As we build out financial market infrastructures (FMIs) based on distributed ledger technology (DLT), face-to-face human interaction has much to contribute to the pace and direction of progress. This truth was self-evident at SWIFT’s Sibos 2019 conference, attended by 11,000-plus delegates at ExCeL London. I was privileged to moderate a panel discussion on the possible paths toward efficient digital cash settlement; a prerequisite step to realising new efficiencies, risk reductions and value in DLT-based financial markets.
Indeed, I owe a debt of gratitude to all our distinguished panellists: John Whelan, head of digital investment banking at Banco Santander; Simon Scorer, senior fintech specialist at the Bank of England; Ousmène Mandeng, senior advisor on global blockchain technology at Accenture; and Sir Geoffrey Vos, Chancellor of the High Court of England and Wales.
If you invite opinion from distinguished central bankers, judges, bank executives and consultants, you can’t expect immediate consensus. But the journey will be smoother and quicker – and thus the benefits greater and more widespread – if we keep examining the concepts and the detail not only with peers and practitioners, but also, as at Sibos, by engaging with a well-informed audience.
The potential for DLT to deliver greater speed, efficiency, resilience and transparency in the financial markets is well known – but there are practical challenges to efficient migration from today’s environment from a legal, operational and technological perspective.
We’re still in the early stages, panellists agreed. In September, Banco Santander issued a US$20 million one-year ‘blockchain’ bond to Spanish investors using Spanish intermediaries under English law. Not only were the securities tokenized, so too was the cash settlement leg – albeit in commercial bank money, as a central bank digital currency (CBDC) proxy such as Fnality’s Utility Settlement Coin (USC) was not yet available.
The transaction was a glimpse into the future, albeit an incomplete one, as panellists acknowledged. The end-state will be native digital assets traded on purpose-built market infrastructures, with ownership recorded ‘on chain’ and transactions settled in a token-based equivalent of central bank money.
The ecosystem around these three elements – the financial assets, the market infrastructures and the cash settlement mechanisms – will need to support three levels of interoperability. First, interoperability is needed between legacy and digital trade execution and settlement platforms, as market participants and operators will not migrate simultaneously. Second, interoperability is required between competing blockchains, so that atomic settlement (i.e. simultaneous exchange of securities and cash, or delivery versus payment) can be achieved regardless of the standards and protocols underpinning the blockchains used by securities and payments infrastructures. Third, interoperability is needed between different means of on-chain payment, or ‘stablecoins’, which differ in terms of underlying collateral and expected redemption value.
Settlement of tokenised transactions in a central bank money equivalent is critical, panellists agreed, not least because of fungibility fragmentation issues if multiple commercial banks issued their own tokens. Further, the settlement of large-scale securities transactions and funds transfers in central bank money or equivalent is required by regulators as a cornerstone of security and stability for any mature financial system. However, the means of achieving this in a digitised context is very much a live debate.
In the UK for example, the Bank of England is not deploying DLT in its revamped real-time gross settlement (RTGS) system, but is keeping an open mind on DLT-based CBDC issuance for financial institutions (wholesale CBDC). But under its ‘Future of Finance’ initiative the UK central bank is committed to promoting competition, including non-bank access to its RTGS system, via API-based connectivity and synchronisation functionality.
The lines of responsibility for core financial market infrastructure have always been fluid between public and private sector actors. At the dawn of the DLT era, it seems reasonable to expect different models and initiatives to emerge. Should central banks operate payment systems based on wholesale CBDCs? Most likely, wholesale CBDCs couldn’t be held by institutions without a reserve account at the central bank of issue, i.e. by entities domiciled outside the currency area. In turn, private sector payment systems have traditionally had much more open access policies than central banks. Thus, DLT based private sector money (with credit risk qualities very similar to central bank money) could potentially be used as settlement asset by these ‘foreign’ financial institutions. This could have profound and positive implications for international liquidity management.
One of the most interesting recent developments is SIX Group’s Swiss Digital Exchange (SDX), which plans to enable issuance, trading and settlement of tokenised securities on a DLT-based platform before the end of 2020. The settlement medium could potentially be issued by the Swiss National Bank, making it the first wholesale CBDC. Alternatively, the settlement medium could be provided by the private sector offering a CHF-linked token with sufficiently robust characteristics to support central bank money-like digital settlement.
Might central banks collaborate to create a unified set of APIs to create a global, multi-currency tokenised clearing and settlement system? Or is it more realistic to consider a private sector utility approach, whereby interoperability between initiatives is supported by a universal settlement mechanism that provides the certainty hitherto delivered by central bank money?
Our Sibos panel shared their views, but could not be expected to come up with definitive answers. On one aspect, they could agree; that the challenge of building DLT-based financial markets is not one for practitioners alone. Central banks, regulators, policy-makers and others involved in the evolution of legal frameworks must also keep up with developments to ensure a balance between realising the benefits of innovation, and protecting the rights of investors and market participants in the new environment.
The potential of blockchain, DLT and smart contracts to transform the financial markets has been discussed for several years now, but with limited tangible ‘real world’ outcomes. Greater certainty on the legal and settlement frameworks will do much to sweep away cynicism and drive forward the construction – at last – of efficient financial markets that can deliver to investors and issuers throughout the 21st century.
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