Tel Aviv Stock Exchange has begun testing a blockchain platform upon which its members can lend and borrow securities.
For TASE, this is part of a broader strategy to turn around a decades-old story of decline and marginalization. Over the past decade, the exchange has lost 40% of its members and seen volumes and the number of listed companies plunge. Trouble began in 2010 when MSCI graduated Israel from its emerging-market indexes to developed-market status, a classic case of no longer being a big fish in a small pond.
Since then the bourse has become a global player in listed fixed income, with the second-largest trading volume in the world covering 723 corporate bond series with a market cap of $120 billion. But it hasn’t found a solution for its dwindling equities business.
Now it is making another attempt – with digital technology at its heart.
Among other steps, it has introduced a plan to attract market makers, and last year it won the listing of its first international exchange-traded fund, from BlackRock, giving Israeli investors exposure to foreign stocks.
But using technology to transform securities lending is its most innovative and risky bet. If it works, this could open up new modes of business. And it puts TASE at the forefront of blockchain adoption.
Uri Shavit, executive vice president and chief information officer at TASE, says securities lending in Israel is interbank, that is to say, bilateral and opaque. Given the small size of the domestic market, it is also expensive. “We want to make a global market for securities lending, to reduce prices and drive liquidity to our exchange,” he said.
Securities lending is the process of lending the stocks (or an equities derivative) on a firm’s books to another firm. Institutional investors are the most common type of lender, as they are the ones owning the assets. Banks, hedge funds, and brokers are typical borrowers, who typically use the stock for short selling (a short sale involves selling a stock and buying it back in a short period of time, hopefully at a lower price).
Can we use it? Can it affect us in the future?Uri Shavit, TASE
Custodian banks typically act as agents, placing securities on loan in return for borrower collateral (cash, securities, or a letter of credit) and collecting interest in return, for a cut. Securities brokers also facilitate such transactions, often as a principal taking one side.
Securities lending is common in big liquid markets like the U.S. but rare and expensive in smaller places. Israel’s bourse has only 439 companies listed comprising a market cap of $239 billion.
Platforming the industry
TASE sees a chance to turn this weakness into a strength, by creating the digital infrastructure to move stock lending on-exchange, with the TASE serving as the clearing house, thus providing transparency which should lower fees. The market will only be accessibly by TASE members.
Currently there are 24 members on the exchange, mostly local banks but also brokers like Citi Financial Products, Flow Traders, Jeffries, Merrill Lynch International and UBS Securities, as well as investment banks Barclays, Citi and HSBC. TASE hopes that creating this unique type of open sec-lending market, combined with new rules for market makers and liquid instruments like BlackRock ETFs, it will attract players and liquidity.
Moreover, Shavit says a blockchain-based market can enable peer-to-peer lending among members, which means asset owners could begin to interact directly, without requiring a bank in the middle – a sort of Liquidnet for securities lending.
When TASE first looked at this idea, Shavit says, it could have built a centralized platform, which might be faster and easier to implement. “But we thought, first, let’s look at the technology,” Shavit said. “Can we use it? Can it affect us in the future? We want to be knowledgeable of the technology and how we can do business with it.”
If you lend, you can also immediately sellUri Shavit
TASE settled on blockchain for two reasons. First, the tech allows members to share only the information they need to reveal, and just to the participants who need to see it. But it is also transparent, in that participants can see their positions around the clock, a feature that a traditional clearing house can’t provide.
Secondly, giving participants information about their assets throughout the life of the loan means they can immediately go to the market to execute hedges. “If you have all the information on your book, if you lend, you can immediately also sell,” Shavit said. “Efficient markets and transparency go hand in hand.”
And then what?
TASE began with Intel’s blockchain solution, Sawtooth, an open-source project under the Hyperledger governance framework. Accenture developed the front- and middle-office interfaces. London-based Blockchain Technology Partners (BTP) was brought in to prepare TASE for deployment and manage the infrastructure and the developer community on its behalf.
Duncan Johnston-Watt, co-founder and CEO at BTP, says his firm specializes in support for Sawtooth projects, similar to the way Red Hat has become the go-to company for Linux open-sourced projects.
TASE has just kicked off testing of the platform on its intranet and hopes to go into production this summer. Members can access the platform via web browsers, but Shavit hopes they take a node on the blockchain – especially institutional investors, as they might find a new and better way to lend their securities.
They are looking to attract domestic and international entrepreneursDuncan Johnston-Watt, BTP
Further ahead, Shavit says the blockchain platform could enable new types of business. “We are looking at tokenized assets,” he said, adding that the priority right now is making sure the sec-lending platform works.
Johnston-Watt, however, said both the Israeli Securities Authority and the Israeli Innovation Authority are working with TASE to study how Israel can be a player in digital assets. “They are looking to attract potential participants, including domestic and international entrepreneurs,” he said.