Insights

Distributed Ledger Technology: Is it Ready for Prime Time?

Anna Tassioula, Global Head of Financial Services Group |

The full trade lifecycle of financial instruments covering trading, settlement, clearance, and cashflows where relevant) bears a high technology cost with inefficient disparate systems, integration challenges, extensive reconciliation requirements, and high potential for errors. Can Distributed Ledger Technology (DLT), a shared ledger in a secure private peer to peer network, offer more efficient, accurate, and lower cost solutions?

Financial instruments have been traded and settled in various forms and forums for a long time and subsequently recorded on the medium du jour. In current times, many types of financial instruments, such as equities, equity options, commodity futures, financial futures, and options on futures, are traded on exchanges. A variety of other instruments are traded on ECNs or even bi-laterally with the trade being executed directly between two or more counterparties without any intermediary. For instruments traded on exchanges or other electronic venues, the actual transfer of ownership is often facilitated by a clearing house or an industry utility.

In all of these cases, each counterparty records and manages its own copy of every transaction across each phase of the transaction. This gives rise to potential errors of omission and discrepancies in the various copies of the transaction. It also creates the need for numerous and repetitive reconciliations to keep the transactional data in synchrony. The inefficiencies in this process – delays, high human effort, potential errors bearing penalties, to name a few – have a large cost impact.

DLT, decentralized, shared ledgers in a private trusted network, offer a great solution for this problem. Transactions can be recorded as Smart Contracts or Digital Assets with an immutable copy in each instance of the shared ledger. These contracts can be executable to ensure that actions can be captured at the point of recording the transaction.

DLT can also abstract the underlying physical technology, which acts as the shared ledger, thus making the network technology agnostic. The advantages of this could simplify the technology supporting the trade life cycle and offer several benefits:

1. Elimination of data discrepancy and the need for reconciliations as the exact same transaction data is recorded in the ledgers of all the counterparties
2. Instantaneous recording of the transaction in all counterparties’ ledger
3. Immediate clearing of transactions, where a clearing house is a party to the transaction
4. Instantaneous pre-trade and pre-clear risk controls baked into the same trade execution and booking process
5. Reduced settlement exposure for clearing houses as well as clearing counterparties in tripartite transactions
6. Reduction in costs for clearance and settlement of transactions
7. Elimination of disputes – none of the parties to the transaction can dispute any of the details of the transaction as they all have the exact same immutable contract data

DLT has been around for a few years, with many exchanges, clearing houses, and broker-dealers dipping their toes in the waters. Large scale adoption has been lacking, however. While the benefits of DLT for trading are not entirely clear, we believe that sufficient momentum will be achieved for the use of DLT for clearance and settlement over the upcoming years.

The barriers to adoption are primarily cost – both the sunk cost in existing technology solutions as well as the disruption cost of adopting a new technology – and any potential regulatory implications.

To learn more about how you can begin embracing DLT at your organization, reach out today.