Blockchain a blessing for capital markets
05 February 2016 Brussels
Image: Shutterstock
Although there are still barriers to the widespread adoption of blockchain in capital markets, a ‘wait-and-see’ approach could be damaging, according to a whitepaper by Euroclear and Oliver Wyman.
The paper suggested that banks’ IT and operations expense in capital markets reaches $100 billion to $150 billion per year, while post-trade and securities servicing fees were estimated at about $100 billion per year. Capital and liquidity costs are also increased because of delays and inefficiencies within market operations.
New architecture, based on blockchain, could allow all capital market participants to work from common datasets, meaning operations could be streamlined, or removed altogether.
This would remove some of the current complexities around fragmented IT and data architecture and a lack of common standards, which lead to constant reconciliation and duplicated processes.
The technology could also increase visibility for fund managers, and allow multiple layers of custody functions to be viewed in one single function.
The paper said: “The obstacles to be overcome are significant, and it is far from clear what will ultimately emerge.”
These obstacles include the limited scalability of the technology, the need for a robust cash ledger, operational risks, issues around managing anonymity, and creating common standards and governance. Regulating capital markets on blockchain was also highlighted as an issue, specifically around making sure any regulation is fit for purpose.
While disruptors in other sectors may have taken an ‘act-first’ approach to regulation, in financial markets, innovators have to secure regulatory approval ahead of time, taking in to account geographical legislation and rules around change-in-ownership. On top of this, currently, once mechanisms are entered in to blockchain they cannot be retrieved. Although this is a security feature, it could also prevent legal intervention, the paper warned.
According to the paper, blockchain provides a new approach to data management and sharing that is being proposed as a solution to inefficiency within the industry. Firms could also reduce financial resource requirements, for example, by reducing counterparty credit risk, which could help to reduce the economic cost of business.
The report concludes that established players in the market should be working with innovators in order to develop standards while preserving the strengths of the ecosystem, including addressing the complexities around legal oversight.
It said the industry should take “a collective view” of the potential of blockchain, and “must embrace this potential, show patience with its development and invest in various innovative solutions to bring it to bear”.
Adoption of the technology could come about through one of three routes, the paper said. Challenger disruptors will be developed outside of core capital markets; regulatory mandates will drive introduction of a new market infrastructure; or collaborative efforts will shift the value chain towards blockchain – although this transition could take as long as 10 years.
The paper concluded: “In the face of uncertainty about the technology, vaguely developed use cases and only conceptual promises of enormous cost saving, industry participants would be forgiven for taking a wait-and-see approach. This may be unwise.”
“If adopted in a widespread fashion, the new technology will bring fundamental changes to the role of different market participants and could shake up each part of the value chain.”
Angus Scott, head of product strategy and innovation at Euroclear, said: “In order to work together to shape a new future, the industry needs to take a collective view on the potential of the technology, which was the intention of this study. The market must embrace this potential, show patience with this development and invest in various innovative solutions to bring it to reality.”
The paper suggested that banks’ IT and operations expense in capital markets reaches $100 billion to $150 billion per year, while post-trade and securities servicing fees were estimated at about $100 billion per year. Capital and liquidity costs are also increased because of delays and inefficiencies within market operations.
New architecture, based on blockchain, could allow all capital market participants to work from common datasets, meaning operations could be streamlined, or removed altogether.
This would remove some of the current complexities around fragmented IT and data architecture and a lack of common standards, which lead to constant reconciliation and duplicated processes.
The technology could also increase visibility for fund managers, and allow multiple layers of custody functions to be viewed in one single function.
The paper said: “The obstacles to be overcome are significant, and it is far from clear what will ultimately emerge.”
These obstacles include the limited scalability of the technology, the need for a robust cash ledger, operational risks, issues around managing anonymity, and creating common standards and governance. Regulating capital markets on blockchain was also highlighted as an issue, specifically around making sure any regulation is fit for purpose.
While disruptors in other sectors may have taken an ‘act-first’ approach to regulation, in financial markets, innovators have to secure regulatory approval ahead of time, taking in to account geographical legislation and rules around change-in-ownership. On top of this, currently, once mechanisms are entered in to blockchain they cannot be retrieved. Although this is a security feature, it could also prevent legal intervention, the paper warned.
According to the paper, blockchain provides a new approach to data management and sharing that is being proposed as a solution to inefficiency within the industry. Firms could also reduce financial resource requirements, for example, by reducing counterparty credit risk, which could help to reduce the economic cost of business.
The report concludes that established players in the market should be working with innovators in order to develop standards while preserving the strengths of the ecosystem, including addressing the complexities around legal oversight.
It said the industry should take “a collective view” of the potential of blockchain, and “must embrace this potential, show patience with its development and invest in various innovative solutions to bring it to bear”.
Adoption of the technology could come about through one of three routes, the paper said. Challenger disruptors will be developed outside of core capital markets; regulatory mandates will drive introduction of a new market infrastructure; or collaborative efforts will shift the value chain towards blockchain – although this transition could take as long as 10 years.
The paper concluded: “In the face of uncertainty about the technology, vaguely developed use cases and only conceptual promises of enormous cost saving, industry participants would be forgiven for taking a wait-and-see approach. This may be unwise.”
“If adopted in a widespread fashion, the new technology will bring fundamental changes to the role of different market participants and could shake up each part of the value chain.”
Angus Scott, head of product strategy and innovation at Euroclear, said: “In order to work together to shape a new future, the industry needs to take a collective view on the potential of the technology, which was the intention of this study. The market must embrace this potential, show patience with this development and invest in various innovative solutions to bring it to reality.”
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