DLT (Distributed Ledger Technology), is IT technology build on philosophy of decentralised database, which content is managed by multiple users. All transactions within spread DLT environment are validated and registered concurrently on several places (nodes) what creates common consensus of credibility of each transaction in given environment.
Probably the most well-known implementation of DLT technology is the Blockchain, which attaches each transaction with digital stamp (hash) proving immutability of the transaction. Transactions are then grouped into blocks and each block of transactions includes the digital hash of previous block of transactions, what creates chain. Therefor the DLT technology if often called also the Blockchain.
DLT approach is in obvious conflict with traditional approach, where a bank institution or a central depository firstly validates an instruction after receiving and then processes it. The result is that only given institution is the one who has full control over the transaction, as it represents the single central processing point. This approach is based on high level of confidence in the institution and also historically proved as the most appropriate so far. In other words, two counterparties in the transaction fully rely on trustworthy institution (third party) in matter of correct processing of their transaction. Arrival of DLT technology naturally brings technical option suggesting that existence of single central point is not essential anymore for processing of a transaction.
What is possible impact of DLT technology to post-trade services?
At the present, central depositories have important and irreplaceable role in final registration of securities ownership . Moreover, many depositories offer also services in area of corporate actions or administration of registers of pledge over securities, or other services.
Leading opinion is that the DLT technology might have potential to change the long term applied customs and processes in area of post-trade services. Whether it has potential to endanger position of central counterparties, custodians and ultimately also the central depositories in their position of key intermediates, is not clear.
Real impact of DLT to the post-trade services can considerably dependent also on (1) development of regulation in this area and (2) on approach of an institution to innovations, whether DLT will be perceived as a threat or opportunity to improve quality of, or to expand the services
With respect to regulation, in September 2020 the European Commission published proposal for a Regulation on a pilot regime for market infrastructures based on DLT. Except the generally declared supporting opinion, in connection with this initiative were defined also certain objections, e.g.:
- current CSDR regulation does not create any barriers to the DLT, thus is technologically neutral. Therefore incorporation of all conclusions from the pilot regime for DLT to existing regulation is more preferable than creation of new special regulation purposefully bound to DLT,
- possibility for MTF to provide also settlement services will generate new risks – the rule „same business, same rules, same risks“ is not applied (depositories have no possibility to operate trading platform, but based on the proposed regulation the MTFs should have possibility to provide settlement services),
- absence of common practice and standards for DLT application to ensure essential ability of DLT systems in post trade services to communicate among each other, and also with established systems, what could result in higher fragmentation in the market.
As regards practical approach of institutions to DLT technology there is information that some of them experiment with practical application of DLT with aim to enhance productiveness and decrease costs in post-trade services, primarily with respect to corporate action, but less in area of their core services. Further facts on current experience show that DLT solutions are able to process also large and complex transactions, but meanwhile reveal existing and unsolved problems:
a) Interoperability – will DLT systems be able to communicate with other surrounding systems if standards are missing? Lack of standards for application of DLT to practice will undoubtedly bring new risks.
b) Will DLT systems be built as public or private DLT networks?
c) Cyber threats – successful attack to smart contracts from the Ethereum platform showed that neither the DLT solution is fully immune against security threats.
It is undoubtful that existing processes and systems can be, from technical point of view, transferred to DLT environment. But what will be the added value and return on investments of these services in DLT environment compared to the traditional setting? Clear answers backed by real and successful business cases in EU post-trade services and valid standards are yet missing.
Author: Karol Gers
