The Depository Trust & Clearing Corporation’s (DTCC) decision, announced this week, to use a distributed ledger technology (DLT) framework to process post-trade lifecycle events – including triggering of payments and managing credit events – for credit derivatives marks a big step forward for blockchain into the core of the wholesale financial markets.
DTCC provides clearing and settlement for equities, fixed income and repo, and is the largest central securities depository in the world, processing 100 million financial transactions a day while acting as the centralized clearing house for more than 50 exchanges and equity platforms.
In derivatives markets, as well as being a global trade depository, DTCC operates a Trade Information Warehouse (TIW) for post-trade processing of contracts between counterparties.
It is the technology behind this warehouse that blockchain is now set to replace.
Last year, DTCC ran a proof of concept, with Axoni, IHS Markit and several market participants testing the application of distributed ledger just to North American single name credit default swaps (CDS).
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Chris Childs, DTCC |
Chris Childs, chief executive of DTCC Deriv/SERV, tells Euromoney: “That proof of concept established that you can take CDS transactions, establish nodes on a permissioned distributed ledger and the technology will distribute the data to nodes on that network exactly as it is supposed to.”
That initial test gave DTCC confidence to move towards full production, with post-trade processing for the entire CDS market, including index and basket trades as well as single-name default swaps, due to be available on blockchain some time in 2018.
Measured in notional principal of both cleared and bilateral credit derivatives processed by DTCC, it puts blockchain at the heart of an $11 trillion market.
Greg Schvey, CEO of Axoni, says: “Deploying distributed ledger technology in production at this scale is a watershed moment for the industry.”
Axoni is a leading provider of DLT to the financial services industry, which announced just before Christmas the completion of an $18 million Series A financing round led by Wells Fargo and Euclid Opportunities, Icap’s fintech investment business.
Axoni attracted investment from Goldman Sachs, JPMorgan, Thomson Reuters, Andreessen Horowitz, FinTech Collective, F-Prime Capital Partners and Digital Currency Group.
This does seem to be one of the first big projects to take distributed ledger to the next level of use - Chris Childs, DTCC Deriv/SERV
For DTCC, Axoni will provide the distributed ledger infrastructure and smart contract applications. IBM will lead the initiative, provide programme management, DLT expertise and integration services, and offer the solution-as-a-service. R3 will offer advice.
The solution has been developed with input and guidance from a number of market participants including Barclays, Citi, Credit Suisse, Deutsche Bank, JPMorgan, UBS and Wells Fargo, and key market infrastructure providers IHS Markit and Intercontinental Exchange.
The aim is reduce the cost of derivatives processing for DTCC and its owner-clients by eliminating the need for disjointed, redundant processing capabilities and the associated reconciliation costs. The vision is to establish a private, permissioned distributed ledger network, governed by industry-owned DTCC, with peer nodes at participating firms.
Parallel running
DTCC will know all of these firms. Unknown actors cannot come on to the system. It is also aware of the unease at the Federal Reserve and other regulators on the security and stability of blockchain.
There will be parallel running of existing TIW processes for some time yet.
Childs says: “It’s our view that not all of our customers, especially the smaller ones, will want to avail themselves of distributed ledger technology immediately and that even some of the larger ones will want to proceed at their own pace. These customers will still be able to access TIW services in the same way as they do today by going through the DTCC as a node on the network.”
However, Childs has seen enough in the initial proof of concept to sense considerable cost and efficiency savings from eventually retiring TIW’s existing systems and moving the whole market onto distributed ledger.
He says: “The benefits that clients may obtain depend somewhat on their current infrastructure and will vary from firm to firm. But if you just look at the number of records each firm has to hold and then reconcile with other firms, that burden will reduce over time with the move onto a distributed ledger.”
While the new distributed ledger will manage post-trade lifecycle events for derivatives contracts, it will not initially clear and settle trades.
“Our aim is to minimize the disruption from this first step, so we won’t be confirming trades using DLT,” says Childs. “Rather DLT will be employed once the transactions have been confirmed.”
Payments
Neither will blockchain be the mechanism for exchanging between counterparties the payments triggered by smart contracts embedded in derivatives transactions.
“We will do the calculations and instructions for payments as we do today, using CLS as the payment agent,” Childs explains.
It shows how the move of wholesale financial services onto blockchain must happen piecemeal, with post-trade processing of derivatives going first and associated payment transfers and initial trade settlement and clearing perhaps to follow, assuming the transfer of the TIW onto distributed ledger works out well.
“The DTCC has other proofs of concept in operation, for example in repo,” Childs says. “But this does seem to be one of the first big projects to take distributed ledger to the next level of use.
“It’s a prefect size of project to do that. It’s big enough to be meaningful for financial markets, but not so big as to be as in any way a systemic risk.”
