Leaders of the world’s leading clearing houses appearing on a panel at ISDA’s 31st AGM agreed that new technologies such as blockchain will play an important role in making derivatives clearing more efficient in the years ahead, but expressed differing views over the potential impact.
CME Clearing CEO Sunil Cutinho said that distributed ledger technologies are among the most exciting innovations to have emerged in recent years, offering the possibility to help the industry move away from entrenched multi-day settlement times and create a new “golden source” of data.
“When you reduce the time lag between a trade and settlement of that trade then you remove risk and you free up capital. So in that way [distributed ledger technologies] can make the market more efficient,” Cutinho told the audience at ISDA’s AGM in Tokyo. “There is also an opportunity to move from reconciliation at some point during the trading day to real-time reconciliation in the same step as execution, removing a lot of back office and side-processes.”
Distributed ledger technologies, or blockchains, are cryptographic ledgers comprising logs of transactions shared across a digital network. Their best-known application is Bitcoin, which uses peer-to-peer systems to make and record payments without the need for a trusted intermediary.
In enabling direct transfers of value, DLTs may undermine the role of banks, exchanges and clearing houses, but equally the technology may be a significant opportunity for those players to increase efficiency and marshal data, evidenced by a surge of investment and research activity into the technology in recent months.
“I see [these type of technologies] transforming our world,” Cutinho said. “They will not replace the need for derivatives but will change the way in which CCPs [central counterparty clearing houses] work.”
Cutinho’s enthusiasm for DLTs was echoed by ICAP’s chief executive officer for post-trade risk and information services, Jenny Knot, who said the potential was “really exciting” for the financial industry.
“The industry has woken up and smelled the coffee, in that what we need is a global standardised ledger, and it will have a phenomenal impact on back office processes,” she said. “It will take out efficiencies and, while we need to do work on implementation, I can see that we will use permissioned databases very quickly.”
DLTs can be broadly split into two species, public and restricted. Public blockchains such as Bitcoin are open to be read by anybody, and anybody can send transactions to the ledger and expect them to be included if they are valid. In addition, anybody can participate in the consensus process that ensures that transactions are valid.
By contrast, private or permissioned blockchains restrict the consensus process to a pre-selected set of participants, each of which must sign off on transaction records for the record to be valid. The right to read the blockchain may be controlled, meaning, for example, that regulators may have access as necessary.
In early initiatives the financial industry has appeared to prefer permissioned to public blockchains, with initiatives such as New York-based R3 CEV bringing together consortia of banks to explore new solutions. The company in recent weeks said it was working on a new blockchain-based platform named Corda that will enable banks to make agreements and service contracts using DLT.
But enthusiasm for blockchain is far from universal and some clearing house executives remain to be convinced that the technology will deliver on its apparent promise. One such is Laurent Curtat, adviser to the group CEO at LCH.Clearnet, who said the company was reserving judgement as to the merits of DLTs.
“I am cautious on blockchain,” he told delegates at the ISDA meeting. “We are watching but are not convinced yet.”
Scaleability
While DLTs seem to potentially be useful in the clearing environment, doubts remain over scaleability, and about the implications of reducing settlement times, Curtat said. Average transactions per second on the Ethereum platform, one of the fastest growing distributed ledgers, was around 0.25 in recent weeks, after hitting a high of 1.25 in February, still far below the level that would be required to service financial markets.
“There is also some doubt about how you connect a distributed ledger to the existing financial infrastructure,” Curtat said. “It’s important to remember that there are existing technologies that can deliver significant improvement, such as advancements in GPU processing, which enable much faster results and get us closer to real-time risk management.”
In a white paper focused on applications of DLT in the post-trade space, the DTCC earlier this year said there are opportunities to improve on existing infrastructure in certain areas – for example, where automation is limited or non-existent or where the technology offers a clear benefit over existing processes.
“Opportunities to explore include: master data management; asset/securities issuance and servicing; confirmed asset trades; trade/contract validation, recording and matching for the more complex asset types that currently do not have strong existent solutions; netting and clearing; collateral management; and, longer term, settlement,” the DTCC said.
However, the white paper cautioned that DLT is still immature and unproven.
“It may not be the solution to every problem and alternative solutions should also be considered in evaluating opportunities to lower the costs and risks of current infrastructure through standardised industry workflows and expanded use of cloud technologies,” it said.