The future is now
27 October 2020
Blockchain is an increasingly appealing option for financial institutions to improve securities lending practices and 2020 is arguably the year adoption went into high gear
Image: Sashkin/stock.adobe.com
Despite recent innovations, the process of transferring underlying securities between parties of a securities lending trade can still take up to several days and involve multiple intermediaries. However, through the emerging technology that is blockchain, financial institutions could reduce costs, increase efficiency, and execute transactions instantly and directly between the two parties, according to its advocates.
Momentum has been building over the years as blockchain peeks its head over the horizon. Progress began in earnest a few years ago with instances such as Deutsche Boerse backing HQLA? in 2018 to develop its blockchain-powered solution for the securities lending market. However, widespread adoption of this new technology has so far failed to reach critical mass — until now.
Arguably the year’s biggest endorsement of blockchain technology came from the Options Clearing Corporation in May when it unveiled an ambitious plan to overhaul its aging securities lending clearing infrastructure with a distributed ledger technology (DLT) platform.
“The system is highly-automated and uses shared smart contracts to perform settlement and life cycle events,” says Matthew Wolfe, OCC’s vice president of strategic planning and development. “The efficiency and automation will reduce costs, manual intervention, and errors. The system is also designed to automatically synchronise that golden copy with all nodes on the network.”
“This will allow lenders and borrowers to share a near real-time view of their contracts and transactions, which can further reduce errors and the challenges associated with legacy reconciliation processes,” Wolfe adds.
The project is being managed by Axoni, a New York-based technology firm that specialises in multi-party workflows and infrastructure and will be built on its flagship distributed ledger protocol, AxCore. An update on the timeline for a soft rollout is expected before the end of the year.
Another conversion occurred in Israel. Despite being one of the largest securities lending markets in the Middle East, Israel has lagged behind its Western peers. Now, it is potentially on the brink of a technological revolution with the Tel Aviv Stock Exchange (TASE) set to launch a first-of-its-kind distributed ledger technology venue dedicated to facilitating securities lending. The platform is due to go live in November and aims to give a much-needed injection of life into the country’s lending market.
Ofer Abarbanel, founder of Contact Prime Brokerage, a firm which specialises in the securities finance sector, explains that the exchange’s top management realised they needed to become more competitive so they could increase their value to its shareholders, therefore, they invested in improving their technology and turned to blockchain.
Similar initiatives are underway at boerses in Malaysia, Singapore and Spain, although none are as far along in development.
Elsewhere, more established blockchain-powered service providers such as Lendingblock, a securities lending exchange for digital assets that went live in 2019, along with SETL and Digital Asset continue to develop their product suites and present what they say is a more efficient way to do business.
Finally, trade bodies such as the International Securities Lending Association (ISLA) and the Risk Management Association (RMA) are making the development of digitisation, which lays the foundation for DLT adoption, a headline policy for the coming months and years.
But, is 2020 the year blockchain finally goes mainstream?
What are the current problems with the securities lending market?
The securities lending market at present, poses problems which create operational inefficiency by virtue of being a series of disjointed bilateral relationships, explains Matthew Phillips, COO and head of delivery at Trading Apps. The industry boasts some secure, well-managed pre-trade activity, but far too many processes are carried out on email and spreadsheets, for example: managing availability and trade lifecycle, he argues. “It is a very opaque market as supply and price data is available to some, and not others,” Phillips adds.
Phillips notes that there is limited data and process standardisation. For instance, close-of-business prices and foreign exchange rates are agreed between counterparties, and then different ones being used for the same security with another counterparty. This is in spite of ISLA’s best practice guide recommending using Bloomberg to standardise these figures.
“There are multiple vendor solutions which look to solve/fix the symptoms of the problem, such as contract compare and billing compare. However, a lot of manual intervention is required, making the process inefficient and prone to further error,” he adds.
Greg Chew, CEO at QPQ, which is developing a DLT-based network infrastructure to enable a fully-digital ecosystem for transactions to be initiated and settled, also acknowledges that securities lending is “by its very nature, more burdened with administration than most sectors”. At its simplest, Chew says, the two major problems facing the security lending market today are time and cost. Both these issues relate to the number of intermediaries and the fees they all charge, he adds.
Wolfe reinforces this argument. When OCC was in the early phase of planning its new clearing system as part of its Renaissance Initiative, it conducted a survey of industry participants about what their greatest pain points were.
Wolfe explains that there were three common responses: “Annual processing, errors, and escalating costs. These pain points largely stem from the daily reconciliation process between the lender and borrower’s record of contracts. There are regularly scores of discrepancies that require manual investigation and adjustment.”
What could be resolved through blockchain?
Since adopting blockchain technology, firms have seen a more automated process of trust by creating a digital ledger of data that stakeholders have access to, explains Chew.
“There is no need for third-party trust intermediation because the data itself — repeatedly confirmed across the distributed nodes — is the proof of truth. DLTs securely record and store all transactional data in an immutable and auditable manner, finally creating the level of transparency that regulators want to see in the financial industry,” he adds.
Phillips highlights that blockchain provides certainty of participant identity, coupled with certainty of the ownership and provenance of assets, and therefore it is no surprise that the technology is gaining traction in the supply and manufacturing chains.
“It is in these chains that assets have a ‘digital twin’ stored in the blockchain, wherein the ownership is moved instantly through transactions which update the asset owner,” he says.
Elsewhere, Wolfe states that as a systemically important financial market utility OCC has very high standards regarding security, performance, resiliency, and recovery. The clearinghouse conducted a proof-of-concept to validate whether a DLT-based system could achieve these standards and Wolfe says it “met or exceeded the non-functional standards”.
“Therefore we felt that we could deliver a system that addresses the industry’s pain points and allows OCC to better serve market participants without making any trade-offs,” he concludes.
Why this technology as opposed to another?
There are many service providers and fintech start-ups claiming to be positive disruptors of the market and touting one form of technological innovation or another, but DLT stands alone in one key area: reporting.
In a blockchain solution, it’s possible to have the regulator on a node in the network, which cuts the cost and complexity of reporting, while also increasing the accuracy and volume of information available to the regulator.
Speaking to SLT in 2017, IBM’s vice president of global financial markets, Keith Bear once said “utilising a blockchain solution would help make areas of the market, such as reporting, much more efficient. It could potentially remove the need for trade reporting all together, which is a mounting concern in the securities lending market with the introduction of unique trade identifiers.”
Any form of systems overhaul is difficult, and increasingly so the larger the firm in question. Moreover, securities finance is at the heart of many institutions, linking internal desks, client coverage, settlements, financing therefore all these internal networks are impacted by change.
This is why Duncan Johnston Watts, CEO of Blockchain Technology Partners, which is working with TASE on its platform launch, says the exchange’s adoption of blockchain was a “bold step to not only innovate by creating a market for its members but also by adopting a distributed systems architecture rather than the classic hub and spoke model”. Blockchain is one of the key enabling technologies that allowed TASE to achieve this, he says. For example, in many instances of securities lending, there is no automated linkage between accounts that indicate where the collateral should go back to, which slows down the process.
A scalable DLT-based platform would reduce manual intervention in the process, which, in turn, would make it faster and create a more transparent record for reporting purposes, as well as, reduce the cost of the transaction as there would be no need for costly intermediaries to facilitate said transaction.
Additional benefits of DLT could be the redistribution of collateral liquidity more efficiently via the enhancement of the interoperability of securities pools residing in various settlement systems and locations.
It is yet to be seen if the future of securities lending is on a blockchain, but 2020 may one day be seen as the year that the adoption of DLT more broadly moved from the industry’s periphery to the mainstream. With many industry players around the world on board and already identifying the problems in the securities lending workflow and how blockchain technology will circumvent them, the time may one day come when technological innovation will crowd out the intermediaries in the sector for the benefit of the key stakeholders involved in securities lending transactions.
Momentum has been building over the years as blockchain peeks its head over the horizon. Progress began in earnest a few years ago with instances such as Deutsche Boerse backing HQLA? in 2018 to develop its blockchain-powered solution for the securities lending market. However, widespread adoption of this new technology has so far failed to reach critical mass — until now.
Arguably the year’s biggest endorsement of blockchain technology came from the Options Clearing Corporation in May when it unveiled an ambitious plan to overhaul its aging securities lending clearing infrastructure with a distributed ledger technology (DLT) platform.
“The system is highly-automated and uses shared smart contracts to perform settlement and life cycle events,” says Matthew Wolfe, OCC’s vice president of strategic planning and development. “The efficiency and automation will reduce costs, manual intervention, and errors. The system is also designed to automatically synchronise that golden copy with all nodes on the network.”
“This will allow lenders and borrowers to share a near real-time view of their contracts and transactions, which can further reduce errors and the challenges associated with legacy reconciliation processes,” Wolfe adds.
The project is being managed by Axoni, a New York-based technology firm that specialises in multi-party workflows and infrastructure and will be built on its flagship distributed ledger protocol, AxCore. An update on the timeline for a soft rollout is expected before the end of the year.
Another conversion occurred in Israel. Despite being one of the largest securities lending markets in the Middle East, Israel has lagged behind its Western peers. Now, it is potentially on the brink of a technological revolution with the Tel Aviv Stock Exchange (TASE) set to launch a first-of-its-kind distributed ledger technology venue dedicated to facilitating securities lending. The platform is due to go live in November and aims to give a much-needed injection of life into the country’s lending market.
Ofer Abarbanel, founder of Contact Prime Brokerage, a firm which specialises in the securities finance sector, explains that the exchange’s top management realised they needed to become more competitive so they could increase their value to its shareholders, therefore, they invested in improving their technology and turned to blockchain.
Similar initiatives are underway at boerses in Malaysia, Singapore and Spain, although none are as far along in development.
Elsewhere, more established blockchain-powered service providers such as Lendingblock, a securities lending exchange for digital assets that went live in 2019, along with SETL and Digital Asset continue to develop their product suites and present what they say is a more efficient way to do business.
Finally, trade bodies such as the International Securities Lending Association (ISLA) and the Risk Management Association (RMA) are making the development of digitisation, which lays the foundation for DLT adoption, a headline policy for the coming months and years.
But, is 2020 the year blockchain finally goes mainstream?
What are the current problems with the securities lending market?
The securities lending market at present, poses problems which create operational inefficiency by virtue of being a series of disjointed bilateral relationships, explains Matthew Phillips, COO and head of delivery at Trading Apps. The industry boasts some secure, well-managed pre-trade activity, but far too many processes are carried out on email and spreadsheets, for example: managing availability and trade lifecycle, he argues. “It is a very opaque market as supply and price data is available to some, and not others,” Phillips adds.
Phillips notes that there is limited data and process standardisation. For instance, close-of-business prices and foreign exchange rates are agreed between counterparties, and then different ones being used for the same security with another counterparty. This is in spite of ISLA’s best practice guide recommending using Bloomberg to standardise these figures.
“There are multiple vendor solutions which look to solve/fix the symptoms of the problem, such as contract compare and billing compare. However, a lot of manual intervention is required, making the process inefficient and prone to further error,” he adds.
Greg Chew, CEO at QPQ, which is developing a DLT-based network infrastructure to enable a fully-digital ecosystem for transactions to be initiated and settled, also acknowledges that securities lending is “by its very nature, more burdened with administration than most sectors”. At its simplest, Chew says, the two major problems facing the security lending market today are time and cost. Both these issues relate to the number of intermediaries and the fees they all charge, he adds.
Wolfe reinforces this argument. When OCC was in the early phase of planning its new clearing system as part of its Renaissance Initiative, it conducted a survey of industry participants about what their greatest pain points were.
Wolfe explains that there were three common responses: “Annual processing, errors, and escalating costs. These pain points largely stem from the daily reconciliation process between the lender and borrower’s record of contracts. There are regularly scores of discrepancies that require manual investigation and adjustment.”
What could be resolved through blockchain?
Since adopting blockchain technology, firms have seen a more automated process of trust by creating a digital ledger of data that stakeholders have access to, explains Chew.
“There is no need for third-party trust intermediation because the data itself — repeatedly confirmed across the distributed nodes — is the proof of truth. DLTs securely record and store all transactional data in an immutable and auditable manner, finally creating the level of transparency that regulators want to see in the financial industry,” he adds.
Phillips highlights that blockchain provides certainty of participant identity, coupled with certainty of the ownership and provenance of assets, and therefore it is no surprise that the technology is gaining traction in the supply and manufacturing chains.
“It is in these chains that assets have a ‘digital twin’ stored in the blockchain, wherein the ownership is moved instantly through transactions which update the asset owner,” he says.
Elsewhere, Wolfe states that as a systemically important financial market utility OCC has very high standards regarding security, performance, resiliency, and recovery. The clearinghouse conducted a proof-of-concept to validate whether a DLT-based system could achieve these standards and Wolfe says it “met or exceeded the non-functional standards”.
“Therefore we felt that we could deliver a system that addresses the industry’s pain points and allows OCC to better serve market participants without making any trade-offs,” he concludes.
Why this technology as opposed to another?
There are many service providers and fintech start-ups claiming to be positive disruptors of the market and touting one form of technological innovation or another, but DLT stands alone in one key area: reporting.
In a blockchain solution, it’s possible to have the regulator on a node in the network, which cuts the cost and complexity of reporting, while also increasing the accuracy and volume of information available to the regulator.
Speaking to SLT in 2017, IBM’s vice president of global financial markets, Keith Bear once said “utilising a blockchain solution would help make areas of the market, such as reporting, much more efficient. It could potentially remove the need for trade reporting all together, which is a mounting concern in the securities lending market with the introduction of unique trade identifiers.”
Any form of systems overhaul is difficult, and increasingly so the larger the firm in question. Moreover, securities finance is at the heart of many institutions, linking internal desks, client coverage, settlements, financing therefore all these internal networks are impacted by change.
This is why Duncan Johnston Watts, CEO of Blockchain Technology Partners, which is working with TASE on its platform launch, says the exchange’s adoption of blockchain was a “bold step to not only innovate by creating a market for its members but also by adopting a distributed systems architecture rather than the classic hub and spoke model”. Blockchain is one of the key enabling technologies that allowed TASE to achieve this, he says. For example, in many instances of securities lending, there is no automated linkage between accounts that indicate where the collateral should go back to, which slows down the process.
A scalable DLT-based platform would reduce manual intervention in the process, which, in turn, would make it faster and create a more transparent record for reporting purposes, as well as, reduce the cost of the transaction as there would be no need for costly intermediaries to facilitate said transaction.
Additional benefits of DLT could be the redistribution of collateral liquidity more efficiently via the enhancement of the interoperability of securities pools residing in various settlement systems and locations.
It is yet to be seen if the future of securities lending is on a blockchain, but 2020 may one day be seen as the year that the adoption of DLT more broadly moved from the industry’s periphery to the mainstream. With many industry players around the world on board and already identifying the problems in the securities lending workflow and how blockchain technology will circumvent them, the time may one day come when technological innovation will crowd out the intermediaries in the sector for the benefit of the key stakeholders involved in securities lending transactions.
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