December 11, 2017
By Harry Stahl, solution architect, Institutional & Wholesale
Last month, my colleague Tony Warren blogged about the five technologies that are reshaping financial services. Blockchain, also known as distributed ledger technology, is one of those that the biggest players in the market are already betting on.
It’s pretty clear why it’s getting so much early investment. Blockchain can capture something that’s done in multiple systems today and put it into a shared system (the eponymous distributed ledger). Once you achieve that, not only is the process more streamlined, but subsequent changes are locked down, auditable and fully controlled, which increases accuracy and efficiency and reduces errors.
In fact, I think we’re about to see the first wave of blockchain adoption. And I will make some predications about the types of situations where it will appear first.
1. Complex functions that involve just a few participants. Manual and time-consuming activities are easy wins for blockchain. And if you have a relatively small of participants involved in the activity, then there’s a lower barrier to adoption because fewer people need to buy into it.
One example is capital call management in private equity. When a private equity general partner calls in capital from limited partners, the fund manager generally picks up the phone or sends an email to request significant amounts of money. The process is complicated and opaque, and therefore time-consuming and a little risky. But blockchain can make it clean, controlled and auditable without requiring GPs or LPs to make costly changes to their IT infrastructure or workflows.
2. Long-lived transactions that involve many different participants and/or multiple systems. On the other side of the coin to the first category of activities, blockchain can also easily improve complicated processes with a large group of participants. The benefits go up in relation to a few factors: the length of the transaction life cycle over multiple events, the number of participants involved during that life cycle, and the volume of these events.
Even a vanilla equity transaction has multiple steps and multiple players – order, execution, settlement, position, potential corporate actions, etc. Fixed income transactions add to this, and derivatives can increase the complexity exponentially. These are natural candidates for blockchain, especially as trade volumes continue to increase.
Take listed derivatives trading. Executing a listed derivatives trade is not rocket science. But more complex instruments involve more and different data and events during their life cycle. Blockchain can capture that in a central and streamlined way – and make the results secure but available to those entitled to access.
3. Regulatory requirements for transparency. The latest regulation on everyone’s mind is SEC Rule 613, otherwise known as the Consolidated Audit Trail (CAT). CAT will establish a central data repository to house a complete record of all equities and options trades in the U.S. national securities exchanges, and self-regulatory organizations will be required to submit trade information to the CAT to allow regulators to efficiently and accurately track all activity through the U.S. market in National Market System securities. Over time, this single reporting process is expected to replace existing ones, such as Electronic Blue Sheets and FINRA’s Order Audit Trail System.
The complete implementation of this will be a monumental task. But to the extent that a technology like blockchain is capturing a subset of these transactions, it will make it possible to collect data cleanly and report it seamlessly. At the extreme, full adoption could lead to the Holy Grail of a single, shared repository of all transactions of any type and at any stage in the life cycle.
4. Where a single institution handles transactions flowing between multiple parties. Blockchain is also particularly suited to activities such as clearinghouse and transfer agency, where one organization coordinates the flow among different parties as well as the technology behind it. They have an incentive to increase efficiency and control – and, as in the first example, the smaller number of participants lowers the barrier to adoption.
I don’t expect that adoption will be monolithic, universal, or instantaneous. But if we start implementation toward the top of the transaction lifecycle – for example, with trade execution – we can rack up some easier wins. That data is relatively clean and straightforward, and capturing it will provide the foundation for tracking the transition through blockchain along rest of the trade life cycle.
As adoption spreads, the power of a single shared source of truth can shift the whole game. Where there’s a single record instead of multiple sources, there’s no need to reconcile records across multiple systems, you have a perfect audit trail, and you can enforce consistent, robust security. And after adjusting operations to reflect the change (not massive but probably not trivial), the result is a simpler, cleaner way of handling the transactions. That’s a feature presentation that everyone wants to see, but it may quickly transform areas that we take for granted today. Are you poised to move as change accelerates?