Financial Market Infrastructures Cite Progress, Concerns with Blockchain Technology

Financial Market Infrastructures (FMIs), which include exchanges, central clearing houses and central securities depositories, are focusing on blockchain or distributed ledger technology (DLT) applications that create cost savings and efficiencies primarily, but some are also pursuing new opportunities, according to a World Federation of Exchanges (WFE) report.

FMIs, due to the youth of DLT technology, are not certain how fully the technology will fulfill what it promises. They also recognize risks including maintaining security standards across legal and regulatory uncertainty.

FMIs Favor Collaboration

FMIs currently favor collaborative engagement with regulators as the technology’s applicability to capital markets evolves.

WFE teamed with the International Organization of Securities Committees (IOSCO) and the Affiliate Members Consultative Committee in surveying post-trade infrastructures and exchanges, collectively known as FMIs.

The report is based on responses form 24 FMIs along with an interview with another exchange. The report does not represent the total industry as it is based on input from early movers in the DLT capital markets arena.

The report focused on DLT’s state of play and focus areas, regulatory and legal perspectives, and opportunities, risks and visions of a post-DLT world.

Interest Remains High

The majority of respondents are investigating DLT applicability to their environment or are actively exploring opportunities. Seven of the respondents have allocated budget for DLT initiatives while 13 said they expect to.

Some FMIs are also working with industry groups including the Post-Trade Distributed Ledger Group and The Linux Foundation Hyperledger Project. The first group focuses on grasping common industry standards and regulatory policy relating to the post-trade environment. The second group seeks to create an open source distributed ledger framework and code base to allow users to build industry specific applications to support transactions.

FMIs are examining the following use cases: clearing and settlement, trade matching and confirmation, corporate actions like dividend payments and voting rights, securities issuance, crowd funding, proxy voting, trade registration, regulatory transparency and reporting.

In the more bespoke area, respondents also seek the following DLT provisions: national anti-money laundering and know your client registries, trade finance facilities, asset registration facility, databases on agricultural receivables, and digital assets.

Further Progress Expected

Respondents highlighted efficiency enhancement, risk reduction and cost savings as main reasons for exploring DLT. The technology is seen as allowing for further process automation, reducing the need for authentication and manual reconciliation. It also reduces the time needed to finalize transactions and allows greater system resilience and data integrity.

Regarding settlement and clearing collateral management, respondents see these features bringing better capital efficiency and reducing capital requirements for market participants.
Some believe DLT investments can unlock revenue opportunities by giving access to new service offerings. Others think the efficiencies will impact organizational structure.

Expected Rollout Time Varies

Respondents varied in their expected time to introduce DLT use cases. One respondent has deployed a working blockchain application and is rolling out another. Others are at the proof-of-concept stage while some are in the design and evaluation stage.

Respondents had varying levels of concern about technical challenges and integrating DLT with existing infrastructure.

Respondents agreed on the need to ensure that DLT solutions align with legal and regulatory frameworks. There were several issues under this topic that need clarification, however. They included privacy laws, data governance issues, intellectual property rules, investor protection, and conflict of interest.

Respondents agreed that open dialog about the technology’s evolution is the most important point. All agreed on a collaborative approach.

Long-term, they felt IOSCO could play a role in establishing global standards and ensure the standards do not conflict with other standards, such as those relating to cyber security or data protection.

Barriers To Adoption Cited

Barriers to adoption include vested interest in protecting existing systems, lack of technical skills, uncertainty about the technology, and legal and regulatory issues.

Asked to name potential risks of DLT application to capital markets, respondents cited immaturity of the solution or uncertainty about application to existing processes, such as handling fraud and theft, and how to ensure non-blockchain transactions are reflected on the blockchain.

Most agreed it is possible and likely for non-financial players to take the lead in DLT development. They did not, however, agree non-financial firms are in a position to roll out DLT solutions in capital markets without existing players’ participation. Respondents felt it would happen in collaboration with existing players.

Respondents offered divergent views on whether DLT will fundamentally affect the structure of their industry.

Also read: Report shows banks concern for transaction confidentiality on distributed ledger technology

New Parties’ Roles Uncertain

Respondents also disagreed on the impact of DLT on trusted parties’ roles and the growth of new trusted parties. One respondent noted the process could require fewer intermediaries. Some saw the emergence of trusted third parties to handle the verification function.

Predictions are hard to make at the current time on the scope and scale of DLT’s impact on financial markets and market intermediaries, the report noted.

The number of FMIs exploring and deploying DLT proof of concepts and solutions will increase.

Where some FMIs approach DLT as a competitive advantage, the existing collaborative approach is expected to continue.

The collaboration will include regulators and policy makers that will encourage adoption of proper regulation that will minimize unintended consequences of policy formation. Some have adopted “regulatory sandboxes” for the fintech industry that can include DLT.

In areas where unregulated and non-financial entities lead DLT development, regulators will have to ensure equivalent protections exist.

New Standards Needed

To the extent that regulatory standards are needed, IOSCO can help develop standards.

Potential use cases will continue to evolve as FMIs and others explore beyond current processes for new opportunities.

WFE will continue to facilitate an open dialog between its members about the technology’s evolution.

Featured image from Shutterstock.

Lester Coleman is a veteran business journalist based in the United States. He has covered the payments industry for several years and is available for writing assignments.