Blockchain’s place in capital markets remains uncertain as it threatens custodian revenues and raises questions over counterparties' roles, say market participants.
According to Christopher Sier, chairman at ClearGlass and HM Treasury fintech envoy, despite the great potential for efficiency gains from distributed ledger technology (DLT), the desire for custody banks to maintain dominance over fund transfers will hinder adoption.
“If you asked the question ‘What is the business case for distributed ledger and blockchain?’ that marketplace is the epitome. The perfect description, the perfect marketplace: inefficient, highly intermediated, closed networks with manual intervention all the way through,” said Sier of capital markets during a panel at the London Blockchain Summit on March 5.
“If you want to see hundreds of fax machines, go to Luxembourg. Because they receive order instructions from wealth managers to buy and sell funds using fax machines and they will accept no other instruction other than a fax.”
The use case for blockchain in capital markets is clear, said Sier, but it would also result in a loss of a revenue for custodians.
“It is a technology issue in the fact that technology is the answer to it, but the thing that you have to overcome isn’t a technology problem – it’s social problem, it’s an oligopolistic problem, it’s private markets problem, it’s a ‘I’m very happy with the status quo, I’m making lots of money’ [problem].”
Siers’s views echo an October 2017 study by Aon on blockchain in securities services, which emphasises that custodian banks stand to lose from blockchain implementation. The study has not been repeated since.
“These organisations make their living by helping buy-side clients cope with inefficiencies of the current dispensation in post-trade securities processing. For them, blockchain is an existential threat of disintermediation from the extraction of a value chain,” said the report.
According to the report, blockchain’s ability to “reduce the cost of the credit and liquidity risks assumed by custodians” will lead to a reduction of their revenues – a $13bn loss, opposed to saving $6.5bn in costs.
But these setbacks have not stopped market participants from trying to infiltrate custodian systems. Calastone successfully migrated its global funds transfer network to its Distributed Market Infrastructure (DMI), a blockchain-enabled network, in May 2019.
Monica Summerville, director of fintech and head of TABB Group UK, says “ahead of the curve” custodians will already be looking at blockchain implementation.
According to Summerville, blockchain would replace the “books and records” at custodian banks. However, custodians offer enough value-added services – managing loans, paying out dividends on securities, offering share splits – that provide a constant stream of revenue.
“I think the custody providers that are ahead of the curve here are looking at where they can save money with blockchain, because a lot of this administrative stuff is just overhead and it could save them a lot of money as well, and they can pass some of those savings on to the client. But they’re also trying to understand how they continue to offer all these value-added services on top,” she said.
Counterparties offering middleman functions are the most hesitant to adopt blockchain, not custodians, says Summerville.
“Obviously, people who are going to be affected the most are going to be most wary. So you can figure out who those people are … if their business model is threatened, they’re going to be quite wary of it and that’s understandable.”
Central securities depositories (CSDs) and central counterparty clearing houses (CCPs) risk having their functions changed fundamentally by blockchain, but according to Summerville new roles could arise for them.
“For the interoperability issue they could find a role for themselves, but they need to be looking at how their role is going to change, and their role will definitely change.”