As milestones go, next week will be a quiet one: on Monday, April 29, the Australia Stock Exchange (ASX) will allow brokers to begin connecting to its new back-office systems based on blockchain.
There won’t be a celebration or ticket tape. It’s just the start of a long process involving I.T. specialists at ASX and among some member firms. But next week marks the start for brokers to register, communicate, and verify identities with ASX’s replacement for Chess, its decades-old post-trade processing infrastructure.
That will lead to beta testing next year, if all goes to plan, actual deployment on what is the world’s most cutting-edge project in finance involving distributed-ledger technology.
For Cliff Richards, ASX’s executive general manager in charge of equity post trade, it’s just part of a journey that has been in the works for three years. Next week represents a technical step that’s already been mapped out.
Perhaps more significant was the recent announcement by Digital Asset – the vendor building the Chess replacement – that it has gone open source. This means any developer can now access its software development kit (SDK) and start using its language around shared workflows.
“Technologists among our customers and vendors are augmenting their work now with Digital Asset’s SDK, now that DAML is open sourced,” said Richards. (DAML is Digital Asset’s modeling language for how it categorizes, secures and shares information.)
While DAML is the language being used for the DLT version of the Chess replacement, ASX has also catered to firms preferring to connect via their legacy systems, albeit through an upgrading messaging standard that can integrate via open-source technologies or via SwiftNet, the protocol of global payments consortium Swift.
But those firms opting to “take a node” and integrate directly onto the distributed ledger will be entering a new world, in which workflows are multilateral, in which information is synchronized automatically among all participants, and in which these members can use the platform to communicate among themselves, if they wish, with or without ASX in the middle.
What it all means
That has huge implications for the work that goes into clearing and settling trades (in cash equities, to start with). In theory, this should streamline or eliminate much of the work, often manual, required to reconcile trades daily among investors, brokers, custodians, the exchange, and their myriad vendors.
But the impact of sharing post-trade workflows will go beyond clearing and settling trades, which will remain the purview of ASX. For Richards, the more interesting conversations are now beginning with regard to how this will enable firms to generate revenues in new ways.
The replacement of Chess – a project that still has yet to be branded with a name – will impact the 106 brokers with an exchange seat, the 2,300 listed companies, the roughly 400 institutional investors and nearly 4.5 million investors who trade via a retail broker.
Industry specialists are already aware that post-trade DLT can lead to new, more efficient ways to handle services such as proxy voting, share registry and corporate actions. Their world will be moving from many bilateral relationships (hubbed through ASX) into a single network allowing for many-to-many communications.
More use cases
And while that might mean less work for global custodians, it also suggests they will have accurate, real-time access to client assets. That, over time, should make risk management much easier, which in turn will let banks free up capital from having to cover the most stable clients.
But that should be just the beginning.
Richards says for many industries in Australia, a handful of listed companies represent the majority of activity, by revenues or sales or market cap. That’s true of insurance, banking, healthcare, transport and other sectors.
Are we jumping on Betamax when the rest of the world is going VHS?
Cliff Richards, ASX
“There are lots of use cases,” Richards says, citing claims processing, medical record transfers, letters of credit and bank guarantees. Right now, the Chess replacement is just for cash equities, but it could apply to bonds, derivatives, land titles, government services – “Any stack that’s in a silo, driven by a hub and spoke, is a candidate,” Richards said.
ASX will not get into the business of building apps on its infrastructure for these companies, but anyone using DAML will be able to do so. ASX will stick to clearing and settling trades, and charge users a fee to access the shared ledger.
The matter of fees is now in play. Because this technology is brand new, with no other large-scale financial examples to go by, ASX had hoped to nip discussion in the bud. It has said it will not charge for access to the shared ledger for three years; after two years, it would begin to negotiate a price with the industry, based on efficiency gains, integration costs, and potential new revenues.
That attempt isn’t working out, as many banks are insisting on some kind of price projections they can bake into their P&L assumptions. Richards says while this remains unresolved, what is clear is that ASX won’t change its fee schedule for the services of clearing and settling trades.
If our existing systems can only be tweaked, then blockchain is useless
Cliff Richards, ASX
What will change is the price of accessing those services via blockchain. This is a discussion for business heads at brokers and custodians, many of whom are still unsure about anything blockchain.
“There is anxiety among our customers,” Richards said. “They’re seeing the value proposition, but they’re wondering, ‘Are we jumping on Betamax when the rest of the world is going VHS?’ They don’t want to be locked into a proprietary system.”
To address that fear, ASX will continue to let firms connect via traditional means – and this is also why Digital Asset made its language open-sourced.
Sleeves rolled up
While the businesspeople are wrangling over price projections, though, technologists at banks and brokers will finally get their hands on the new system next week.
There won’t be much in the way of functionality. The next year will involve stage-setting work such as setting up accounts, compiling reference data, and testing bilateral delivery versus payment. “We’ll be stocking the library,” Richards said.
If all goes well, by summer next year ASX will be ready to launch a testnet, with the full system built over a series of releases. Only then will some firms move into beta testing, to make sure they and ASX have failsafe positions, full disaster recovery, and can ensure finality of settlement.
It’s a lot of work around an uncertain technology. ASX has been here before: in the late 1980s it was the first stock exchange to fully dematerialize. From then on, owning securities involved being included in a single electronic database, and giving up physical paper securities required a change in mindset.
Is this the way to do it?
Of course, it’s one thing for a single market to go electronic, particularly one that is relatively small. It’s another to create a blockchain that will require integrations and changes in workflows that have external implications. The project has generated plenty of grumbling about costs. Is it worth it, and is ASX important enough to pull global financial institutions with it?
Richards says it will take time for use cases to emerge other than a more efficient means of clearing and settling trades. But global firms are happy to experiment in Australia, which is well regulated, experienced, and big enough to be interesting ($2.1 trillion market cap, $40 trillion of notional outstanding derivatives).
But it’s also small enough to contain any setbacks, as well as to offer a simple regulatory structure in which it’s possible for ASX to try something different. The U.S. and European Union might be far more influential but their exchanges and regulatory bodies are fragmented, and banks have not been able or willing to move forward with blockchain pilots for securities.
Finally, ASX is Australian. The government and local financial participants would be even more skeptical of an ambitious blockchain project promoted by a U.S. tech company, which would not be considered as accountable.
Richards says the biggest reason for the industry to support the project is its potential for enabling financial services to expand in a safer way.
“If the world today is a given, and our existing systems can only be tweaked, then this technology [blockchain] is useless,” he said. “But what if the fragility of our capital markets [infrastructure] is becoming dangerous, and it needs to be fixed? Then you’re open to change, if it brings both efficiency and new sources of revenue.”