DLT May Strain Liquidity

Shanny Basar

The Bank for International Settlements warned that the adoption of distributed ledger technology may not lead to faster settlement and could introduce new liquidity risks.

The BIS Committee on Payments and Market Infrastructures said in a report yesterday that much work is needed to ensure that the legal underpinnings of DLT arrangements are sound, governance structures are robust, technology solutions meet industry needs, and that appropriate data controls are in place which satisfy regulatory requirements. The BIS added: “It also seems clear that changes and related efficiency gains are more likely to be incremental than revolutionary.”

The regulator acknowledged that blockchain may enhance market transparency and allow faster settlement but warned that there are new risks.

“In most instances, the risks associated with payment, clearing and settlement activities are the same irrespective of whether the activity occurs on a single central ledger or a synchronised distributed ledger,” said the BIS.

However, DLT may pose new risks including the lack of interoperability with existing processes and infrastructures; ambiguity relating to settlement finality; questions regarding the soundness of the legal underpinning for DLT implementations and issues related to data integrity, immutability and privacy. In addition DLT arrangements may take longer to achieve settlement than current real-time gross settlement systems (RTGS) because the process for validating a transaction and reaching consensus in DLT is potentially more complex than with a central entity.

“As with RTGS systems , real-time or near real-time transfers allow for a reduction in credit exposures,” added the BIS. “It, however, also places higher demand on liquidity. Faster transfers suggest that participants will also receive funds and securities more quickly, freeing up liquidity that could be tied up in collateral as is the case in today’s financial market infrastructures.”

Another risk is that if smart contracts automatically execute on a blockchain, it is possible that macroeconomic conditions could automatically trigger margin calls across financial market infrastructures, leading to severe liquidity demand across the financial system and creating a systemic event.

However the Depository Trust & Clearing Corporation, the US post-trade market infrastructure, yesterday announced the successful completion of a DLT proof-of-concept to manage the netting process for US treasury and agency repos with Digital Asset. DTCC and the developer of DLT solutions for financial institutions demonstrated the successful netting of “start” leg repo transactions with prior end-of-day net securities obligations in the DTCC environment.

In the second phase, DTCC and Digital Asset will form a stakeholder working group to collect feedback and determine whether the solution meets the performance and integration needs of DTCC’s technology environment while allowing for integration with member firms. This is expected to be completed by June 2017, when DTCC will determine whether to move ahead with the development phase.

Michael Bodson, president and chief executive of DTCC, said in a statement: “DLT was chosen because of its real-time information sharing capabilities, enabling all parties to quickly view repo details after trade execution lowering risks and costs while enabling users to take advantage of the benefits of a central counterparty.”

In Europe SETL, the London-based financial blockchain specialist, also announced the opening of a Paris office to develop its eurozone activities. The new office will be led by Pierre Davoust, formerly deputy head of the financial markets unit at the French Treasury, who has become chief executive France. SETL maintains a permissioned, distributed ledger of ownership and transaction records, simplifying the process of matching, settlement, custody, registration and transaction reporting.

Davoust said in a statement: “Paris is a large financial centre, with a particularly strong asset management community. So it is a logical step for SETL to develop a local presence in Paris as we aim to put end-users of financial markets, such as issuers and investors, at the centre of our strategy.”

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