Market regulators have criticised the lack of transparency in securities lending. Are the incoming reporting standards enough to fix the problem?
Over the course of history, opaque markets have proven to be the venue for the Devil’s work. The lack of transparency in any market leaves the door wide open for unfair pricing, and it inhibits the free market from functioning fairly. The reporting standards of the Securities Financing Transactions Regulations (SFTR) are a good start but globally more can be done. Regulators are right to criticise the lack of transparency in the system, but we do not believe the new SFTR standards do enough to fix the problem as they only cover EU firms and EU branches of non-EU firms.
Each and every bit of incremental improvement in reporting standards will shed much-needed light on this, the last bastion of opacity in today’s markets. US Supreme Court Justice Louis Brandeis said it best: “Sunlight is the best of disinfectants.” Our new technology opens an enormous skylight so that sunlight can pour into this corner of the market.
Are emerging technologies such as distributed ledger technology the answer to the industry’s transparency issues?
These technologies have enormous potential to increase the security, transparency, and auditability of the financial system, particularly in the area of securities lending. Today, there are a number of financial intermediaries that make the securities lending process opaque and complex, increasing friction and instability in the financial system. It is difficult to track not only ownership of underlying shares, but also to track that a given short sellers’ locates correspond to any underlying shares on a one-to-one basis. With blockchain technology, shares and locates can easily and transparently be represented and tracked.
How is tZero approaching the issue of transparency and what can blockchain bring to securities lending?
For the better part of the last decade I have been the most outspoken advocate for more transparency in the securities lending space. The opacity in the marketplace and the nature of the current voice market has been the biggest impediment to free market price discovery. As evidenced by the recent class action lawsuit filed by multiple public employee retirement systems, the intentional actions of a few have caused tens of billions of dollars to flow to monolithic Wall Street prime brokers and custody banks rather than to the people who deserve it, the underfunded pension plans and retirement systems representing the hardworking men and women of America.
There is now public information proving 75 percent of the overall revenue of some of the largest prime brokers is derived from the lack of transparency in securities lending. In a time where pension plans are at great risk there is no excuse for prime brokers posting billions in profits deceptively expropriated from the retirees of America. The application of blockchain technology in an open transparent free market environment eliminates the opportunity for bad actors to profit from the lack of information.
tZero’s blockchain-based digital locate receipt (DLR) platform ensures that valid locates are generated from valid underlying securities, while providing a more transparent marketplace for lending. A DLR is a digitised version of a traditional Regulation SHO locate. Regulation SHO established ‘locate’ and ‘close-out’ standards that are primarily aimed at preventing opportunities for unethical traders to engage in naked short selling practices. tZero has created a DLR platform that captures share inventory and audit trail information and stores that information permanently on a proprietary blockchain, ensuring that locates accurately correspond to underlying shares. Short Sellers are able to purchase DLRs on tZERO’s platform, which runs an overnight auction on for the benefit of inventory providers (such as pension funds). Short sellers are then able to short the underlying stock up to the quantity of DLRs they’ve purchased. All DLR creations and purchases are registered to the blockchain, which prevents naked short selling that arise from inaccurately sourced locates.
New blockchain initiatives are launching every month, how long until blockchain is a mainstream topic in the industry?
Blockchain technology has quietly been investigated in the financial industry for three years, but in 2017 there has been an explosion of interest in the space. This was precipitated by a sharp rise in the price of cryptocurrencies in the first half of 2017, followed by a boom in the number initial coin offerings (ICOs) coming to market—over three times more has been raised via ICOs this year than via traditional VC funding. The attention these two areas have drawn has led to a more general awareness of blockchain, the technology underlying these cryptocurrencies and tokens. We believe that as this awareness continues to blossom, blockchain could be more disruptive to industry and society than the internet was, and we are only starting to see its potential unfold. Blockchain gained critical awareness in 2017, and over the next five to ten years, hundreds of industries will begin to introduce this technology to increase the efficiency of existing business processes (by as much as 80-90 percent, we believe), lower coordination costs, and introduce new business models. We believe this technology will cause a deep and fundamental change in the way that our societies conduct commerce.
Our DLR product currently has 4700 tickers in the system with approximately 25 percent deemed hard to borrow stocks; and we will be onboarding more soon. We have already gained traction among inventory holders and short sellers and expect to continue to see steady growth in the product
What’s in the pipeline for tZero in the next 12 months?
tZero currently has the only US Securities and Exchange Commission (SEC) approved alternative trading system (ATS) for blockchain securities. We recently entered into a joint venture with RenGen and Argon Group to launch this ATS for the trading of security tokens issued in ICOs. As mentioned, there has been a boom of ICOs this year, accounting for $1.2 billion in funds raised, as of early August.
There was a lot of uncertainty around the regulatory status of these ICO tokens until July of this year, when the SEC announced that some of the coins being offered are actually securities. Because of this, these is huge demand to register and trade many of these ICOs within an SEC compliant trading system. Currently, tZero is the only such system that exists, and now with Argon and RenGen as partners, we can provide the advisory services and liquidity that issuers need to launch ICOs and trade in the secondary market.
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