How can distributed ledger technology be leveraged to enhance central securities depositories and potentially change core services such as transaction settlement and issuance?
As a starting point, distributed ledger technology (DLT) could provide an improvement to several existing technology platforms. The really interesting thing about DLT is that it creates a shared database that has security built in. The database is updated in near-real time, allowing access only to those parties that have permission to access the data. With DLT, firms can simplify a lot of the processes and systems that exist today. In the current US clearing model: firms submit trades; the trades go through layers of the firms’ own technologies; they then get translated and sent over to the Depository Trust and Clearing Corporation (DTCC), to the Fixed Income Clearing Corporation (FICC) or to the National Securities Clearing Corporation (NSCC) if it’s a clearing message, or to the Depository Trust Corporation (DTC) if it’s a delivery order or a settlement message.
DTCC runs these messages through our own systems, sending the output back to the firm in the form of a translated message, which they then add into their own database. If we could all leverage a common database, with a common set of business rules, data schema and business logic, we could eliminate translation layers that are required today, along with layers of code that interpret business logic. Participants would benefit from a common understanding of what a trade and a transaction looks like, greatly simplifying processing for all firms participating in the process.
However, that doesn’t mean that DLT is going to turn off or replace all aspects of the existing technology used in settlement processes today. While the core elements of the technology allow information to be shared, it doesn’t necessarily mean that every transaction has to settle, which is similar to what happens in the public bitcoin network. In the US equity markets, 100 million daily trades would require settling a hundred million transactions instead of the two million that come out of netting.
This trading activity typically includes trading strategies and brokered trades, which are offset through netting and result in a reduced net funding requirement. DLT could potentially be leveraged to enhance and improve processing and risk management in this space.
There are aspects of DLT that enable significant cost savings, simplify processing and remove complexity, but one size doesn’t fit all. The technology must be tailored to the appropriate business case.
How could the technology affect the growing demands of the regulators towards market infrastructures?
DLT could simplify the way regulators access information. The DLT model is based on the concept of ‘permissioned network members’ having nodes, with each node taking on a different function and capability. For example, one node could be an active market participant entering trades. Other nodes could govern the ledger and administer who’s allowed to form part of the ledger. There could also be nodes purely for ‘read’ permissions.
A regulator could, for example, obtain a read permission node that would allow them to see all of the trading activity they are entitled to see within their specific jurisdiction.
While the solution could be global in nature, the trades that are not in their jurisdiction would not be visible to them.
Based on discussions with industry participants and particularly from Sibos, what are some of the main conclusions around DLT that you can share?
It has become apparent that today, there is a much more realistic view of the state of this technology and how fast it is going to develop, in comparison to last year when expectations for its near term use and application were far greater. The industry is gradually starting to realise that existing processes and practices are not going to be transformed in a matter of months and that this will be a long journey with opportunities and benefits that will take time to be realised. The technology itself needs to evolve. It needs to mature and undergo proper security and capacity testing and incorporate appropriate governance procedures. It also has to be proven in an industry-scale production application, which has yet to be achieved.
Ultimately, however the industry chooses to implement and adopt DLT, it must be consistent with the long-standing industry goals of mitigating risk, enhancing efficiencies and reducing costs for market participants.