Blockchain To Mobilize Cross-Border Collateral

Shanny Basar

Four international central securities depositories are building a blockchain prototype for cross-border mobilization of collateral which should be ready for regulatory scrutiny in the second quarter of this year.

Deutsche Börse said in a statement that four international central securities depositaries in the Liquidity Alliance are developing LA Ledger in cooperation with the German exchange operator. The Liquidity Alliance was established in January 2013 with the aim of providing a platform for CSDs to collaborate on collateral management.

Gerd Hartung, SVP, strategic execution at Deutsche Börse, told Markets Media that Liquidity Alliance started discussions on distributed ledger technology/blockchain about a year ago.

“We decided that cross-border mobilization of collateral was the priority,” Hartung added. “We then launched a proof of concept, progressed to implementation and are now building a prototype.”

LA Ledger, which uses blockchain from the Linux Foundation’s open source Hyperledger project, allows the transfer of collateral to be recorded in the books of the sender and receiver in near-time leading to a significant time advantage and cost saving, especially across borders. Hartung said: “Today, moving collateral across borders usually requires external market settlement and the use of intermediaries, such as agent banks.”

The four firms building LA Ledger are CDS, the Canadian Depository for Securities Limited, Deutsche Börse’s central securities depository business Clearstream, Strate in South Africa and VPS in Norway.

Glenn Goucher, president and chief clearing officer of CDS, TMX Group’s clearing and depository business, said in an email: “CDS is excited to join the Liquidity Alliance and eager to engage with our global counterparts in developing new, efficient solutions to ease cross-border collateral transfers. This is an essential tenet of TMX’s overall digital strategy to pursue real-world business applications for emerging technologies and will contribute to positioning Canada as a leader in the adoption of blockchain-based technology.”

Hartung added that more and more risk takers are looking to diversify received collateral beyond domestic securities and using LA Ledger will make it much easier to mobilise high-quality international assets for this purpose.

A VPS spokesman said in an email that the Norwegian CSD joined the Liquidity Alliance in 2014 with the ambition of releasing a new service for inbound and outbound collateral mobilization across different jurisdictions. “With the cooperative approach and proven collateral solution, Liquidity Alliance was the natural choice for VPS when selecting a solution and partners,” he added.

 He continued that the prototype will be a “use case” to discuss DLT with Norwegian regulators.

“Clarifying the regulatory issues will be of great importance for potential use of DLT in other parts of our business,” said VPS. “Joining this project will also give VPS  new insight with DLT in general, knowledge that will be used when considering new technology solutions in VPS.”

Consultancy Aite Group said last month in a report, Top 10 Trends in Institutional Securities & Investments, 2017: Black Swans Take Flight, that distributed ledger technology is only a physically distributed database with  decentralized control and has to be combined with other IT components, such as operating systems, applications, middleware, hardware, and software, to be used.

“One of the most important reasons that none of the ongoing pilots have been able to move to the production phase is the lack of technology expertise in implementing DLT systems into a legacy environment,” added Aite. “It will take enormous educational effort and at least a few years’ time to have an adequate DLT workforce to support the scale required for industrywide adoption.”

The consultancy continued that clearing and settlement is one area where DLT could add fundamental improvements through a combination of blockchain and smart contracts and so should be explored.

“But the reality is that a security transaction settlement process will always involve both the security leg and the cash leg, while DLT systems fail to handle the cash leg by themselves.” said Aite. “Without fiat currency being able to be issued, transferred, and settled on a DLT system, settlement finality will not be achieved no matter how the smart contracts are designed, unless some sort of cryptocurrency becomes recognized as having the same features as central bank money.”

In addition, Aite said the capital markets industry needs to agree on standards, especially around data, and regulators have to design legal, enforcement and governance frameworks.

Hartung said: “The LA Ledger prototype should be ready in April or May for validation by the regulators of the LA Ledger parties and this will then be followed by targeted consultations with clients. The service will then be developed, taking into account their feedback.”

Deutsche Börse has started a number of projects investigating the use of distributed ledger technology in the financial industry. Today the exchange announced a riskless transfer of commercial bank money using distributed ledger technology.

“DLT’s decentralized character allows for direct interaction between participants giving it the potential to simplify complex processes,” added Deutsche Börse. “Established market infrastructure providers such as Deutsche Börse, who services the whole value chain from one source, play an important role when it comes to exploiting this potential while at the same time fulfilling industry standards.”

The concept is based on a collateralised coin, CollCo, and the involvement of Eurex Clearing, Deutsche Börse Group’s central counterparty. All peer-to-peer payments based on tokenized commercial bank money are accompanied by movements of collateral between the respective Eurex Clearing members using the CCP’s functionality and rules.

Deutsche Börse said: “As Eurex Clearing interfaces with the Group’s central securities depository Clearstream, the new concept might also offer the potential for efficiency gains in post-trade processes like settlement and asset servicing.”

The exchange will consult with clients, regulators and central banks to obtain feedback on its prototype, based on Hyperledger Fabric, for which it has filed a patent application.

Last November Deutsche Börse and Deutsche Bundesbank, the German central bank, jointly presented a functional prototype for blockchain-based settlement of securities for centrally issued digital coins, as well as the pure transfer of either digital coins or digital securities alone. They are developing the prototype so it can be used to analyse technical performance and scalability.

In addition, Deutsche Börse has taken a minority stake with a board seat in Digital Asset Holdings. which is led by chief executive Blythe Masters, to develop blockchain technology software for financial intermediaries.

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