Paul Dowding, a New York-based managing director and blockchain lead at Gartland & Mellina Group, has no doubts about the potential of blockchain, also known as distributed ledger technology (DLT).
The executive has worked across custody, securities lending, prime brokerage, trading and asset management during his career and believes blockchain can revolutionize way securities are transacted, cleared and settled.
The problem, however, is getting there. According to Dowding, there are several limitations and flaws present in current distributed ledger technology proof-of-concepts.
“Most focus on payments or settlements for limited-purpose use-cases with low-volume, high-latency small-population transactions in unregistered securities,” says Dowding, who has previously worked at Chase Manhattan Bank, Goldman Sachs, Morgan Stanley, BNY Mellon and Bank of America.
Further, he believes the proof-of-concepts are not capable of comprehensively recording a working market’s need for non-ledger referenced and potentially undefined obligations e.g. shorts, payables and financing.
“For blockchain to work, it has to support a working market (i.e. the access capital and the liquid means to securely trade the various securities therein) and securities financing (repos, securities lending) is the lubrication for a working market.
“This is the approach blockchains and distributed ledgers should be pursuing not just faster, better, cheaper clearing and settlement, which all the current solutions are pursuing and failing to achieve regardless.”
Securities lending, therefore, may well end up being an area blockchain enthusiasts look at more closely to get their technology up and running. At the same time, this could solve some of the longstanding operational, transparency, cost and risk issues associated with lending and borrowing of securities.
“There are key areas within securities lending that blockchain is an excellent fit for,” according to Sivaskanthan Jegatheswaran, an IT analyst focused on securities lending at Canada’s National Bank.
“These include contract compare (daily comparison of trade details necessary for an accrual business), mark to market (daily marking of trades, necessary for accurate accrual and exposure), and efficient, automatic triggering of recalls/returns/buy-Ins.”
Caitlin Long, president at Symbiont.io, a smart contracts platform for financial sector uses of blockchain technology, reckons securities financing capabilities are a “must” for blockchain-based trading platforms.
Having run the pension solutions group at Morgan Stanley before joining Symbiont, Long’s experience tells her that blockchain-based securities lending will attract more lenders to the market, not fewer, because blockchain offers asset managers transparency into where your securities are at all times and should facilitate fairer pricing (especially for hard-to-borrow stocks or bonds that trade “special” in repo).
“Today, securities lending is a black box for lenders and that causes fiduciary asset managers to be cautious – you don’t always know who your counterparties are, can’t control borrower creditworthiness, don’t know how long collateral chains are when you rehypothecate an asset, can’t be sure you’ll get your securities back as promised, and can’t prove that you’re achieving the highest return for clients because pricing is done on a portfolio basis.
“The issue is especially tough for ERISA plans, and I believe the ERISA plaintiff’s bar will focus on securities financing at some point – remember that ERISA fiduciaries are personally liable. Also, Treasury Market Practices Group (TMPG) fails charges are starting to become a material cost for the buy-side to absorb. Because of all of these factors, I believe blockchain-based systems will help keep the buy-side at the securities financing table – even more actively than they are today.
“At Symbiont we built our platform to offer the full range of securities financing capabilities for assets on our platform,” Long adds.
Among the various start-ups and financial market participants involved with blockchain, custodian banks appear to have been the most active when it comes to exploring use cases for securities finance.
Since the middle of last year BNY Mellon, for example, has been collaborating with tech giant IBM to design and create a blockchain-based application for securities lending. State Street has also been testing a blockchain system that it hopes can be used to streamline the securities lending process.
“We see great potential value in leveraging distributed ledger technology to create better alignment, notification, and synchronization across internal and external parties involved in securities lending transactions,” says John Burnett, head of blockchain development for State Street.
“Certainly some of the benefits we are looking to achieve could be gained through other technologies, but we see blockchain as a core foundational technology that we will combine with other technologies as part of our broader efforts to further digitize the bank.”
More broadly, Burnett says, at this point, the current blockchain projects underway across the market have “yet to prove the interoperability and scalability” that will be required. However, State Street expects that to change as the technology and use-cases continue to mature.
Elsewhere, executives at Chicago-based clearing house OCC, which handles stock loan trades as well as derivatives, told Global Investor earlier this year that they are considering a number of ways that distributed ledger technology could enhance its clearing services, and securities lending is the leading use case.
“We believe there are significant gains in efficiency that could be achieved by having a ledger that tracks the lending of securities, particularly when the shares are lent multiple times,” Matt Wolfe, OCC’s vice president, new products, told GHlobal Investor.
“Having the complete record will support a more efficient and effective return process with an enhanced ability for security owners to participate in voluntary corporate actions, and with improved market data.
“We also see opportunities for product innovation on the blockchain, such as new ways of collateralizing loans as well as improved capabilities for structured lending agreements. Such changes would improve market stability through reduced operational and settlement risk.”
Charles Cascarilla, chief executive and founder of blockchain firm Paxos, says his organization has spent a lot of time thinking about securities lending.
“Whether its stock loan or repo, blockchain offers the benefits of being able to manage collateral, counterparty exposures and chain of title,” he explains. “However, we think it would be beneficial to start from a settlement perspective, rather than focus on the funding dynamics. Settlement is where it makes sense to take first steps forward with securities lending.”
The New York based-executive says that his staff have taken a look at one or two securities lending specific projects with significant market players. “In the end, these were big system upgrades which didn’t really lend themselves to a blockchain solution. I’m not really aware of anyone in the market who wants to do blockchain on securities lending at the moment. We envision touching upon that in 12-18 months, but securities lending is not imminently on our product road map.”
While it is still early days, many firms, including NYSE-listed Broadridge, clearly believe there could be an application for blockchain technology in certain areas of the securities finance lifecycle.
“We have made strategic investments internally and with a number of fintech vendors in the blockchain space and are currently working with several customers on proof of concepts in the bi-lateral repo area,” Martin Seagrott, marketing director, securities finance and collateral management at Broadridge, told Global Investor earlier this year.
“We continue to see an accelerating evolution of the number and complexity of block-chain initiatives affecting the financial services sector. Broadridge is determined to understand and participate in this trend.”
One to watch?
The Australian Securities Exchange (ASX) has said that its new post-trade solution to replace its legacy Clearing House Electronic Subregister System (CHESS) platform is still in testing phase, with the software on track for assessment in December by a third party.
The ASX is anticipating a final consultation on the blockchain-based technology to occur by March 2018, when it will determine if distributed ledger technology (DLT) is in fact the right solution.