Skipping the more complicated or broader reaching applications for the moment, blockchain appears to be gaining momentum in specialized operations serving smaller user groups . Although no one cited any live cases, representatives from FIS and Symbiont who spoke at a gathering hosted by financial services conference planner Global Markets Insight were quick to point out the specific merits of using blockchain technology for reconciliation and syndicated loans settlement, respectively.
Commonly associated with the virtual currency Bitcoin, blockchain technology has made its way into the post-trade clearing and settlement space. The premise is that financial assets can be expressed in digitized form through token-based assets — which track balances, but still rely on manual processes — or autonomous smart contracts on a distributed ledger, which financial firms can access either at will or on a permissioned basis. All of the financial intermediaries involved in buying and selling assets could have the same view of the assets with ownership transferred through the distributed ledger.
Wall Street is certainly spending plenty of money on analyzing blockchain, investing in new ventures and developing proofs of concept. Blockchain technology took up just US$30 million of budgets in 2014 and US$75 million last year. The figure could skyrocket to US$440 million by 2019, estimates global consultancy Accenture. Just about every Tier-one bank, not to mention US market infrastructures Depository Trust & Clearing Corp., and Nasdaq have announced a multitude of projects of individual and consortium projects underway.
However, it could still take until 2025 for blockchain’s widescale implementation. Concerns over scalability and speed have arisen. Legal uncertainty is certainly also roadblock and has created a chicken and eggs scenario. Market players might not be comfortable in taking the full plunge into blockchain technology unless the US Securities and Exchange Commission offers some concrete rules or guidance. The SEC, in turn, may be looking for more concrete evidence that blockchain technology will benefit regulatory compliance and auditing, as many operations specialists believe. With data accuracy and verification a given, there should be no worries on the validity of reporting, middle and back-office experts attending the New York blockchain event tell FinOps Report.
Even so, one potential use, reducing the time it takes to settle an equities or fixed-income trade in the US could be a pipedream for multiple reasons, say panelists at the event. For one thing, the pending two-day settlement cycle in the US is considered efficient enough. Another issue is that the Depository Trust Company, the US national securities depository and its sister clearinghouse National Securities Clearing Corp. are market-owned fixtures and would have to make substantial operational adjustments. So would multiple trading venues. Last but not least, there are still too many paper certificates in circulation. ASX, operator of Australia’s exchange, is working on the use of blockchain for settlement, but all securities are dematerialized in that country — held only in electronic-form– and the exchange owns the depository system.
First the Easy Ones
At least for now, market players are happy to focus on the low-hanging fruit, or what can be easily accomplished. “Banks will start off with using blockchain for asset classes that are bilaterally traded and/or have no central clearing authority,” says Chris Brodersen, an executive in the blockchain technology research unit of Accenture, which is part of a consortium of financial firms that have invested in blockchain technology provider Digital Asset Holdings.
Using blockchain technology for reconciliation and syndicated loans is a no-brainer. Reconciling or matching and verifying data points through manual or even electronic means would be eliminated, or at least reduced, because everyone in the network accessing the distributed ledger would be working off the exact same data on the ledger. In the case of syndicated loans, the volume of trading in the syndicated loans market isn’t nearly as high as in the equities or fixed-income markets where electronic trading platforms and centralized clearance and settlement systems abound. Buyers and sellers of syndicated loans are part of a closed group of players — a scenario which mirrors the structure of a permissioned distributed ledger where the ledger and its data would be open to only an approved set of participants. The ledger would provide an immutable record of just who the counterparties are.
Paul Clapis, director of product management for technology giant FIS, a provider of popular reconciliation engine IntelliMatch, insists that blockchain technology would at the very least accelerate the migration from spreadsheet based reconciliation to automated reconciliation. “Blockchain technology improves data validation and consistency — two obstacles to automated processing,” he says. “The early adoption will likely be for internal reconcilation. The concept could ultimately be transferred to external reconciliation between banks and external service providers.”
Financial firms are spending far too much time on reconciliation, because of how data is distributed. Each business line in a financial firm has its own version of the attributes of a financial asset or the economic terms of a transaction. Some of the data points may be replicated, while others may differ. Implementing blockchain technology relies on business lines to agree on what the data points located on the distributed ledger should be before the crytographic encryption takes place.
No firm would include all of its data or transactional information on a single distributed ledger, but the number would certainly be far fewer than the number of physical databases. “Each ledger would likely represent all the information on a particular asset class the firm is trading or all of the trades executed or pending or all of the cash payments expected and made,” says Clapis. Voila: the number of reconciliations that have to be performed daily would naturally decline. There would be fewer exceptions, or discrepancies to catch.
Why not just keep the multiple versions of the data and simply rely on reconciliation tools? After all, there are a handful of brand name players popular in the financial industry. For starters, not everyone is using an automated reconciliation engine. And even those firms that do must then deal with the exceptions or red flags it generates. Some firms rely on multiple reconciliation teams to go the extra mile through manual intervention.
More than Cost Reduction
For financial firms that already employ automated reconciliation engines, blockchain technology might not cut down the reconciliation costs by as much as for those relying entirely on manual labor, concedes Clapis. However, there are other benefits such as ensuring the data integrity, security and access. Unlike in traditional databases, the data stored on the distributed ledger cannot be changed by anyone at the firm. Hackers will also have a harder time accessing the data because distributed ledgers encrypt individual transactions or messages stored on the blockchain. Every data point is protected at the data element level so in order for someone to access the data it would have to break the encryption. Last but not least, the distributed ledger could also limit the amount of data accessible for a particular contract or asset class by business unit.
What will happen to reconciliation vendors if blockchain technology were to take off? Clapis would only say that FIS’ Intellimatch would fit into the new distributed ledger structure. Other reconciliation software firms contacted by FinOps Report declined to comment.
While the syndicated loans market has made some progress in cutting down paper-based interactions, the scenario is far from ideal, prompting the need to find quick solutions. There is still enough inefficiency in the current semi-automated systems to make for a lengthy settlement times — 19.3 days on average according to the trade group Loan Syndications & Trading Association (LSTA). Participants in the market complain it is far too costly and operationally cumbersome to close a deal on a syndicated loan because of all the information that must be recorded, verified and transferred among the fund managers, broker-dealers and banks involved.
Delays in the settlement time will not only increase counterparty risk and cost, but also hamper the ability of registered investment funds are to meet the SEC’s proposed rules on liquidity management issued last September. Fund managers are wary of the restrictions the SEC is imposing on the amount of illiquid assets they can hold and their ability to meet redemption requests quickly during times of market volatility. In January, 2016, the LSTA told the SEC that it wants to “transform” syndicated loans settlement over the next three years to make it adhere to other asset classes. The US is moving to a two-day settlement cycle for equities and fixed-income instruments in 2017.
Through a new joint venture, smart contract technology upstart Symbiont and its partner Ipreo, a provider of deal execution systems for new issuances, are hoping to cut down the settlement timeframe for syndicated loans, while taking a bite out of the commanding industry lead enjoyed by Markit’s Clear Par platform. Markit has been promoting the use of its new platform Markit Clear, an upgraded version of its legacy Clear Par system, to satisfy the syndicated market’s need for greater efficiency.
In September 2015 Ipreo launched an automated platform called LTS which it said was designed to shrink the time it takes to settle a syndicated loan trade to three days. Ipreo has not disclosed just how many users, if any, signed up to use LTS. Symbiont is bringing its smart contract technology to the table, which it says allows users to efficiently issue, manage, locate and trade smart contracts on any distributed ledger.
Mark Smith, chief executive of Symbiont, insists that the entire process from the origination of a syndicated loan all the way to its settlement in the secondary market trading can be handled through smart contracts called SmartLoans. Depending on how quickly counterparties and agent banks communicate with each other it could take even less than five days to settle a syndicated loan. So far, one agent bank and five fund management firms are signed up to use the new distributed ledger technology platform for syndicated loans, whose launch date has yet to be announced.
Smith also could not specify just how much less using the new methodology will cost, compared to using Markit’s platform. However, he says that relying on SmartLoans will be a lot cheaper for counterparties and agent banks — the organizations corporate borrowers hire to keep track of who owns how much of each syndicated loan and register ownership changes.
Markit wouldn’t comment specifically on the joint venture between Ipreo and Symbiont joint venture, but recently gave some credence to the merits of blockchain technology. “Blockchains are a long tail game and over time it will help loans and other markets address operational risk, improve balance sheet utilization and ultimately change the risk profile of complex financial products and promote market liquidity,” says Scott Kotyra, managing director of Markit’s loan settlement business in a May 6 blog appearing on Markit’s website.
Still, Markit is eager to ensure that the current technology remains viable even if it isn’t perfect. In a subtle comment on potential competition, John Olesky, head of product development for Markit writes in a blog appearing on Finextra last year, “Being 10 percent better is better. You don’t have to automate every step in your process to be better, so going from 10 steps to 7 steps is worth the effort. If we all do our best to use available technology, the market will definitely feel the impact.” As evidence, Kostyra cites a recent LSTA operations event where some banks revealed they are settling about forty percent of their trades on a T+7 basis.
Smith agrees that behavioral changes are just as important as technological, but why not create the best mousetrap. “Relying on the most advanced technology will be a great motivator,” he tells FinOps.