SDX, the new exchange being designed by SIX Group – the main financial infrastructure provider in Switzerland – is not building yet another crypto trading venue.
Its ambitions are bigger than that. Alpine, you might say.
Martin Halblaub, SIX Digital Exchange’s Zurich-based CEO, sat down with DigFin to outline the project’s scope. Three aspects seem most relevant to investors, banks and brokers worldwide. So do another trio of big unknowns.
First, he says, SDX will be an exchange for all asset classes. It wants to launch next year with traditional securities – equities, bonds, structured products – and with exposures to new ones such as real estate. And then it can add bitcoin or various tokens.
“From the end user’s point of view, SDX will let you access every tradeable asset via your mobile device,” he said.
Second, SDX is meant to be global. Unlike national stock exchanges such as its parent, anyone through their broker or other financial institution can list, sponsor, invest or trade on SDX. (Not to be confused with this SDX.)
Today, SIX Group holds the entire value chain of finance in Switzerland. It owns the national stock exchange, the central clearing house and the depository, and it runs the national bank payments system. SIX in turn is owned by 130 Swiss financial institutions.
But, Halblaub said, “SDX is not ‘Switzerland Inc.’ It is a global exercise.”
Third, the exchange is using blockchain technology to cut out a lot of the post-trade processing that typifies traditional exchanges. This is what also enables it to be global, and multi-asset. Unlike most crypto exchanges, SDX is strictly wholesale, and it will be under Swiss regulation.
Setting up SDX
There are still plenty of unanswered questions, but he says the exchange will go live in the first half of 2020. By which point most of these unknowns will have to be resolved.
These include the need for standards, legal changes, and scalability.
Although important, though, Halblaub says the bigger picture is about recreating the value chain of financial transactions using new technology. “How can we change it and start a growth business, not just for cost efficiencies, but to create new business opportunities?”
SDX will let you access every tradeable asset through your mobile deviceMartin Haublaub, SDX
Plans by Facebook to launch its own cryptocurrency are just more evidence that there are big companies out there with huge warchests that will enter traditional financial markets. They are a threat to the status quo, so SDX wants to position itself as a solution.
“We’re a digital intermediary at a time when the crypto world is beginning to disintermediate the financial sector,” Halblaub said.
He has been a banker and stock-market leader in his native Germany, with executive stints at Hannover Stock Exchange and Norddeutsches Landesbank, before starting up his own consulting, which included advising SIX.
“I left banking after the GFC because it became boring,” he said. In early 2018 he and SIX’s top management cooked up the idea of a digital asset exchange, and SIX’s brass asked him to serve as CEO.
“I said yes because it hits home with the things I’m interested in,” he said, before counting off on his fingers: “Potential industry impact. Learning curve. It’s challenging. And it’s fun to do.”
Work in progress: standards
There are several lines of unfinished business before SDX is ready. One is the lack of standards regarding digital assets. This is the case worldwide, and many entrepreneurs have simply ploughed ahead, but SDX is meant to be institutional and regulated.
For example, KYC, everyone’s favorite topic. Halblaub says SDX will not be responsible for doing KYC checks. Instead it sets standards, and the blockchain governs this. But he concedes, “This is still a work in progress.”
What about the need for standards, to attract institutions and win regulatory approval – and the risk these end up squashing innovation? “It’s difficult,” Halblaub said. “We have to develop this industry over time. Everything is in flux. We are taking a stepwise approach.”
It’s challenging. And it’s fun to doMartin Haublaub, SDX
Generically, he contrasts SDX with today’s unregulated digital-asset exchanges. “They can list any ICO, and there’s no user protection. So they need to evolve toward transparency and basic principles so investors don’t get ripped off…these things will vary by market segment. There’s no one-size-fits-all.”
That will also go for fundamental questions like, how do you classify a token? How do you value it? SDX is likely to come to its own standards, which it hopes will become industry standards, but expect plenty of variation worldwide.
Industry standards go hand in hand with regulation and international law. These areas are unsettled, but Halblaub insists SDX is not engaging in regulatory arbitrage to attract liquidity or other boons. Instead, he wants major jurisdictions to develop a minimum standard: Who issues a right that can be transferred in a way that is legally binding.
However, legally binding how? For example, do digital assets fall under companies law, as equities do? Or under civil law, is often the case for national securities depositories? How does this work if SDX is listing assets to be traded by global players anywhere?
While SDX can deploy all of its systems from Switzerland, and the technology doesn’t require a physical presence elsewhere, the company is alert to the fact that it might need feet on the ground in some markets, both for sales as well as for cooperating with local regulators. “We would probably do so through local partnerships,” rather than opening SDX branches, Halblaub said.
The initial market challenge will be attracting use cases for listing tokens on SDX, instead of securities on traditional venues. Quickly though it might become ensuring the blockchain undergirding SDX can handle global trading at scale.
In other words, like any trading venue, SDX will be competing for liquidity, best execution, and quality market participants.
However, this is the one challenge that SDX and its partners, including vendor R3, can control.
This is a risk-decreasing exercise on an industrial scaleMartin Haublaub, SDX
(SDX selected R3 because it’s already a major B2B vendor, but the exchange is handling many aspects of the build itself: the policy engine on top of R3’s operating system, the matching engine, the connections to outside trading systems, and custody and managing private keys. For R3 chief David Rutter’s take, see here.)
The solution to bringing trading costs way down is atomic settlement: the simultaneous execution of both the cash and securities legs of a transaction, with no central counterparty risk and no delivery-versus-payment workflow. “This is a risk-decreasing exercise on an industrial scale,” Halblaub said. “That’s what we’ve built.”
There will be no role for a Euroclear or a LCH (London Clearinghouse) at SDX, standing between counterparties and reconciling their data. (There will still be a role for a DTCC-type player to clear and settle trades.)
Old models, new models
Getting rid of the clearinghouse will change business models for investors and brokers. For example, hedge funds can’t sell short, and there’s no role or need for collateral management. Asset servicing, including corporate actions, will be executed over the blockchain using smart contracts.
But while this is taking away certain existing businesses, Halblaub expects the platform will create new ones: “We are creating a whole new value chain. Widening the asset spectrum will lead to new business models.”
SDX therefore is making a two-pronged play: on the one hand, creating a far more cheap and safer venue for trading things that already trade on exchanges, like stocks, bonds, structured products and funds. And on the other hand, enabling these to trade side by side with tokenized assets, crypto-currencies and representations of new asset classes, from property to art.
Hong Kong offers crypto exchanges path to regulation
But the SFC’s Ashley Alder also declares war on bitcoin futures traders.
Ashley Alder, the CEO of Hong Kong’s Securities Futures Commission, is blazing a path to regulation for crypto-trading platforms.
It offers crypto exchanges a route to becoming licensed, provided they trade at least one virtual asset that is deemed a security. The SFC is therefore taking a huge step toward the institutionalization of digital assets, and giving some operators the chance to use a Hong Kong base to distinguish themselves globally.
At the same time, however, Alder said the SFC intends to take action against bitcoin futures operators, particularly those marketing high degrees of leverage.
“We’ve been concerned for some time about platforms offering virtual-asset futures contracts to the public,” Alder said on stage at Hong Kong Fintech Week. He cited these contracts for being extremely volatile, high risk, and difficult to value, all exacerbated when exchanges offer enormous amounts of leverage, and charges that some of these platforms engage in manipulation by changing trading rules during the lifetime of a contract.
Alder says the SFC will go public with such risks, and warned that those who offer bitcoin futures may be in breach of the Securities Futures Ordinance or the Gambling Ordinance – in other words, engaging in criminal activities.
OKEx has been one platform accused of changing its trading rules mid-contract, according to the South China Morning Post.
Path to licensing
But the big news from Alder is the decision to legitimize those crypto exchanges that can meet the SFC’s traditional compliance requirements for brokers and market operators, opening the possibility they can receive a Type 9 license for exchanges.
Some crypto exchanges hailed the move. BC Group called it a “watershed moment for financial services in Asia and institutional adoption and trading of digital assets.”
Worldwide, the only regime for requiring licenses for crypto exchanges is the state of New York, which in 2014 issued its BitLicense for any entity carrying out virtual currency activities in the state or for New York residents.
Circle, Coinbase and Square are among those license holders.
But what Hong Kong is doing is far more ambitious. First of all, the SFC does not recognize bitcoin as a currency, but it acknowledges the existence of a broader realm of digital assets that is rapidly permeating the traditional world of finance.
The Libra catalyst
It was Facebook’s June announcement of its Libra project, the most prominent of stablecoin ventures, that really galvanized the SFC, however.
“These [stablecoins] claim to have a mechanism to stabilize their value by backing a virtual token with fiat currencies, commodities, or a basket of other crypto assets,” Alder said. “They not one hundred percent stable, but they are in contrast to a crypto asset such as bitcoin which has no intrinsic value whatsoever,” which is why bitcoin and other alt coins are volatile.
Libra has lit a fire beneath central banks, financial regulators and politicians, because Facebook’s reach means Libra can be adopted globally very quickly. Although the consortium backing Libra has since lost prominent members, Alder said, “The Libra project has at least galvanized regulators across the world to look at the opportunities and the risks in digital assets. That is a complete change from the relatively relaxed attitude of last year.”
Instead, officials around the world realize they need a coordinated response involving many domestic authorities responsible for financial supervision, consumer protection, privacy, data, anti-money laundering and other functions – not to mention an international coordination.
“Libra and similar ideas have raised such fundamental issues about the digitalization and potential privatization of money that they’ve already inspired the beginning of a new global, multilateral approach,” Alder said.
The SFC’s plan
So the SFC is taking the initiative to generate progress on creating a structure to regulate crypto exchanges. There are dozens of these operating in Hong Kong; because there’s been no regulation to date, they all operate beyond any investor-protection compliance.
At last year’s Fintech Week, Alder announced regulation for brokers and fund managers, but this excluded the platforms where most people go to access or trade virtual assets.
The SFC is releasing terms and conditions for exchange operators to meet the traditional standards for trading venues around custody, market manipulation, KYC, AML and insurance, along with guidance on fitting these to blockchain, hot and cold wallets, protocol forks and airdrops.
But the new rules will still leave gaps, which require new legislation to address. Platforms that totally avoid listing or trading securities tokens can continue to avoid regulation. Nor will the SFC have the authority to take legal action against operators for market misconduct if they remain outside its supervision. “Essentially it’s a framework allowing a platform operator to opt in to regulation,” Alder said.
“This is just an interim measure…The game-changing proposals involving stablecoins are likely to be a catalyst for accelerated thinking on a globally consistent set of regulatory expectations.”
What Citi Ventures’s incubator seeks in Asia
Victor Alexiev, the regional lead at D10X, talks about the technologies transforming institutional business.
Victor Alexiev is Singapore-based Asia-Pacific lead for Discover 10X (D10X), the new product incubation arm of Citi Ventures. He joined in 2018 and now covers incubation, programs and strategic partnerships for Citi’s institutional clients group.
D10X launched in the U.S. in 2016 to foster innovation from within the bank, encouraging lean-startup thinking as well as coordinating third-party build, buy or partnership decisions with other parts of the bank and its clients.
The following is a transcript of an interview with DigFin, which has been edited for style and conciseness.
DigFin: What kind of innovative models are you trying to develop?
Victor Alexiev: In Asia, it’s about new products and new services in the ICG [institutional] part of the franchise, so the projects we work on are mainly B2B and B2B2C. We’re not just looking internally. We also try to partner with technology companies as we find pain points they address.
What kind of business models are you looking for in this region?
Finding solutions for Citi’s markets, commercial and investment bank business.
Why not for the consumer side, which is such a big part of Citi’s P&L?
We do have D10X in our consumer business for North America, but not in Asia, at least not at this stage. In Asia, consumer fintech and quite fragmented and competitive, and my personal view is that you will need to put in a lot more resources in order to achieve meaningful results.
Is innovation within a huge bank, particularly if you’re focused on B2B – is that an oxymoron?
Yeah, a lot of people think that innovation with corporations is too slow. It’s true in part, as we have to go through a lot of compliance, sourcing and H.R. checks. But we’re looking after companies and people’s money. But once you identify a product fit, you scale much faster. I’m here to build something meaningful within a large institution that has a global footprint.
Within B2B, what kind of ideas are you looking at?
Most projects are new models of customer engagement. Our most public project that was built and rolled out via D10X is Proxymity, an end-to-end proxy voting platform offered to custodians, that directly connects issuers and investors in real time.
Customer engagement sounds very, um, consumery.
A lot of corporate and institutional business platforms for banks is clunky. Or it’s based on business models that just seek to skim basis points by processing large volumes. What will next-generation banking look like? What happens if banks become platforms for others to create value? What do direct-to-consumer models look like for our transaction or investment banking?
So even at the corporate level, you need better customer engagement.
That’s right. For example, an increasing number of clients want to consume our products via an API instead of calling our salespeople. We’ll still need salespeople but we have to be realistic that our evolving client expectations demand a different experience.
What does engagement mean? Can you give me an example?
We’re finding, for example, that buy-side clients are less interested in reading a full research report. But they’re very interested in parsing the underlying data that made that report. Decisions are becoming more quant-driven, so we don’t need to offer as many products. It’s about helping our clients make data-driven decisions and providing them with data-driven products
Is that just a matter of better product design?
No, it means we need to transform the entire organization, to be an end-to-end digital driver – “customer engagement” can’t be just about our front office. “Digital” is about culture and people.
I often hear about banks changing their culture, changing the ways they do business, the mindset – yet the rhetoric doesn’t describe the reality. At best it’s a partial change.
There’s an increasing urgency within banks in general. Margins are thinning, and there is a realization, or a willingness, to transform. We’re trying to speed up the process by providing examples of what “good” looks like.
Where have you implemented new solutions so far in Asia?
Initially we rolled these out in our markets and securities services business. We focused on custody, securities services, equities, and foreign exchange. Gradually we’re bringing new technologies to spread products, corporate banking, investment banking and transaction banking.
And within those divisions, what parts of Citi are you focused on? Operational efficiencies?
Efficiency is important but lots of departments are already looking at this. I also see at other banks a lot of innovation labs doing proof-of-concepts that may not reflect the actual business needs. The projects I work on all have separate, independent P&Ls, and are focused on client-centered new value creation.
You had mentioned client engagement at the institutional level. What are your clients asking help with?
Long-only funds want data to help them with things like modeling ESG portfolios (for environmental, social and governance standards). More short-term trading clients want data-centered models to take faster data-driven decisions.
We explore questions like what do next-generation pension funds look like? What about insurance? How do we support sovereign funds in managing impact-oriented portfolios?
You’re not big on blockchain consortiums and such?
We are, if it meets business needs. We participated in Komgo, a blockchain consortium for documentation in letters of credit that finance commodities trades.
What are the particular technologies that you’re trying to adopt?
Machine learning, APIs and blockchain are the three deep, transformative domains. For these to flourish requires a bigger internal transformation, a broader regulatory understanding of them, and a cultural mindset change.
That’s a lot. Any anecdotes you can give, to make that a little more concrete?
We’re about to publish with ASIFMA a white paper on STOs [securities token offerings] exploring what it would take to make these go mainstream. Our takeaway was interoperability. A fintech can issue a real-estate token, say, in their local jurisdiction, operating under the same local regulation for securities or property. But how do you open that to international investors, or institutional investors, or create a global marketing capability? The complexity quickly goes up. The same goes for, say, using A.I. with certain clients for real-time pricing and execution of F.X. or overnight collateral. What does that mean, how could it change the market? We’re exploring use cases, doing experiments – to do it right, we have to get out of the lab.
Are you finding lots of B2B technology companies in Asia who fit into these needs?
There are few startups that are enterprise-ready, globally scalable and that could deal with our clients. They need to be either close to the customers – meaning they already have insight, client integration of lots of data – or have differentiated tech that it is scalable, high performance, and can help banks solve specific problems.
But I’m bullish on tech in Asia. We’re seeing the dawn of Asian tech: the technology itself is maturing as companies shift from copy-and-paste to developing more core tech. And we’ve seen more B2B fintech move from trying to compete with us to partner with us.
Hope for handling corporate actions?
The industry is shifting from evolutionary fixes to transformational change.
DigFin moderated a webcast last week on the topic of using new tech to handle the thorny old problem of processing corporate actions. Mention “corporate actions” and you mostly have ops and tech people at financial institutions reaching for aspirin, or something stronger.
Corporate actions are anything a publicly traded company does that impacts its securities, debt or equity. Even straightforward things like a stock split come in all different flavors. There’s no one cone to hold all this ice cream. Banks, brokers, fund managers, and trading venues have invested zillions into processing transactions, but corporate actions is always “the poor cousin”, as Dean Chisholm, Hong Kong-based COO for Asia Pacific at Invesco, put it during the webcast. And because of the complexity, vendor solutions have been too expensive.
Mention ‘corporate actions’ and you have ops and tech people reaching for aspirin, or something stronger
But the industry can’t ignore corporate actions. Alan Jones, Singapore-based head of business development for Asia at SmartStream Technologies, pointed out that corporate actions today represent the highest point of risk to operations. As firms look to scale their businesses – with new markets, new products to handle, and an ever-increasing variety of actions to handle – they need to deal with this final barrier to straight-through processing. Do that, they can then begin to add value, like analytics on top that can give investment firms, for example, a view as to how good a job their service providers are doing.
The good news is that technology is evolving to the point that automating corporate actions is looking possible. The biggest enabler is cloud computing. Cloud isn’t just about saving on cost, noted David Fodor, Sydney-based head of business development for financial services at AWS. It’s about scalability and flexibility. Moving to cloud computing is the precursor to handling the vast amounts of data required to come to grips with something like corporate actions.
There’s no one cone to hold all this ice cream
Cloud is just a starting point, though. One challenge is that corporate actions involves many players, said Satyan Patel, senior VP for global client development at Hong Kong Exchange. Stock markets like HKEX connect to depositories, custodian banks, securities brokers, data vendors and investment firms. And then you have the issuers themselves, whose announcements are often in the form of unstructured data (like text on a PDF). The good news is that, beyond firms’ own IT spend, the finance industry is gradually adopting new standards, like ISO 20022 for messaging. That will help reduce the amount of unstructured data.
However that still leaves a lot of data of questionable integrity out there, which defies manual processing. Francis Breackevelt, chief operations head for Asia at BNY Mellon, in Singapore, said the full range of new technology needs to be brought to the fore. Whereas for years, transaction processing was an evolutionary process, he thinks the industry is at a point of major change. From simple robotics to natural-language processing and other forms of artificial intelligence, firms are on the cusp of tackling the variety of corporate announcements. They are looking at distributed-ledger technology to enable industry-wide processing.
Corporate actions processing isn’t going to be solved like flipping a switch. It requires a critical mass of industry player involvement, guidance from regulators, confidence in the data, greater adoption of enabling tech like cloud, and successful implementation of A.I. Then all of that needs to be implemented to the extent great enough to bring processing costs down, a lot. But fintech is making possible the goal of automating corporate actions in a way that until now has been just a dream.