An modernising post-trade processes, distributed ledger technology could also bestow new roles on industry participants. Deutsche Bank’s BoonHiong Chan assesses three industry initiatives that elucidate how incumbents might evolve.
“The street finds its own uses of things”
The blockchain technology that underpins bitcoin has inspired the creation of other types of Distributed Ledger Technology (DLT). In turn, the different DLT types are being trialed across the banking and financing industry, including by central banks, to determine if and how new efficiencies, competitiveness and growth prospects can be effectively gained.
In the capital markets, early experimental results have been promising and the new technical possibilities are drawing an exciting outline of a digitised and DLT-based future. DLT can potentially be at the core of a modernised post-trade securities services industry that would be distinguished by concurrent and coded-intelligent processing; clearly differentiated from the “paper” era, and the current “automation” era that deploys computers to automate paper-based sequential paradigm flows.
As development progresses in the industry, newly gained insights of business model possibilities are also leading to deeper questions such as: what could a future DLT-based securities post-trade industry mean to present day incumbents?; to what extent could the technology disintermediate the industry and how could post-trade incumbents evolve?
The blockchain technology that underpins bitcoin has inspired the creation of other types of Distributed Ledger Technology (DLT)
These are complex questions with interdependent factors that will influence participants’ transformative journeys into new roles and ways of doing things. Some of these factors include the technology used in digital infrastructure, the infrastructure’s new operating models, and laws and regulations.
Digital infrastructure can influence new future roles
For example, digital assets require a digital environment and infrastructure like common data definitions to operate. The organisation of this environment can shape new roles in post-trade.
For financial market infrastructures, a number of leading traditional stock exchanges are already building on the foundations of a modernised industry with a digital infrastructure for digitised securities to thrive. Here, there are broadly three types of efforts:
• A walled-garden digital environment, operated by a centralised service provider that will service a digital asset’s “end-to-end” lifecycle activities.
This first approach is exemplified by initiatives such as those launched by Deutsche Boerse in Germany, Switzerland’s SIX Digital Exchange (SDX) and the Stock Exchange of Thailand (SET).
These are creating new digital exchanges that would handle cryptocurrencies and/or digital asset’s activities, from primary issuance to secondary market trading, settlement, custody and asset servicing i.e. a “horizontally” integrated model that would aggregate a number of key services onto a single platform.
While in principle, this integrated model may lead to a reduction in the number of intermediaries required to service issuers and investors to save costs for these stakeholders, different distributed ledger technologies that could be used in horizontally integrated models should introduce different and new value creation areas. These areas will require new skills which incumbents could offer.
Since a digital asset’s smart contract would model the asset’s lifecycle activities and enable automated investor and compliance rules management, its construction will need close interactions with issuers to create the digital asset such as a “DLT bond” before it is introduced into the digital environment.
This makes the client-facing construction of a DLT bond or other digital asset an activity that needs to be completed prior to the asset’ entry into the walled-garden. Today’s incumbents can take on this constructor role albeit with new multidisciplinary capabilities. The horizontally-integrated digital infrastructure would then provide a cybersecurity-safe digital trading and settlement environment for the programmed digital assets.
• DLT-enabled post-trade engines
The second type of digital environment is represented by the ambitious work of the Hong Kong Exchanges & Clearing group (HKEX) and Australian Securities Exchange. The work aims to embed DLT into their core post-trade engines and workflows, and address immediate industry issues. This introduces the DLT concurrent communication paradigm and methods to the processing of traditional asset classes like equities without digitising these asset classes.
"By connecting key stakeholders of a transaction, it can minimise reconciliation and work in duplicative operational activities to add to productivity gains"
For example, HKEX Project Synapse proposes a shared industry utility, concurrent communication flows and common data definitions between market participants to improve the Hong Kong-Shanghai Stock Connect programme.
This implementation of DLT could allow domestic custodians to host a local market infrastructure connectivity node for their clients, and possibly clients of their clients, as part of new DLTenabled services. By connecting key stakeholders of a transaction, it can minimise reconciliation and work in duplicative operational activities to add to productivity gains. Similarly, with industry shared utility infrastructure such as trade matching and block trade processing, it should also enable participants to minimise technology investments. In such a model, the existing post-trade incumbents’ roles may expand in the future.
• Interoperable platforms
The third type of digital asset environment sees the traditional securities market infrastructure interfacing with fintech “pure plays” like DTCC-Paxos Settlement Services and Singapore Exchange with Capbridge. The interface would bridge the “traditional” securities market infrastructure regulated environment with the digital operating capabilities of the fintechs.
In this case, the current incumbents’ roles could evolve to use the fintech-traditional market infrastructure as an operational platform, shrinking their own infrastructure layers, and pursue other strategies like client experience, credit, liquidity, technology risks and market risks management services as differentiators to their clients. Over time, this route could lead to the formation of a new class of post-trade service providers for digital assets, in ways similar to how payment services fintechs like AliPay have risen to intermediate and process transaction flows.
The different digital environment and operating models can influence the future roles of post-trade service providers. Other key external factors should also be holistically analysed: including regulations, clarity of legal relationships and liabilities that are necessary for concurrent communication, market acceptance of new ways of asset and investor protection and safety, market adoption and other innovations such as digital money for atomic settlement.
Multi-nature cryptographic structures such as a “hash time-locked contract” that can function as an escrow, a DVP settlement method and as a Call option will also need to be addressed. The impact of digital assets and their environment on securities lending and other related capital market activities would also influence how a new securities post-trade market could unfold. In the future, incumbents will also need to recognise that not all roles may survive.
So by mapping out the exact process flow changes, and more open industry discussions to identify the potential changes in each other’s roles, incumbents can become better prepared for the future.
The results would also determine if DLT would be able to modernise the existing securities post-trade industry structure, and to create new roles and opportunities for participants.