It’s possible that, in 10 years, every trade will be recorded and managed on a distributed ledger. But it’s not probable.
Every week there’s at least a new blockchain pilot or proof-of-concept (PoC) release, but there are distinct questions remaining over, well, what is it going to do?
“Everything for everyone” seems to be the answer. The Royal Mint in the UK, for instance, is developing a distributed-ledger system for trading bullion, the rationale for which seems to be eliminating settlement risk by transferring ownership within the Mint’s vault when you trade through a token or an exchange-traded fund. Fine. Makes sense. Equity markets solved this years ago by creating depositories like the Depository Trust and Clearing Corp. (DTCC), so why do you need a distributed-ledger system if it’s all kept in one vault?
That’s a genuine question, by the way. If anyone has the answer, then please do enlighten me.
In addition, there are projects in repo trading, in derivatives markets, in cash equities and most other areas you can imagine.
Then there are other PoCs, like the Calastone test for mutual funds earlier this week. Aggelos Andreou has a good piece up on this, with some telling quotes from analysts. Blockchain is great, they said, but what it offers can largely be accomplished by existing systems. Further to that, on the buy side, you have a culture that is slow to adapt to new technology—wary even. The buy side is inherently conservative, at least in the funds space, and the technology will have to prove itself thoroughly before any widespread adoption.
I should probably say now that I’m not a blockchain cynic. I’m also not a technologist, and I don’t necessarily understand the deep intricacies of the technology, but I know enough to see how it can benefit post-trade processes, for instance, or areas like supply chain management.
But there has been a tendency to over-publicize the tests for blockchain, and perhaps inadvertently, create the impression that it’s going to radically overhaul the financial system as we know it. It probably won’t. Targeted areas, absolutely. The way in which capital markets function? No.
Suggesting that blockchain can replace clearinghouses, for instance, is patently ridiculous. That risk management function is sorely needed in the market, and crucially, it’s not just a function of information. Clearinghouses manage risk by mutualizing it among their members through margining, collective default funds, and broad powers of assessment such as margin gains, haircuts and cash calls. That is a function of capital, and often, human judgment, not ledger agreement.
Likewise, if every exchange has its own blockchain, then efficiency will absolutely be improved. Reconciliation, confirmation, all those steps that should have been solved already, will likely be solved by distributed ledger. But it’s not going to replace the exchange. And indeed, there are questions about efficiency if every market infrastructure has its own permissioned blockchain—is that not just reinforcing fragmentation?
Technology like DLT could, and I stress could, make sense for initiatives like Target2-Securities, which operates on a pan-European basis, or perhaps for institutions like the DTCC, which handles the vast bulk of equity trades and processes most credit-default swap trades in US markets. There may even be use-cases at central hubs like clearinghouses, exchanges or swap execution facilities, at least on a post-trade basis.
But let’s not get carried away. And also, in the spirit of technology enthusiasm, forget about other innovation, as the World Federation of Exchanges (WFE) pointed out in its response to the European Commission’s fintech consultation, which closed on June 15.
“While there has been much focus to date on distributed-ledger technology, the WFE believes other technological areas will develop that are at least as important—if not more so—to the exchange and post-trade space,” they said. “These include: cloud computing, artificial intelligence, big data and robotics.”
This week on Buy-Side Technology:
- As mentioned above, Calastone completed a PoC test for a distributed-ledger system recently. It all went swimmingly, according to, er, Calastone, which is somewhat light on the technical details. But it’s going to be a good thing for the mutual funds market, the vendor says. Others aren’t quite so optimistic.
- IBM had a big event this week in New York, where it showed off its emerging overmind, Watson, and talked about its applications in RegTech. The event had a panel hosted by a man whom a person on Twitter called “one of the most influential editors in the industry.” We call him Tony, and he filed an article on this beforehand. I filed a less-influential one afterwards for Sell-Side Technology.
- Those mean Europeans might want the UK’s main clearinghouses to relocate to the Eurozone, leading to much hand-wringing over relocation policies by UK-based LCH, which also has a Parisian clearinghouse. I’ve never really understood this argument, as UK oversight of clearing is… fairly robust? I mean, the Bank of England is hardly a shrinking violet. Still, begun, the Brexit Wars have. Marvellous.
- In yet more blockchain news, R3’s Corda entered public beta last week. It’s pretty big news for them, and for HP, which is integrating it into its high-performance environment. Also Thomson Reuters talked about its Smart Oracle, and I get the use of the word smart and what it denotes, but at what point is everything smart and the word becomes largely redundant? Everything I mentioned above is still true.
As always, any thoughts or comments are welcome. Send me an email on [email protected] or give me a call on 646-490-3974.
Anthony and James delve into how the systematic internalizer regime is shaping up, and then examine the regtech sector.Subscribe to Weekly Wrap emails