It’s been two years since Australia Stock Exchange surprised the market with its intention to replace its clearing and settlement systems with one based on blockchain technology. The project is going forward, but adoption by counterparties may prove slower than ASX executives originally hoped.
DigFin interviewed bankers, regulators, brokers and technologists in Sydney as well as Hong Kong to understand what to expect as ASX begins to roll out its replacement for Chess, the post-trade plumbing it has relied on since the early 1990s. (ASX declined to comment for this article.)
The move to introduce a next-generation platform in the form of vendor Digital Asset Holding’s distributed-ledger technology is bold. It harkens to the building of Chess itself, which was among the first in the world to dematerialize an exchange’s processes—a move that was criticized at the time for being risky and expensive, and is now regarded as visionary.
But back then, ASX was mutualized, a utility serving the industry. Today it’s a for-profit corporation, and bound to draw skepticism. Moreover, two years ago blockchain was enjoying “save the world” hype; today more people understand it well enough to assess its limitations. Putting post-trade systems on a distributed ledger is audacious, but many market participants aren’t convinced it’s necessary or are put off by its costs.
ASX implicitly admitted such by agreeing to let members access its new infrastructure either via a node on the distributed ledger—or via standardized messages compatible with SWIFT and FIX, popular protocols for exchanging messages for payments and securities.
“Lots of domestic firms using the infrastructure don’t want to upgrade,” a well-placed source told DigFin. “They see short-term costs in return for long-term promises.”
Some market players reckon plenty of firms will never take a node, and will use these conventional messages forever (dubbed ISO 20022, an upgraded version of the messaging types used on Chess).
An Australian bank’s chief technologist said: “The Chess replacement [with Digital Asset’s blockchain] will succeed, but ASX still needs to drive adoption. The experience will only be as good as the integration with brokers and custodians, at scale.”
Such grumblings are typical of smaller brokers, but there are signs that even big banks still have a lot of questions about what the project means. ASX released a lengthy consultation paper in May. The number and volume of responses is reportedly big, so much so that working through it could delay the next phases of implementation. ASX’s timeline for going live, Q4 of 2020 or the first quarter of 2021, could be extended.
Although some of these lingering questions focus on the tech itself, people involved in the replacement project acknowledge that the biggest challenge is adoption. “People need to understand how it plugs together, the benefits, and how to integrate,” said a source on the project.
Here are some of the outstanding issues.
What is it?
This is where ASX and Digital Asset have made the most headway. Fewer people now associate DLT with Bitcoin. ASX is building a permissioned, private network. There is no public broadcasting of all transactions to achieve consensus. The specifics of Digital Asset’s tech are still confusing, however: only one part of its build, called the Global Synchronous Log, represents DLT, while others such as a store for smart contracts and protocols for different types of participants, do not.
What benefits will accrue from adopting DLT?
DLT mutualizes financial-market infrastructure across participants, at scale, and securely. This removes duplication and therefore reduces latency, errors, risk and capital requirements for conducting transactions. Heritage systems have hardened into silos that can’t be upgraded, even as regulatory and market demands increase. DLT can allow the industry to shift to a new, more efficient infrastructure that should make everything operate faster and safer, which in turn should boost volumes and franchise values. The challenge is that these gains are only realized when a critical mass of participants are on the network.
Will DLT shorten settlement cycles?
Australia now operates on a T+2 schedule, whereby delivery of securities versus payment takes place two days after the trade. In theory, the new infrastructure could compress this, as it removes the need for a lot of reconciliation. But experienced market pros say there are other, pragmatic reasons to need T+2 when dealing with international investors. ASX likens this to when it moved the industry to T+2 from T+3, but until there is mass adoption of this technology, shorter settlement cycles seem unlikely. But people want clarity from ASX on this.
Will the platform connect to other technologies out there, including other blockchains? What if the technology changes?
The “interoperability” question is probably the most pressing, and the hardest for ASX to answer in specific terms. It broadly says yes, it will be interoperable, but no one knows what this means. Some insiders note that Digital Asset is also working with DTCC and Deutsche Borse, suggesting a global community of equities infrastructure is evolving around Digital Asset. So does this imply that the rest of the world will have to adopt this technology, if ASX sets out its stake first? Or, put another way: is ASX big enough in global markets to nudge, say, NYSE in the same direction?
How will this change the way participants engage with ASX?
Another way to look at this is as an open-source project. In April, Digital Asset released the software developer kit for DAML, the Digital Asset Modeling Language. Yes, the integration commitment on adopters is significant. But anyone on a node is basically able to link their data to ASX through DAML, which means everyone can communicate with anyone else on the network. It’s no longer a bilateral relationship with a central counterparty. Instead of relying on ASX for innovation and upgrades, participants can develop their own solutions that could be used by the entire market—such as, say, proxy voting, or corporate actions processing, or extending DLT into other products listed on the exchange, including bonds and derivatives (which currently get processed by Austraclear, ASX's debt-market version of Chess).
What else ASX might attempt to do with this technology?
Sources suggest a big reason for this project, in addition to delivering benefits to brokers, is to allow ASX to take over businesses such as registry and investor services, an obscure but lucrative industry dominated by vendors such as ComputerShare and by global custodians. Indeed, one custodian exec told DigFinthis project could eventually disenfranchise sub-custody networks, by allowing global custodians with a node to plug in directly.
What regulations must change?
Australia’s Minister of Financial Services will need to approve it, and Australia’s competition agency will also need convincing this is in the interest of the industry. No one has a solid grasp of what regulations will have to change to accommodate the new tech, but many people assume such changes will be required, to allow participants to cease their traditional reconciliation and reporting activities. What won’t change: ASX’s obligations to manage risk and promote stability.