Blockchain to disrupt market infrastructure providers

Blockchain to disrupt market infrastructure providers

Distributed ledger technology could transform the role of market infrastructure providers but will not eliminate the need for firms such as clearing houses, according to a new report by Europe’s main financial regulator.

A majority of respondents to the discussion paper by regulator the European Securities and Markets Authority said distributed ledger technology (DLT) will change the operations of market infrastructure such as central counterparties (CCPs) and central securities depositories (CSDs).

But the new technology methodology is unlikely to force these firms out of business, according to respondents cited in the new Esma paper.

"The European securities regulator has previously said that its approach to blockchain is "wait and see," commented David Futter, fintechs partner at law firm Ashurst. "This approach hasn’t shifted, with the regulator taking a cautiously supportive attitude throughout today’s paper on the potential benefits and risks of DLT on the securities market."

Futter said the Esma paper does acknowledge that blockchain could result in the redundancy of some roles or processes in the longer term. He added: "Clearly, this would necessitate another raft of changes to European financial regulation if it does, as well as a fundamental change in market structure."

Widespread adoption is "still some way off", according to the Esma paper, but DLT challenging current financial market infrastructures could be just a decade away.

Niche applications and several proof of concepts are anticipated by respondents in the short-term (in the next one to three years). Following this, specific internal bank and fund solutions could emerge.

According to two respondents, DLT and legacy systems will likely "co-exist" for the next 20 to 30 years "depending on the degree of acceptance from investors".

Several participants stressed that certain functions performed by CSDs, such as notary or registration functions, would "remain necessary in a DLT environment".

It was generally agreed in the report that adoption would start in "niche, possible unregulated, low volume and relatively 'simple’ markets." The paper read: "Sophistication would increase over time, once the concept has been proven."

Some expect DLT to be applied to cash or short-term instruments first, whereas others anticipate that non-cleared derivatives, including cross currency swaps and non-eligible exotic products, would adopt the technology before cash instruments.

One respondent suggested that it would be easier to leverage on blockchain for static data (such as securities reference data or corporate action information from prospectuses), rather than for transaction processing.

Alternatively, there is potential for the usage of blockchain in customer identification, and transaction recording and identification for alternative asset classes such as real estate and private equity, according to another participant in the report.

German clearing house Deutsche Boerse announced on January 23 that it had developed blockchain-based technology to transfer payments via collateralised tokens. Under the new initiative, commercial bank money can be transferred via a distributed ledger, enabling clearing members to exchange payments without credit risk.

A third of investment firms cited potential impending regulations related to technological innovations such as blockchain and artificial intelligence as a top priority for the coming year, according to a new survey by consultancy firm Synechron, reported by FOW on January 6. 

According to the survey, more than a third of firms see the lack of blockchain talent as an issue and another 31.3% of respondents said they were working with external partners for blockchain-related projects. 

FOW reported on December 16 that blockchain experts, despite estimating that mainstream implementation of the technology is between two and 10 years away, expect 2017 to be a year of progress for the blockchain in financial services.