monopolistic position.”
Instead of naming ESMA as a suitable leader, like it previously did, Euroclear hints that it is, being industry owned, in a better position to take on the role: “Perhaps the only way for the industry as a whole to agree who should develop such solutions is if they all collectively develop and own it together as in the case of blockchain.”
Euroclear is not the first to suggest that an industry-owned organization is well positioned to act as a central body. American post-trade financial services company, the Depository Trust & Clearing Corporation (DTCC), provides clearing and settlement services to the financial markets. The corporation expressed a similar opinion in a white paper released last week.
DTCC also sees many benefits of adopting distributed ledger technology to substantially improve capital market infrastructures. “The industry has a once-in-a-generation opportunity to reimagine and modernize its infrastructure to resolve long-standing operational challenges,” stated DTCC president and CEO Michael Bodson.
The DTCC report also states the need for a central body to lead the effort in adopting distributed technology, and an industry-owned organization is recommended.
“DTCC believes it is best positioned to support and coordinate the evaluation and standardization of the distributed ledger platform, help address industry challenges and determine whether it is a better solution than existing technology.”
Since both DTCC and Euroclear have signified the importance of a central body that is industry owned, and both are qualified as user-owned and user-governed organizations specializing in the settlement of domestic and international securities transactions, some may consider them competitors vying for the position.
However, a collaboration between them as a joint central body is not a far-fetched idea. There is already the precedence of a joint venture between the two organizations, certifying that they can work together. The venture between DTCC and Euroclear was formed in September 2014, and aimed to streamline global collateral processing. The collaboration is called DTCC-Euroclear Global Collateral Ltd., and has a headquarters in the UK.
Regardless of whether a central body evolves or not, both DTCC and Euroclear conveyed unequivocally that the wait-and-see approach “may not be wise.” This message concurs with the UK Government Chief Scientific Adviser, Sir Mark Walport, who recently released a report urging the UK government to start using blockchain technology immediately.