23 AugMight Blockchain help securities markets?
This week follows from the previous post, which looked at how moving securities balances from one platform to another was not a totally new idea. Building on that, I would like to illustrate how Distributed Ledger Technology (DLT) might work in securities settlement.
A little accounting example is a necessary
evil ingredient in helping develop the thinking. Figure 1 shows a simplified set of accounts for Nestle Reg and Nestle ADR’s.
Figure 1: Simplified Accounting for Swiss Registered Shares & ADR’s
In today’s practice, to create ADR’s, the agent has to divide up or segregate its holdings in the Swiss domestic CSD, Central Securities Depository, and then create a position in the US CSD based on what has been segregated. That 10 long position can then be used to deliver ADR’s in the US.
If the Distributed Ledger is introduced, figure 2 illustrates how this might look. This model assumes that it is the Swiss CSD, as the home CSD of Nestle which makes the transfer to the Distributed Ledger (DL). Once some banks had balances in the DL, they would be free to take advantage of all the clever things that DLT can do; move things around almost in real time, use relatively cheap processing. But!
Figure 2: Simplified Accounting with a DLT model
This looks straightforward; balances have been moved, real securities exist in the the DLT. First question: trust. Who operates the DLT: everybody, anybody, nobody in particular? In a previous post, we established that there are already issues with dishonesty around Bitcoin operators. Who would control the operators or have operators? Quis custodet ipsos custodians (sic)? You might ask. At the simplest of levels, to have equivalent trust in a new platform, it would be very reasonable to suggest that you would both need and want to have the equivalent of today’s CSD’s and their regulatory overseers.
Second question: money. In financial services, the end point for a transaction is something called settlement. That normally involves the exchange of goods and money; insiders refer to this as delivery versus payment aka DVP. In a previous post we established that Bitcoin has shortcomings as a means of payment. I was intrigued by a recent announcement about a FinTech start-up focussed on smart securities. “Niederauer backs ‘smart securities’ startup Symbiont,”Finextra June 10th. Nowhere did it mention money, how to pay for what is bought. All the claims about improvements in speed of execution are all valid, but how do you sort out the end game, the payment?
Third question: asset servicing. In the world of securities, even if you are as much of a “buy and hold” investor as the great Warren Buffet, you would like a dividend on your shares, or an interest payment on your bonds; Mr. Buffet likes these more than most. UBS may well be the agent for Nestle and it could distribute funds to cover the dividends on 100 shares, but 25 of those are in the DLT. Without a connection to some means of payment, using DLT for securities does not make sense.
Lessons to be Learned
The three challenges or obstacles noted above are very real ones. To help understand DLT’s potential and to begin to shine a light on what might be needed to use it in established spaces in financial services, I started with securities. Very deliberately.
To take advantage of the potential of all this new technology, the financial services world will need to solve for “money” as the major foundation on which all else can be built.
More to follow, watch this space.
My own epiphany in matters Bitcoin and distributed ledger technology is the result of three independent sources: I am indebted to Emmanuel Mogenet at Google for his inspiring gift of a Bitcoin, to Richard Brown at IBM for so readily sharing views and educating the latecomer and finally to Reid Hoffman for his seminal article in the May 2015 edition of Wired UK: “Reid Hoffman: Why the block chain matters.”
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