Why post-trade wholesale market infrastructure is down

Our industry’s wholesale capital markets post-trade infrastructure is increasingly inadequate.

With increasing market volumes, the likelihood of a major systemic issue occurring is very real.

The money transfer mechanism is dated. Although trading can and does take place in real time, it takes at least 24 hours for the buyer and seller to agree on settlement criteria and to move funds.

This not only creates huge settlement risk, but also freezes funds for long periods of time. Banks’ funding and liquidity profiles are impacted, as are the reserves they must hold in their accounts.

The extent of the problem

Putting this into context, the Bank for International Settlements (BIS) estimated in 2019 that, of the nearly $19 trillion worth of currency settled each day, nearly $9 trillion is settled without any default protection. counterpart. $9 trillion is almost twice Japan’s annual GDP.

In the case of a conventional, non-PvP bilateral settlement, it is almost impossible for each counterparty to predict when the other will honor its obligation. Therefore, to ensure that they always have sufficient liquidity to meet their cash obligations, banks must maintain large balances in their nostro accounts.

A 2018 report by Oliver Wyman estimated that between 10 and 30% of a bank’s total liquidity reserves arise from intraday liquidity needs, with a negative cost of carry of around 100 basis points. For large banks, the report says, this typically equates to $100 million to $300 million in funding costs per year from intraday liquidity. In the current economic climate, this cost will only increase.

The main centralized settlement processes used today are batch-based, limit direct access to the largest financial institutions, limit the number of asset classes that can be settled, and rely on existing technology. Users are constrained by process inflexibility and lack of configurability. Other constraints exist in terms of hedging restricted by currency and by counterparty.

In short, the problem is getting worse: with rising market volumes, the likelihood of a major systemic glitch occurring is very real.

Implementation of new technologies

Clearly, the market needs a settlement solution that is not asset class or industry specific (as is often the case today). The solution must solve the problems of today while extending to the asset classes of the future, leveraging the efficiencies of advanced cloud and data analytics.

The entire post-trade process should be covered, from matching to settlement, enabling efficient and automated clearing of trades as well as fast and risk-free settlement or payout.

However, “rip and replace” is not an immediate option for most companies: they need a highly reliable and secure solution that can interoperate with existing systems and existing business processes.

Meeting current and future challenges

Distributed ledger technology (DLT) provides the speed, transparency, choice, auditability and non-repudiation required by market participants today. It is immutable, resilient and inviolable.

Practically, DLT offers a single source of truth to the principles of a transaction. Both parties can be confident that the values ​​derived from the compensation calculations are correct, and there is no need to reconcile the results separately. Payments can and should be made very efficiently immediately afterwards.

DLT also provides the ability to run collaborative or intelligent workflows where each party runs a common process from a common set of data. These workflows not only present opportunities in terms of automation and speed of processing, but the technology exists today to enable the delivery of PvP settlement in a fully automated and configurable way. This eliminates the need for businesses to resort to resource-intensive, human-error-prone manual processes.

By applying 21st century technology to outdated post-trade processes, seamless and auditable instant transfer of funds can be achieved, making the uncertainty of 24-hour settlement cycles a thing of the past.

DLT-based technology can operationalize many of the benefits of blockchain for capital markets, providing a proven and scalable framework for risk-free settlement of assets.

About Terry Simmons

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