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For China’s OTC markets, the blockchain race is on

Financial regulators have fired the starter’s pistol on upgrading the country’s equities infrastructure.



On July 15, the China Securities and Insurance Regulatory Commission gave permission for the country’s blockchain development community to get to work on equity trading venues. The next day, the People’s Bank of China gave financial institutions guidelines on how to assess blockchain-related features to be included in their customer-facing apps.

Ever since President Xi Jinping exhorted the nation to “seize the opportunity” to adopt blockchain technology in October, 2019, the nation’s legion of software developers and financial institutions have been moving to develop use cases.

These efforts have remained in the shadows, as general policy must then be followed by regulation, which in turn needs more detailed guidelines. So the twin moves last week signal that formal experiments may now begin.

The race is on

The starting point will be in the country’s OTC stock markets. Beyond the two big public bourses in Shanghai and Shenzhen, or their secondary boards, China hosts a plethora of small regional and private exchanges. In keeping with the country’s size and diversity, each province or major city promotes its own equity venues, however small.

It is among five of these that the CSIRC has decided to begin shifting the trading infrastructure to distributed ledger.

“These exchanges will be testing a new infrastructure based on distributed database using cryptographic tools,” said David Chang, vice president of the Shanghai Blockchain Association, and CEO of a solutions provider, Blocknology Digital Ventures. He says the focus will resemble RegTech functionality: upgrading the operations to trace, authenticate and verify stocks on OTC markets.

Although there is no timetable as to when any of these infrastructure changes will go live, Chang says it won’t take long. “Each city is racing to the first. The technology isn’t hard: lots of software companies have built blockchains. Now we have the regulatory green light to implement it.”

OTC markets

The focus will be five small exchanges in Beijing, Shanghai, Jiangsu, Zhejiang and Shenzhen. These are private markets for small companies, especially tech startups. The first of these markets was created in 2006 to provide a means of financing non-listed companies in Zhongguancun Science and Technology Park, known as the Silicon Valley of Beijing.

Alongside these SME venues are many local exchanges or specialist venues; Tianjin has the largest.

These are off limits to retail; only individual company shareholders and some qualified institutions, including a few mutual fund companies, may trade.

A so-called Third Board, the National Equities Exchange and Quotation (NEEQ), is the back-end system that enables trading for authorized investors. NEEQ registers about 6,400 companies that, as of 2019, had raised a total of $70 billion. That’s not nothing, although it’s tiny compared to the A-Share market cap of the Shanghai and Shenzhen public equity markets (combined market cap of Rmb71 trillion, about $10 trillion).

The regulators obviously want to experiment with shifting infrastructure to small, private markets. But the Shanghai and Shenzhen bourses have reportedly been working on their own blockchain solutions. Eventually the OTC experiments will be expanded to the A-Share market.

Post-trade to start

Chang says right now the focus will remain on post-trade processing, to cut out reconciliation and other intermediary functions, and put exchanges’ footing on a more efficient platform. “There are no tokenomics,” he said.

There is a chance that if regulators are satisfied with the operations side, however, they will then seek to expand the distributed ledger system to include issuance and trading, and create a digital equity asset market.

For now the OTC market project is separate from China’s “decentralized currency/exchange wallet” project, or DCEP, its payments move to digitize the yuan. It’s not hard to see though that once people have the option of making payments with digital money that they will use it to trade tokenized securities.

First, though, these OTC venues need to prove their tech. Each province or city has its own cluster of blockchain developers. There is no national standard. The race among these local exchanges is therefore not just for the glory of being first to launch, but to deploy the best technology so that it has a chance of being chosen by regulators to become a national standard.

Financial institutions and tech companies are now in a race to be ready to participate in next-gen infrastructure, and ultimately to do business in digital assets. Big tech companies like Ant and Tencent will likely win licenses, along with the big state-owned banks. For commercial banks and smaller tech companies, there will be a wave of partnerships, with banks looking for blockchain developers and fintechs keen to get access to payments and securities trading licenses.

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