Blockchain technology is transforming securities exchanges, albeit in a quiet way.
Behind the trading on securities exchanges is a complex web of financial plumbing that facilitates the delivery of traded assets, payments, risk management tools, stock lending services and many more. Over time, electronic technology has enabled these functions to become more efficient, introducing faster paper-free processing, reducing counterparty and settlement risks, and releasing capital that was previously tied up in margin arrangements.
Now, the innovations that facilitate digital asset trading, including Distributed Ledger Technology (DLT) and Daml smart contracts from Digital Asset, have the potential to accelerate the development of post-trade services. Hong Kong Exchanges and Clearing Limited (HKEX) is launching a new settlement platform, Synapse, to augment the post-trade infrastructure for ‘Northbound’ leg of Hong Kong’s Stock Connect links with the Shanghai and Shenzhen exchanges. In Sydney, the Australian Stock Exchange (ASX) is replacing its CHESS dematerialised settlement system with a DLT-based platform. And Singapore’s SGX is trialling blockchain-based services for fixed income instruments.
“We have been working with Digital Asset for years, so we believe in the technology and the long-term benefits it promises,” says Mark Wootton, Regional Head, Local Custody and Clearing Asia Pacific at BNP Paribas Securities Services. “It represents a step-change for clients, exchanges and regulators.”
We have been working with Digital Asset for years, so we believe in the technology and the long-term benefits it promises. It represents a step-change for clients, exchanges and regulators.Mark Wootton, Regional Head, Local Custody and Clearing Asia Pacific at BNP Paribas Securities Services
How it works
DLT and have quite distinct use cases, says Wootton who has been involved in projects with the several exchanges. “DLT has the capability to create a secure decentralised database that is updated in real time – a single source of truth. Daml, on the other hand, is a more flexible resource that uses smart contracts to enable simultaneous actions that previously had to be sequential.”
In Australia, ASX’s replacement for its CHESS post-trade platform will use both. This will offer all the functionality of CHESS but add new services that market participants have requested: DLT will replace the traditional central counterparty: post-trade settlement data will be distributed over a network of secure nodes that are updated in real-time.
This arrangement will provide rich audit-trail data, increasing confidence in the market. It will also enable numerous parties to gain simultaneous access to data that currently sits in silos. In addition, Daml will use smart contracts to automate numerous manual procedures. “The new technology means the ASX can iron out a lot of manual processes: things like proxy processes could be streamlined and corporate actions such as dividend payments further automated, reducing inefficiencies,” explains Wootton at BNP Paribas.
Because Daml is an open-source application platform, third parties will be able to develop add-on applications that can be hosted on the platform via APIs – application programming interfaces – on a plug-and-play basis. “We have worked with Digital Asset, whose DLT is being used by ASX and HKEX,” says Wootton. “Having a strong relationship with key providers involves us having healthy dialogue where information can be shared and clients’ needs discussed. It’s part of being a respected service provider.”
More and more participants are seeing what these blockchain technologies can do and they are gaining momentum. The next steps will be adding more and more parties to the ecosystem so there’s a mutual benefit across the industry. In the longer term, this will deliver real value into the market.Mark Wootton, Regional Head, Local Custody and Clearing Asia Pacific at BNP Paribas Securities Services
Horses for courses
HKEX plans to leverage Daml’s ability to resolve complex consecutive processes with smart contracts to power Synapse. Northbound Stock Connect is a T+0 market, meaning trades are settled on a same-day basis – a narrow window in which to correct any processing problems. Synapse will enable all parties to a transaction – brokers, clients, custodians and even regulators – to access a centralised real-time view of every transaction. This increases confidence that Northbound trades will be settled, reduces settlement risk, and provides rich data for analysis. “It’s a small link in the chain, but it’s the start of an iterative process which is a smart, pragmatic approach by HKEX,” explains Wootton.
Meanwhile, Singapore’s SGX has focused on fixed income markets to trial Daml technology, using it to create an end-to-end system for issuing and servicing bonds. The new process speeds up settlement from T+5 to T+2, reducing the risk of unsettled trades failing, as well as automating key events such as coupon and redemption payments. The first bond was issued on the platform in September last year.
Japan’s planned Osaka Digital Exchange (ODX) takes a different approach, focusing on developing new markets in digital securities. ODX will leverage the flexibility of DLT and smart contracts to offer trading in cryptoassets, starting in 2023. It will enable out-of-hours trading in smaller trade sizes or lots, attracting smaller investors like private individuals. It will also offer access to alternative assets such as property, art, and film distribution rights in digital format. “It’s a promising use of the technology,” says Wootton at BNP Paribas. “The key will be regulation – we’ll be keeping an eye on these developments.”
A change of mind
Large-scale projects like the ASX CHESS replacement and HKEX’s Synapse involve more than rolling out new technology. The changes they bring need to be integrated into a whole ecosystem of banks, brokerages, service providers and data vendors. Entrenched practices must be adapted to the new regime, which requires communication, consultation and testing. “A new platform still needs people to interact with it, so a change of mindset is required,” says Wootton. “It takes people a few rehearsals to build their understanding, so you have to bring all parties along from the start.”
The quiet revolution in post-trade services continues. “More and more participants are seeing what these technologies can do and they are gaining momentum,” Wootton says. “The next steps will be adding more and more parties to the ecosystem so there’s a mutual benefit across the industry. In the longer term, this will deliver real value into the market.”
Distributed Ledger Technology (DLT) is the encrypted decentralised database network that underlies blockchains. It is able to update transaction records, including changes of ownership and payments, simultaneously across a web of nodes. Once a block containing updated information has been added to the chain, it cannot be changed, making the record secure. These qualities make DLT a strong candidate for creating auditable records in asset trading markets, including share registers.
Daml is a programming language used to create ‘smart contracts’ . Smart contracts are protocols that carry out automatic operations, such as executing transactions. Using Daml, complex smart contract-based automations can be tailored, simplifying and accelerating previously less-efficient processes. Where numerous stakeholders are involved Daml-based smart contracts can reduce the chain of dependencies involved, enabling all parties to view the operation and execute their role near-simultaneously.
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