SWIFT: Blockchain Won't Remove All Third Parties in Securities Trade

It may come as little surprise to find that blockchain technology could require a major re-imagining of the securities market.

But a report published today by the research arm of financial messaging service SWIFT argued that the technology does not entirely remove the need for third parties, even if it demands a "substantial re-engineering of business processes across multiple securities market firms."

The major finding of the report, based on interviews and focus group meetings with individuals from 75 organizations in technology and post-trade processing, is that industry firms need to re-imagine their role in post-trade processing – but this, SWIFT goes on to say, is not in itself an existential threat.

Michael Mainelli from Z/Yen Group, who co-authored the report, said in a statement:

"The challenge of using mutual distributed ledgers in securities markets is not just in demonstrating technological feasibility, but in achieving the necessary industry coordination to reengineer business processes across securities firms."

The research paper, entitled "The Impact and Potential of Blockchain on the Securities Transaction Lifecycle", found that blockchains or "mutual distributed ledgers" could significantly reduce the $40b per year spent in post-trade processing of securities around the world.

But the report also highlighted the “danger” of “unrealistic expectations" as new technologies like blockchain are explored.

Some roles irreplaceable

Conducted by the SWIFT Institute, the academic branch of SWIFT, with the help of Mainelli and Alistair Milne from Loughborough University’s School of Business and Economics, the researchers based their results on two “general insights” gleaned from the interviews.

The report's authors argue that blockchains can be "expected to replace" the safeguarding function of third parties in the post-trade environment, an arrangement that seeks to prevent the proliferation of duplicate and fraudulent transactions.

The technology is also being positioned as a means to replace the current means of cataloguing transaction histories and dispute resolution applications, according to the report.

But a third function of a trusted third party in this context – the act of confirming or validating the existence of a thing being traded – cannot be replaced by blockchains, the report goes on to say.

The authors state:

"In real world contexts distributed ledgers do not entirely remove the need for central third parties. The central third party role narrows towards confirming identity and asset existence (notary function), as well as dispute resolution and enforcement of legal obligations."

Expensive process

In the current securities transactions framework, the responsibilities and access of various parties are "well understood by the participants", including institutional investors, asset managers, custodian banks, brokers, hedge funds, central counterparties and central securities depositories.

The shift from third parties that possess a combination of trusted documentation and institutional knowledge to a mutual distributed ledger could prove “problematic” because the semantics behind how third parties choose to use available services and data is never fully expressed in processing logic.

The report continues, that while this isn't an impossible process, it will undoubtedly prove to be an expensive one, explaining:

"Given the problems of understanding poorly documented legacy systems many years after their original implementation, it might be argued that the necessary evolution in existing systems will be prohibitively expensive."

Based on the interviews, the report concludes "unsurprisingly" that a permissioned blockchain is preferential to a permissionless blockchain.

"The key insight for us is the availability of 'configuration files' for cryptographic control of access and updating rights to ledger participants," the report states. In other words, the ability to ensure that not everyone can see everything.

Complications

According to the report, the interconnected nature of the securities trade ecosystem means that altering any single part of the workflow will impact many other areas, not all of which stand to benefit from a blockchain.

One example given in the report is syndicated lending, which can take 20 days or more due to legal complications "not affected by the method of recording ownership data."

It's the interconnected nature of securities transactions that, according to the report, should raise questions as major financial institutions and enterprises look to develop proofs-of-concept.

Rather than focusing on one specific application, conceptual developers should bear in mind "substantial changes in operational arrangements" for tasks that include collecting, warehousing and analyzing data for a wide range of applications.

The report concludes:

"The challenge of using [a] mutual distributed ledger in securities settlement is not just demonstrating technical feasibility but also a coordinated reengineering of business processes across multiple firms."

Accounting image via Shutterstock.