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Asia Pacific’s DLT initiatives offer valuable lessons for global capital markets
Asia Pacific’s DLT initiatives offer valuable lessons for global capital markets
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Asia Pacific’s DLT initiatives offer valuable lessons for global capital markets

12/10/2020


Accelerating the use of smart contract technology to optimise market workflows

Given Asia Pacific’s economic momentum and affinity for advanced technology, it is perhaps unsurprising to discover that several Stock Exchanges in the region have picked up the baton when it comes to Distributed Ledger Technology (DLT) and its best recognised version of transaction recordkeeping, Blockchain.

While many financial markets, including in the US and Europe, have opted for a wait-and-see approach, Asia Pacific provides compelling examples of institutions that are on track to deploy DLT solutions in production. For instance, the Australian Securities Exchange (ASX) is striving to completely replace its Clearing House Electronic SubRegister System, or CHESS, with new DLT and smart contract based infrastructure in April 2022. The upgrade is expected to bring a host of benefits, such as more control for issuers and investors, cost efficiency and enhanced security.[1]

The Monetary Authority of Singapore (MAS) began exploring the use of Blockchain and DLT as an alternative to existing clearing and settlement systems in 2016.[2] And this September, the Singapore Exchange announced the successful issuance of its first $400M digital bond, which used smart contracts to capture the rights and obligations of the parties involved, in a landmark move for the region's bond market towards adopting DLT.[3]

Elsewhere, Hong Kong’s bourse operator, HKEX, is also considering applying smart contract technology to its flourishing Stock Connect programme. The solution is being designed to bring automation and transparency to pre-settlement workflows, to reduce settlement periods and risk in the trading of mainland China shares by international investors in Northbound transactions.[4]

Admittedly, enterprise DLT remains in its nascent stages compared to other fintech developments, but the technology’s potential to profoundly enrich the industry is gaining broader recognition. According to the World Bank, financial sector stakeholders should not miss the opportunity to help shape DLT and realise its transformative powers.[5] It is precisely this mindset that is being demonstrated in Asia Pacific, and the region’s commitment to examining smart finance solutions offers insights for global peers.

The steady march of automation

Modern global markets are incredibly diverse, with participants ranging from small independent brokerages to multinational investment banking organisations. Today, each member relies on their own bespoke technology and data storage solution to complete their tasks in common workflows. The impact is that each firm processes the same task in different ways, and stores the same information in different formats. This creates risk and leads to breaks between firms as they all need to coordinate and communicate with one another to deliver services to end clients such as investors and issuers.

These multi-party workflows are precisely where DLT and smart contracts can add value by standardising processing across firms, guaranteeing consistent automation and enabling true straight through processing. Thanks to the real-time synchronisation of data, issues are identified more quickly and risk can be reduced for all parties. The technology, which is expected to underpin clearing, trading and settlement in the future, is especially advantageous for building more efficient custodial services.

“In securities services, we’ve got these challenges where global custodians need to communicate with local custodians and then communicate back again with the market. Smart contracts and distributed ledger technology can give you the capacity to automate that process from end to end in a standardised way that executes consistently,”

says Jon Rout, Business Development Director for APAC at Digital Asset, a fintech company delivering smart contract-based solutions.

For Gary O’Brien, Head of Custody Product for APAC at BNP Paribas Securities Services, DLT offers the ability to significantly improve today’s sequential processing and concurrent messaging used throughout post trade workflows. DLT brings a world where all parties receive the same information simultaneously, is a huge plus point.

“Any kind of automation, such as smart contracts, that can help manage fluctuating market conditions or allow a greater volume of settlements to flow through the pipe is obviously a benefit,”

he notes.

Optimising liquidity across the region

One of those core business functions is managing liquidity, which is a very different proposition in Asia than in Europe or the US. Different markets in Asia Pacific use different currencies, with different funding available in each. As such, investors selling a security in one market are required to complete an FX transaction to cover a securities trade settling in another market. This can cause a delay in funding. Similarly, brokers that operate regional hubs in Asia Pacific may need to move funds between markets to complete the timely settlement of transactions with their clients. One solution is for brokers to seek intraday liquidity solutions from their banking partners in order to cover any peak activity whilst avoiding significant fixed costs that could hit profitability.

TPC provides an alternative financial solution: the clearing party could, for instance, provide intraday liquidity solutions to a broker on an uncommitted, undisclosed basis to assist in the coverage of its daily activity. Or the clearing party could do so on a committed or overnight basis to add more certainty.

In addition, TPC can deliver significant cost savings. Costs such as capital requirements, payments of margin calls and contributions to the default fund are passed to a TPC partner. Added to which, TPC does away with the need to maintain a separate relationship with a local bank for cash settlements and liquidity requirements. In contrast, in the account operator model, a broker is responsible for all of the above except infrastructure upgrades.

Ahead of the curve

While competition among the region’s financial hubs has provided a crucial impetus, there is yet another key reason why Asia Pacific in particular is demonstrating global leadership in DLT based smart contract applications: its capital markets are much more fragmented as a result of the different trading and legal regimes across countries. These markets also tend to function with a vertically integrated national infrastructure, usually characterised by a single stock exchange, clearing house and central securities depository. Consequently, demand is growing for smart technology to streamline procedures and drive integration.

Faced with a distinct set of problems to solve, institutions in the region have identified the business cases first and then assembled relevant cross-functional teams to ensure the right tools are built.

“One of the criticisms often levelled at Blockchain is that it's a hammer in search of a nail, or a tech in search of a problem. But Asian Exchanges have been extremely focused on what the specific business problems are,”

explains Rout.

Those actions have not gone unnoticed by their western counterparts. The lessons learnt in Asia Pacific are being relayed to the rest of the world, allowing other players to refine the parameters for their own pilot and production projects.

“We’re at a tipping point where the value propositions are becoming clearer. The US and Europe are really starting to look at the value propositions around asset tokenisation and the acceleration of settlement cycles that are emerging from the Asian use cases. DLT is well placed to also deliver benefits in terms of the velocity and usability of collateral.”

Rout adds.

A second essential takeaway from Asia Pacific is the adoption of a step-by-step yet agile approach to assimilate the technology into existing core infrastructure.

“It's not a good idea to rip out all of the legacy systems and replace them wholesale without a significant amount of testing and proof work,”

says O’Brien.

Instead, he recommends ‘hybrid’ model – seeking to combine legacy and new platforms and infrastructure throughout the investment cycle – which would permit participants to assess and prioritise the changes that are going to bring them maximum value. This backwards-compatible solution is vital to support the diverse spectrum of market actors as well as facilitate scaling up to seize new opportunities made possible by the technology at a comfortable pace.

Evolving mindsets and creative collaboration

Ultimately, realising the true value of smart contracts and DLT relies on an inclusive, market-wide mindset. Rather than stopping at their own organisation’s front door, finance executives should look beyond traditional boundaries and zoom out to tackle genuine opportunities optimise entire workflows across the market. An upshot of this attitude is a shift to new kinds of partnerships with specialists and vendors who can share their expertise and knowledge. It is an increasingly active space with plenty of collaborators to choose from; in Hong Kong alone, nearly 40% of the 57 fintech firms launched in 2019 operate in the Blockchain sector. [6]

Additionally, it is important for national regulators to join development discussions to prevent roadblocks down the line. According to O’Brien, although enterprise DLT does not require any regulatory change at the moment, the technology’s ever expanding scope and its numerous permutations should be reviewed early on.

“When the technology is being used to create new digital assets and digital securities, that part of the market is where regulation needs to be analysed to ensure the safety of assets, as well as the safety of investors,”

he says.

As more distributed ledger pilots and production implementations come to the fore, blockchain and smart contract capabilities can be further empowered by other innovations, such as application programming interfaces (APIs) and artificial intelligence. Moreover, there is a growing realisation across markets that a combination of these data solutions will only improve the performance of the interconnected financial services industry. As O’Brien notes:

“Certainly, I’d be surprised if we don't see a dramatic increase over the coming months in the number of market infrastructures and securities services organisations in Asia and globally starting to leverage this technology to reimagine existing workflows, and deliver major client benefits.”

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[1]  https://www.asx.com.au/services/chess-replacement.htm

[2]  https://www.mas.gov.sg/schemes-and-initiatives/Project-Ubin

[3]  https://www.sgx.com/media-centre/20200901-sgx-collaboration-hsbc-and-temasek-completes-pilot-digital-bond-olam

[4] https://www.chinadailyhk.com/articles/127/170/214/1573146330710.html

[5] https://www.worldbank.org/en/topic/financialsector/brief/blockchain-dlt

[6] https://blockchain.news/news/hong-kong-fintechs-embrace-blockchain-and-dlt

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