Stock exchanges are rapidly gaining ground on the adoption of Blockchain in the trading and post trade space, integrating the technology into their core systems and activities. In this article we look at three exchanges’ ambitions and the potential opportunities and challenges for market participants to keep up with the pace of change.
The process by which financial institutions buy and sell securities is not homogenised across different markets in the Asia Pacific (APAC) region. Nor is it particularly streamlined – multiple counterparties (exchanges, central securities depositories [CSDs], central counterparty clearing houses [CCPs], global custodians, broker-dealers and agent banks) are interposed between issuer and investor. All of this adds to the frictional costs of trading.
With so many intermediaries in the securities chain, global connectivity can at times be impeded, especially as a great deal of post-trade infrastructures utilise their own, bespoke interfaces and proprietary messaging applications.
Adoption of Blockchain or distributed ledger technology (DLT) is seen by many experts as a potential solution to the challenges currently facing securities markets under intense cost pressure and searching for new ways to expedite and augment securities trading practices.
Market infrastructures – particularly across APAC – are rapidly gaining ground on the adoption of Blockchain in the trading and post trade space with a number of providers trialling and even integrating the technology into their core systems and activities.
So who is adopting Blockchain?
The transition to Blockchain at ASX
The Australian Securities Exchange (ASX) has been a harbinger of Blockchain innovation. It announced back in 2016 that it would transition its 25-year-old CHESS (Clearing House Electronic Sub-Register System) to DLT. And do to so, they are partnering with Digital Asset Holdings, a leading provider of DLT, to create a working prototype of a post-trade platform for its cash equity clearing and settlement processes. The ASX initiative is something which BNP Paribas Securities Services has been involved with over the last few years.
Notwithstanding CHESS’ accomplishments in the local market, namely facilitating the dematerialisation of physical share certificates and helping the trade settlement cycle transition from T+5 to T+2, experts believe a DLT-supported platform will enable ASX to better future-proof its business, deepen its product pool and provide for a better, safer client experience. ASX has since confirmed that it will go live with DLT in March-April 2021.
HKEX turns to Blockchain
While ASX is adopting DLT on a fairly enterprise-wide basis, other exchanges are applying the technology to specific projects. Hong Kong Exchange and Clearing (HKEX) is working with Digital Asset and BNP Paribas to enhance its post-trade infrastructure, specifically accelerating the processing of northbound transactions on Stock Connect, an exchange linkage between HKEX and the Shanghai Stock Exchange and the Shenzhen Stock Exchange.
Despite providing investors with easier access to domestic Chinese A shares, Stock Connect has been encumbered by various operational issues from the start, disincentivising some institutions from participating in the scheme. Presently, investors trading China A Shares via Stock Connect only have a brief four-hour time window to settle their transactions, forcing institutions to pre-fund their trades, thereby exposing them to settlement risk.
The absence of real delivery versus payment (DVP) also precludes some regulated fund products such as UCITS and AIFMs (alternative investment fund managers) from trading on Stock Connect. Nonetheless, a number of leading providers including BNP Paribas have developed integrated broker-custodian models or special segregated account structures to facilitate real DVP for clients. While these models are structurally sound, BNP Paribas and HKEX have been working extensively to further improve the process for end investors.
HKEX is developing a prototype solution to enable market participants to specify their settlement workflows in advance, helping to bridge time zones, while allowing for real-time synchronisation of the post-trade status between asset managers, brokers, custodians and the Hong Kong Securities Clearing Company, HKEX’s CCP. Many believe this DLT solution will help increase foreign investor flows via the Stock Connect access scheme.
And Singapore joins the Blockchain club
In addition to ASX and HKEX, the Singapore Exchange (SGX) is also integrating Blockchain technology into its core infrastructure. In November 2018, SGX and the Monetary Authority of Singapore (MAS), the local regulator, confirmed they had successfully developed DVP capabilities for the settlement of tokenised assets across multiple Blockchain platforms.
Not only does the prototype shorten the trade settlement cycle (and reduce settlement risk), but the simultaneous exchange and settlement finality of digital assets and securities on different platforms vastly improves operational efficiencies during the course of the transaction. SGX and MAS are also assessing whether to automate the DVP settlement process through smart contracts, or self-executing, algorithmic legal agreements.
Getting past the experimental phase
There is an abundance of Blockchain proof-of-concepts (POCs) underway across banks, infrastructures and institutional investors. While innovation should be roundly supported, securities markets need to ensure Blockchain initiatives are harmonised to an extent across organisations, otherwise the technology risks being developed in narrow, siloed ecosystems, which could possibly prevent interoperability in the future.
In order to stop this from happening, firms need to agree on universal standards and implement joined-up governance frameworks underpinning Blockchain. Just as SWIFT enhanced industry-wide efficiencies and reduced market risk by shaping the standards underlining financial messaging, so too do the leaders in the Blockchain movement. This could be done by integrating DLT with ISO 20022 or through an entirely new solution. A failure to find common ground on market standards could result in Blockchain becoming highly fragmented and netting few – if any – cost benefits for the end users.
It’s only the beginning
It is very likely that stock exchanges will continue to leverage Blockchain technology and pursue proof of concepts which could bring about major improvements in securities trading for end investors and intermediaries. Anticipated improvements could principally come in the form of lower trading costs and the removal of a number of the risks involved, and could lead to firms accumulating healthier returns.