How can technology help manage collateral and improve market efficiency? Biser Dimitrov of Tata Consultancy Services explains more
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What are some of the main challenges with conducting a securities lending transaction?
We can clearly distinguish three main groups of challenges in securities lending transactions. The first group I would call structural, and the challenges there are related to the inherited complexity and multi-level hierarchy of transaction workflows with multiple intermediaries. We also have to deal with all the non-standard process interfaces with multiple entities, and lastly, there is a lot of fragmentation of collateral pools across counterparty and depots.
The second group I would call transactional, and here I would include the inability to track on near-real-time basis, the lack of straight-through process (STP), and timely exception management and enforcing restriction on re-use and re-hypothecation. The transactional inefficiencies result in higher costs and errors requiring manual interventions.
I would classify the third group as regulatory challenges where we have to deal with different levels of account segregation requirements and the difficulties achieving transparency and disclosure at all the levels.
How can technology help clients manage collateral in a securities lending transaction?
Due to the rapid growth of distributed ledger technologies (DLTs), blockchain technologies and the maturing of tokenisation concepts, we saw an opportunity to improve the way non-cash collateral is managed.
We have developed a system based on blockchain and smart contracts, which tokenises the collateral used in the securities transaction. We have replaced the collateral agreement with a set of custodial smart contracts that sit between the borrowers and lenders. Because of the efficient use of tokenised collateral, we have reduced the counterparty risks and complexity, lowered the costs and managed to achieve the following benefits:
• Increased visibility of the available collateral—the securities are made available for other transactions/usage immediately after settlement
• Made the collateral already available in case the borrower defaults, and it can be used to cover the lender’s losses
• Overall improved efficiency
• Eliminated dispute management
• Eliminated the need for reconciliation
• Enabled instant settlement
• Enhanced regulatory transparency
• Reduced back-end functions, saving costs and enhancing efficiency
• Eliminated manual errors and associated risks, building confidence in the market
What are the opportunities to be had with non-cash collateral and what are the challenges?
Our latest research data shows that there is a general migration from a cash to a non-cash environment, accompanied by a decrease of corporate bonds as non-cash collateral. On the other hand, the non-cash collateral represents at least 60 percent of all transactions globally and as much as 90 percent of European government bond lending. One of the main challenges with non-cash collateral is that its availability depends heavily on the settlement dates. For example, non-cash collateral is not transferred to the lender until the settlement date, which prevents the lender from properly allocating those securities until they are received.
How can technology help improve efficiency?
We have seen great benefits from implementing a DLT solution providing a single source of truth; it eliminates the need for reconciliation as well as plugging in a robust smart-contracts-based layer. Smart contracts are, in essence, software programmes that, once deployed on a blockchain, can store and record the terms of a contractual agreement or any predefined business logic. For our specific case of collateral management, we saw that smart contracts can replicate the existing central counterparties/collateral management/bilateral collateral framework and collateral agreements. We have embedded business and operational rules to enforce the required performance. The benefits we experienced from our DLT solution include:
• Event/rule-based triggering of transaction workflow and automated execution
• Linkage with securities accounts at central securities depository/depots. Cash accounts are plugged in via Stablecoin frameworks
• A simplified and less hierarchical business process with an optimised interface
• Real-time/near-real-time transaction updates
• Privilege-based transactions and ‘view only’ access to involved entities
Some in the industry argue that blockchain is a solution looking for a problem, what are your thoughts on this?
We used to hear that a lot in early 2017, but not anymore. We are lucky enough that the CIOs and CTOs we work with are already past that stage and, through numerous proof-of-concept and pilot projects, are well convinced that there are huge benefits of a distributed trust system in an enterprise environment. These new systems are able to provide the disruption and thus the leadership in the financial services that everyone is looking for. The change of the paradigm is covering almost every aspect of the current operations, from governance, rules and oversight, through change in the regulatory frameworks, to enabling privacy, complexity and scalability.
The use cases where blockchain and DLT can be applied successfully are numerous and span over huge industries like telecommunication, aviation, supply chain, trade finance, custody, data storage, know-your-customer (KYC) and identity verification, travel and e-commerce. The important point is to fully understand the use case and estimate the trade-offs when applying DLT and have a complete understanding of the problem you are trying to solve. At the end of the day, blockchain is not one-solution-fits-all, and for that technology to work it needs a deep understanding of the use case and to be applied by an experienced team.
What projects are Tata Consultancy Services currently working on in the technology space?
TCS is working on multiple blockchain/DLT implementations for the customer across multiple industry verticals. In the banking, financial and insurance services space we have helped our clients implement multiple proofs-of-concept/value, pilots and a few production systems in the areas of corporate actions, KYC, custody, commercial lending, securities lending, mortgage servicing rights transfer, loan origination etc.
We have also helped our clients in aviation with implementations ranging from aircraft maintenance tracking to baggage tracking. Similarly, in healthcare and insurance space we have implemented cold chain, medical drug supply chain counterfeit detection etc. In the renewable energy space, a marque implementation we did is the trading and tracking of renewable energy certificates.
Responses were written by Biser Dimitrov and Chak Kolli, Phd, CTO of the BFSI North America unit.
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