Blockchain and Capital Markets - so much to reconcile

10.02.16 Steve Miller

Blockchain technology has been hailed by admirers as having same the revolutionary potential that the internet did two decades ago. Entrepreneurs, politicians, and investors have been quick to voice their ideas about the ways it could create efficiencies and reinvigorate a range of industries ranging from retail, to insurance, and even the legal profession.

Why all the excitement?

Blockchain technology creates new possibilities for organising and sharing data. The central principle is to create a single version of the truth, which can be accessed and used by all participants. This shared version, or ledger, can combine data which would currently be stored in different systems to create a much richer dataset than exists in any one data source today.

This in turn enables new processes to be developed, based on the availability of transparent real-time data - and the impact will undoubtedly span multiple industries. But the most compelling use cases for blockchain technology are undoubtedly in finance. Storing client identities, handling cross-border payments, simplifying trade clearing and reconciliation processes, or even creating self-executing smart contracts like bonds that automatically pay interest to the holder at set intervals, are all situations that would lend themselves to blockchain’s consensus-driven distributed ledger mechanism.

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Within the financial services industry, the excitement around blockchain is being most keenly felt within Capital Markets. After all, storing and agreeing datasets of financial obligations and ownership is the central premise of Capital Markets operations. Existing processes are complex, and due to fragmented data structures using incompatible standards, extremely inefficient.

In particular, our customers tell us that data reconciliation is a drain on resources, and often involves an element of manual processing which can introduce errors and unacceptable levels of risk. So it’s not hard to see why blockchain technology holds such a strong appeal.

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Is this really a problem worth solving? Euroclear and Oliver Wyman recently published a joint paper called “Blockchain in Capital Markets: the Prize and the Journey”. The paper calculated that IT and operations expenditure in capital markets is close to US $100 billion per year among banks. In addition, post-trade and securities servicing fees are in the region of $100 billion, and significant capital and liquidity costs are incurred as a result of delays and inefficiencies within market operations. If blockchain technology could reduce these costs by just a few percent, it would mean billions of dollars in annual savings.

How will the financial services industry adopt blockchain technology?

The Euroclear / Whyman report posits that there are three key drivers for adoption. The first is disruption by FinTech challengers, the second is collaborative efforts by industry players, and the third is mandated policy by industry supervisors or regulators. Which of these is likely to prove most persuasive?

While FinTech startups with a focus on innovative blockchain use cases are hitting the headlines, and undoubtedly raising the profile of the technology as a whole, I believe that outside of the retail and payments space, their impact is likely to be somewhat limited.

Instead, it is quite apt that the adoption of this consensus-driven technology will require industry consensus. Several major players including JP Morgan, Wells Fargo, State Street, and the London Stock Exchange Group have already joined forces to examine the potential of blockchains. The R3CEV consortium, a working group formed of 42 banks, is also collaborating to develop a protocol for blockchain technology for the banking sector. In addition, nearly every major bank and financial institution currently has it's own internal task force charged with understanding the technology and its implications for their business.

We are also seeing increasing interest from industry bodies who are keen to inspect the technology from a regulatory standpoint and shape its evolution. Given that change in the securities markets has historically been either collaborative (e.g. FIX) or mandated (e.g. de-materialisation), it seems likely that adoption will be driven by a collaboration between incumbent financial institutions, combined with regulatory policy driven by bodies such as Euroclear, the DTCC, or the ECB. And while such broad collaboration is likely to mean that adoption will happen, it is also likely to mean that - as with so many previous initiatives - it may take much longer than originally anticipated.