Not Quite The Capital Markets Block Chain Revolution, But Perhaps Evolution In Post Trade?

Over recent years, DLT solutions have been hailed as a driver for post trade transformation.  2021 is apparently the year that blockchain begins its climb out of the ‘trough of disillusionment’ according to the Gartner hype-cycle report of 2019[1]. What sparks this climb, according to the research, will be advances in technology and ‘pragmatic use cases uniquely supported by blockchain’. Whether or not this occurs remains to be seen, but our own view of its evolution mirrors a similar thought process.

In 2019, we published an insights paper titled ‘Time for a reality check – how close is the blockchain revolution in capital markets’[2] in which we discussed with a cross section of industry participants the likelihood of disruption within the post trade environment. Much of this dialogue focussed on the need for separation of the narrative around crypto assets (such as Bitcoin) and the underlying benefits of distributed ledger technology (DLT) itself (such as Blockchain). The former being viewed as being slower paced in terms of transformational impact – due to regulatory requirements around market infrastructure – but the latter could provide clear benefits in its adoption for point solutions to solve clearly defined market problems.

As we enter 2021, the market landscape exhibits some progress in this area – specifically within the FX processing arena, where various examples of the technology providing value are evident. Part of this maybe due to the relative simplicity of the underlying asset, with none of the complexities associated with securities being involved in the process. Alternatively, or perhaps additionally, it may be that benefits of faster or improved settlement creates a more tangible business case for adoption, when considered through the lens of intraday liquidity management under BCBS 248. Irrespective of the drivers, this seems to be the area where the most traction has been gained in adoption of post trade DLT solutions. Two key use cases stand out of particular note:

  • FX Confirmation & Netting. CLSNet[3] has been developed upon a DLT framework designed by IBM, providing users the option to confirm and net payments across 120 currencies. This provides benefits to CLS users – who can know improve processing in currencies settled outside CLS – and for broader market participants who are not existing CLS users – but are able to still capture netting and reconciliation benefits. One bank noted within their case study – Bank of China Hong Kong – exhibited a 98% reduction in the number of payments and a 50% reduction in funding through its adoption.
  • FX Reconciliation & Settlement. Baton and Cobalt[4] have recently teamed up to consolidate offerings they both have in this space. This leverages the shared records that Cobalt provides for an FX trade to support reconciliation and matching, with Baton providing capability around collateral visibility and settlement. Whilst a relatively new offering, both providers have an existing user base of large banks whom you would expect to see adopting this joint-offering in the near future.

What is evident about both of these use cases is that a) the actual settlement doesn’t require digital currencies, the solutions plumb into existing payments infrastructure and b) that they are designed to operate alongside, not instead of, legacy systems and processes. This is a good example of the ‘pragmatism’ needed to develop mainstream adoption of the technology – where industry-wide collaboration around widescale market infrastructure adoption is not required. Merely, development of a narrowly defined user case that can provide demonstratable value to the marketplace. And which can be progressed with a small group of pioneers or early adopters, to prove out the value associated with the concept.

The industry track record of cross-industry collaboration to harmonise and streamline post trade infrastructure is poor at best, where vested interests have typically stymied good intention. Core to the benefits of DLT solutions is the requirement to bring together industry participants to collaborate on shared infrastructure – so perhaps one of the triggers for progression towards wider adoption will be to mirror this approach. Namely for solution providers to bring the technology to address a specific post trade problem, not bringing technology in search of a problem.

It will be interesting to see how 2021 continues with this trend of pragmatic adoption and movement towards the next phase in the cycle, namely the ‘slope of enlightenment’.