The European Central Bank (ECB) has published a working paper on blockchain technology, examining its potential role and impact in securities markets.
Written by ECB economists Andrea Pinna and Wiebe Ruttenberg, the paper casts a wide net on the various possible market applications and repercussions distributed ledgers could have in the marketplace, while examining different uses for smart contracts within securities market infrastructure.
Entitled “Distributed ledger technologies in securities post-trading” and published on 17th April, the report echoes a growing chorus of industry stakeholders, regulators and market observers who see a potentially strong impact of the technology in finance.
Yet, the paper’s authors go on to argue that some market elements – particularly the regulated ones – won’t likely be replaced even if there is a broader sea-change brought on by the use of blockchain applications in finance.
The paper states:
“The current debate on DLTs is very much focused on the technology itself, and on how disruptive the roll-out of this technology could be for the current post-trade market and its market players. It should, however, be kept in mind that, irrespective of the technology deployed, certain functions present in the post-trade market for securities will always need to be performed by institutions.”
Market could drive change
Overall, the paper provides a bird’s-eye view of the current post-trade settlement environment, establishing some of the pain points that blockchain advocates hope to improve with the technology.
“Current market conditions – with low interest rates and the expectation of an increase in collateral demand due to regulatory changes – have squeezed financial intermediaries’ margins, making the fixed costs of non-profit making back-office procedures more of a burden,” the authors write, adding:
“Financial intermediaries are therefore hoping that DLTs may allow them to avoid certain reconciliation processes and reduce the amount of collateral and capital bound to the settlement cycle.”
Still, questions remain, the authors assert as the paper continues.
Outstanding infrastructural and legal questions, particularly related to the exact legal standing of a distributed ledger used by banks, need to be answered, they said.
Interoperability, the authors indicated was one such problem area.
In order for the technology to see significant adoption among major financial firms, standards of operation will be needed to actually connect any future networks that might take shape.
“Harmonization is…still needed,” the authors wrote. “To have market-wide gains in terms of safety and efficiency, every system in the market might need to be able to communicate with all the different DLTs adopted.”
Degrees of adoption explored
One notable part of the paper explores potential outcomes of the industry’s ongoing experimentation of blockchain tech.
Under one scenario, post-trade institutions use blockchain applications to improve overall efficiency, but their underlying infrastructure remains as-is. In this case, so-called “siloed” distributed ledgers would help operators shave costs, while still being subject to the same kind of interoperability challenges seen today.
On the more extreme end, peer-to-peer networks would potentially cut out the clearing and settling incumbents entirely, putting the hands of securities issuance and purchase entirely in the hands of investors and the companies selling those assets.
“Companies and governments could issue their financial instruments directly on the ledger, which would be of particular interest to start-up companies issuing shares by private placement, whilst smart contracts would execute any corporate action automatically,” the paper explains.
Ultimately, the paper’s authors state that it’s still early to project the technology’s exact impact. However, they speculate that any changes will happen over a longer timeline.
The paper concludes:
“It is possible that a DLT may find its way into the mainstream market, but should this happen, it is more likely to cause a gradual change in processes, rather than a revolution in the market.”
The full ECB paper can be found below:
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