Time for a Reality Check: How Close is the Blockchain Revolution in Capital Markets?

Despite the frequent claims that blockchain is a ‘solution looking for a problem’, the past three years have seen nearly all major capital markets firms embarking on some form of blockchain or other distributed ledger technology (DLT) project. And for good reason. According to Accenture, organisational complexity and legacy structures are costing the industry roughly $700 billion annually, including the cost of capital, with many existing processes having remained unchallenged for decades. As a result, a large number of proof of concepts have been launched by leading firms and institutions to explore the potential application of blockchain technology to transform many of these existing systems, not only in terms of front office and trading but also across the full range of post-trade functions. Notable examples include the nine institutions currently collaborating with FX settlement provider CLS and IBM on a trial blockchain project called “Ledger Connect”, while the Depository Trust & Clearing Corporation (DTCC) also expects its credit derivatives Trade Information Warehouse (TIW) to move to a DLT platform in the coming months.

Yet the pace of DLT adoption in the capital markets remains much slower than has been seen in other areas such as trade finance, with the majority of projects currently limited to small scale, in-house PoCs. Given the scope, complexity and systemic importance of the clearing and settlement landscape, is it realistic to expect a blockchain revolution anytime soon? In this article, Nicola Tavendale and Mike O’Hara of The Realization Group speak to Sophia Grami and Mohammed Cherif of Synswap, OBITO’s Stephane Savanah, James Maxfield and Ali Rutherford of Ascendant Strategy and Olaf Ransome from the USC Project, about whether DLT transformation in the post-trade sector is closer than many expect and what industry leaders should be doing to prepare for the change.



The current scarcity of blockchain success stories in the financial markets is mainly due to firms not fully understanding the technology in terms of what it can, and cannot, do, says Stephane Savanah, Chief Scientist at OBITO. “This is because many only have expertise in either capital markets or in blockchain technology, but few have significant experience in both,” he explains. “But without being able to see both sides, they will struggle to develop workable blockchain solutions.” OBITO is one example of a blockchain platform designed specifically to handle financial instruments as tokenised assets and smart contracts. By using the Bitcoin Cash blockchain, trading in these instruments becomes as simple as sending someone Bitcoins, according to Savanah. “Once you’ve tokenised it, you can trade it on the blockchain,” he adds. “Ownership of that instrument is then the same as ownership of Bitcoin, which is determined by the transaction on a block. In other words, once it’s on a block it’s settled.”

This near real-time settlement is a far cry from current standard settlement times of T+2, which is why blockchain settlement is one of the main trends in the post-trade sector at the moment, according to Sophia Grami, CEO & Co-Founder at Synswap. Yet while there are some large settlements projects underway in the derivatives space, notably the DTCC project, scepticism continues around blockchain’s immediate potential, with most projects still in the PoC stage and few having gone live to date. Yet Grami believes this is normal in capital markets, with many non-DLT projects also having been in the PoC stage for several years before finally going live. “But the markets do need to realise that blockchain is just a technology and will not be appropriate for everything,” Grami warns. “Large institutions are also generally not fast movers, so trying to build a DLT platform that involves a network of banks all using a new technology is realistically not going to happen overnight. So far there have not been that many live projects, but I think now more will be able to launch this year or in the next couple of years.”

“Large institutions are generally not fast movers, so trying to build a DLT platform that involves a network of banks all using a new technology is realistically not going to happen overnight”

Sophia Grami, Synswap


Typically, such networks are formed when banks join together to use one solution, which then creates a monopoly, adds Mohammed Cherif, Co-founder at Synswap. However, there are now a number of DLT initiatives and start-ups which offer to take care of this network creation process for them, Cherif adds. A good example of this is the LedgerConnect project, which creates blockchain infrastructure for DLT start-ups to use in deploying their solutions to banks and other institutions. “Bringing the banks together on a ready-made technology network serves to greatly accelerate the adoption process,” Cherif explains. “Such initiatives allow firms like us to really focus on developing products, without having to first create new blockchain networks or systems. This is why we partner with CLS on the LedgerConnect project.”


Keep it simple

Research from Fiserv and Finextra also indicates that at a macro level, banks are reasonably focused on the silos which they believe will be disrupted by DLT in the coming three to five years. In the case of securities, 65% either agreed or strongly agreed that the sector would be transformed by blockchain or DLT initiatives. Yet the fact that blockchain technology is available to use still does not overcome the difficulties which all banks have in getting the new technology on their legacy infrastructure, says Olaf Ransome, Utility Settlement Coin (USC) Consortium. He believes there is also a further key ingredient missing from the whole DLT discussion, namely institutional-level payment. He explains: “You need legal certainty that what you’re doing is okay and that the process is robust. We’re missing that payment method. It’s a certainty that many trade finance and wholesale banking processes will move to DLT, but they will find that the end delivery function – usually cash settled – will be missing.”

“It’s a certainty that many trade finance and wholesale banking processes will move to DLT, but they will find that the end delivery function – usually cash settled – will be missing.”

Olaf Ransome, The USC Project

The T+2 settlement model also requires significant margining and additional risk processes, including the posting of significant collateral. But Ransome argues that this model could be re-imagined by using tokenised assets on a blockchain platform, providing fast confirmation that the buyer does indeed have the funds and the seller has the securities to complete the trade. The USC project takes this one step further and replicates fiat currencies as digital cash on blockchain, backed by fiat currency held with the central bank. “Then suddenly you’ve got T+0, nearly instant settlement, and post-trade now looks completely different: no margin, no CCP, none of that,” he adds. “All the banks have to do with their old, creaky legacy systems is make a few ledger entries to reflect what’s happened in the real world, which is a whole lot easier than completely changing their infrastructure. They then end up only having a subset of their legacy processes, so instead of the ten steps they had to take originally, now they may only need to do two.”

With DLT solutions such as the USC Consortium now addressing specific challenges to DLT implementation in post-trade, do institutions need to re-architect their middle and back office processes in preparation for a seismic market structure change? The answer may actually be no, they don’t, says James Maxfield, Managing Director at Ascendant Strategy. “If the world starts to move to an instantaneous settlement model in the next two years, organisations will probably find they are able to adopt an already proven use case from the initiatives currently underway,” he adds. “But there is a timeline to the evolution of blockchain technology and organisations now need to start considering how this type of instant settlement, or how some of the other operational impacts of DLT, are going to affect their processes in the near future.” According to Maxfield, this disruption is likely to start with the more straightforward aspects, such as trade reconciliations, with institutions needing to think about the current use cases, such as USC, and what benefits they could bring if blended with their existing processes. They may even still need to reconcile some aspects of their trades anyway, because although settlement within the distributed ledger is instant, a regulator or an auditor might require additional controls to be in place as well, Maxfield warns.

“If the world starts to move to an instantaneous settlement model in the next two years, organisations will probably find they are able to adopt an already proven use case from the initiatives currently underway”

James Maxfield, Ascendant Strategy


Beyond the hype

Legacy technology and internal processes also vary greatly between different organisations, so there is unlikely to be a neat ‘one-size-fits-all’ approach to implementing DLT technology into these systems, adds Alastair Rutherford, Managing Director at Ascendant Strategy. He explains that because integrating some of these new mechanisms into institutions’ post-trade stacks will potentially be very complicated, organisations have to be quite strategic in how they approach this to fully reap the benefits of this new technology. “One key way banks can start doing this is through involvement with DLT consortiums, some of which are moving beyond PoC and are already into B and C rounds of funding,” Rutherford says. “If you have a consortium of banks that are putting serious capital behind these projects, that should be a strong indicator this is potentially where the action is going to happen.”

Taking USC as an example, if this is used to help create an environment which enables banks to exchange US dollars instantaneously within their own infrastructure with other consortium members, then that could potentially help reduce the amount of capital which needs to be posted. This could in turn have a very significant impact on related services, such as Treasury functions.

At the same time, blockchain is still a relatively nascent technology and organisations should be wary of any industry ‘hype’ which springs up around DLT-related concepts. According to Savanah, this includes current discussions around private or permissioned distributed ledgers. Although the notion of a private ecosystem may appeal to some firms, say for use in trading financial instruments, Savanah argues that blockchain is not even needed or well-suited for this purpose. He explains: “Blockchain is there for a permission-less, trust-less ecosystem. As soon as you put in an element of trust or a permissioned system, then you’ve already undermined the reason for having that in the first place. But if you’re talking about using a public blockchain, that is a completely different thing.”

“Blockchain is there for a permission-less, trust-less ecosystem. As soon as you put in an element of trust or a permissioned system, then you’ve already undermined the reason for having that in the first place”

Stef Savanah, OBITO


 Achieving levels of comfort

Savanah believes that ideally, organisations should be looking to ride on top of an existing ecosystem which is maintained, and essentially paid, for by independent parties, such as Bitcoin miners etc. This reduces the significant overheads involved in trying to build a DLT ecosystem from scratch, but which still allows firms to build a private layer on top for trading instruments, such as bonds or futures, as tokens. “Once that platform is created, they can trade financial instruments on blockchain in almost the same way as Bitcoin,” adds Savanah. Yet while Bitcoin’s current infrastructure has restrictions on block size which would limit its ability to handle institutional trading volumes, work is also underway on developing a Bitcoin Cash protocol, which will remove this block cap and allow for unlimited transactions. “Bitcoin protocol is also robust; it’s never going to be hacked,” adds Savanah. “You can build a second layer on top of it which can be hacked, but you’re never going to undermine the underlying infrastructure.”

In addition, firms such as Synswap are already successfully using the distributed database and distributed processes to help automate many of the post-trade workflows. Banks using the service can then complete their trade using Synswap to send the trade details to the ledger, with all parties able to share the same view of the trade in real-time. “We embed our matching algorithm in the ledger which then matches both sides of the trade,” Grami explains. “If not matched, it will be able to highlight any disputes and discrepancies to help those be quickly resolved.” By creating a network of banks who share a distributed ledger, they are then able to build a database which allows them to calculate or net cash flows, distribute processes or agree on valuation methodologies for how they value instruments in the ledger ie swaps.

Yet the blockchain industry, like the cryptocurrency sector, is waiting on more robust regulatory guidance to help move processes along faster and provide institutions and start-ups alike with a greater degree of certainty. “However, a lot of solutions don’t require any regulation in the end, such as software development, but for some case studies it would help to having more clarity,” adds Cherif. “Ideally, regulators might even join the ledger as well, so that they can view trading activity, derivatives exposures etc in real-time. But that is currently a long way off.” A further way to raise comfort levels around the use of tokenisation and utilities in capital markets is to establish a consortium, such as the USC project, which now includes 16 leading financial market institutions. “The consortium identified a number of challenges which they needed to see greater feasibility around, such as knowing that the Central Banks would not put on the brakes further down the line,” explains Ransome. “We have reached a pivotal moment; the project has found a way to address many of the consortium members’ concerns and now needs to set up in a formal way which keeps both the regulators and the Central Banks happy.”

“Ideally, regulators might even join the ledger as well, so that they can view trading activity, derivatives exposures etc in real-time. But that is currently a long way off.”

Mohammed Cherif, Synswap


 Reaping the benefits

In addition, the industry as a whole increasingly seems to believe that tokenisation and peer-to-peer networks will prove the logical ‘next step’ on the technology front, Ransome says. “As the industry takes that step, there is then also an opportunity to change the way payment occurs. For example, rather than having a series of decentralised account-based systems which require money to be held in one place, we could instead create one central pool of funds which would simplify this process and create greater efficiencies,” he adds. According to research produced by Oliver Wyman, typically 10-30% of total liquidity reserves result from intraday liquidity requirements. These reserves, have an approximate negative cost of carry of 100 basis points in the current rate environment, equating to a cost of $10m for every $1bn of buffer held. “Yet imagine the savings if they used one single pool of funds in each currency instead,” says Ransome. “Not only would the liquidity position improve very quickly, but the cost savings would prove to be an annuity for life.”

This concept of shared infrastructure to reduce costs is not new and the utilities concept has been well known in capital markets for at least the past decade. However, the reason the utilities model has not yet worked is because of the ownership issues and not knowing how to make that happen using existing infrastructure, explains Maxfield. “But successful DLT collaborations between multiple counterparts creates exactly the same effect,” he argues. “Because it offers shared infrastructure, it creates shared costs. It’s just not called a utility anymore or managed service. It’s now called a distributed ledger.” The potential for mutualised DLT infrastructure to generate significant cost savings for the industry is also highlighted in the Accenture report. The study found that despite significant levels of investment in trade and post-trade automation chains, around $150 billion of industry costs in this area are the result of “pure complexity costs”. By leveraging a combination of DLT and industry utilities, the study argued more than $100 billion in cost savings would be possible.

“Achieving a blockchain nirvana is not so much a technical challenge as it is a coordination and change management challenge”

Alastair Rutherford, Ascendant Strategy



This is why, despite the scepticism around blockchain and uncertainty about the as yet unrealised potential of the technology, many in the capital markets industry are realising the benefits of investing now in developing some of the more promising use cases further. Post-trade infrastructure in particular is very sticky around its costs, adds Rutherford. “Banks cannot afford to not to have their eyes on this, because in practical reality, there isn’t actually another alternative,” he warns. “Achieving a blockchain nirvana is not so much a technical challenge as it is a coordination and change management challenge, but those blocks are now starting to be chipped away as more PoCs come to the fore.” Maxfield agrees, adding that much of the negativity based on how difficult or complex it will be to implement blockchain projects is correct, but it remains because of huge upsides which could be realised. “It’s potentially going to be transformational, even revolutionary, rather than evolutionary,” he predicts. “But organisations need to start taking those small steps now in order to set these wider changes in motion.”


Ones to Watch: Three significant DLT POC’s and what they could mean for capital markets

  • HSBC settles $250 billion worth of forex trades using blockchain in the last year. The application of blockchain by a leading global investment bank for completing FX trades and payments is a significant indicator that the technology is gaining traction. According to HSBC, the benefits of using blockchain have included greater levels of automation, reduced reliance on external technology, lowering the incidence of errors and delays as well as cutting costs and helping optimize its balance sheet.
  • The Depository Trust & Clearing Corporation’s (DTCC) blockchain project enters testing phase ahead of expected go live in early 2019. One of the world’s largestfinancial services infrastructures will launch a DLT platform for its credit derivatives Trade Information Warehouse (TIW). Testing will be conducted by a consortium of 15 leading banks, including Barclays. According to the Lee Braine of the Investment Bank CTO Office, Barclays, the project “will bring distributed ledger technology to life in a demonstrable way that will enhance efficiencies and lower costs and risks for the industry.
  • CLS rolls out DLT-based payment netting service in Q4 2018. The leading provider of settlement service for the FX market launched CLSNet, a bilateral payment netting application which runs on distributed ledger technology from IBM. Backed by Goldman Sachs and Morgan Stanley, the new platform is intended to reduce the post-trade risk present in settling foreign currency trades in emerging markets. According to CLS, this standardised and automated payment netting process will also lead to improved intraday liquidity, reduced cost, improved operational efficiencies and “ultimately support business growth”.