By Bernard Lunn
On Tuesday, our Research Note focused on the question:
Today, our Research Note focuses on the question:
Who will create Real Time Settlement?
Will it be:
- The beneficiaries of real time settlement such as Banks?
- Existing Intermediaries?
- StartUp Intermediaries?
The beneficiaries of real time settlement such as Banks
Here are two reasons to think Banks will create real time settlement:
- They benefit the most from the elimination of credit and market risk
- This is where most of the Proof of Concept budgets are currently being spent and Banks are also investing in startups in this space.
In this scenario, which is close to the accepted wisdom, we should watch the standardization process. The logic goes like this:
- This is pre competitive. All Banks benefit equally from real time settlement.
- This will only happen when enough banks agree on standards.
One advantage of having some grey hair in this industry is having seen other equally compelling logic around standards making result in….absolutely nothing. In reality, the players often either think that they can create some competitive advantage by keeping something proprietary.
The one possible exception to this is in OTC markets which we explore below.
First we need near real time payment
We can see initiatives in both America and UK to move to near real time payment.
In America, this is led by the Federal Reserve. This article points out that they are playing catch up with other countries. The US dominates Capital Markets, so this move is critical.
These initiatives have nothing to do with Blockchain and may use the ISO 20022 standard message format.
Payment is only one part of securities settlement
The payment is for securities that are settled (transferred to the new owner). This has to be simultaneous – you don’t want to pay and then not get your securities or vice versa. The time to transfer securities to a new owner varies, depending on type of security and jurisdiction. This is usually shown as T+x where T is the Trade execution day.
For Marketable Stocks (Equities), it is
- T+3 in America
- T+2 in Europe
For listed options and government bonds it is usually T+1.
The process steps are:
- Trade (usually on an Exchange but can be Over The Counter)
- Clearing (between banks). This is the part that confuses newcomers to this business. Money and securities are not “sent” or “wired”. Messages are sent that adjust ledgers in different bank accounts and custodian accounts. That is the part that sounds like a Blockchain system.
- Settlement. The final step when payment is made.
When we talk about near real time capital markets settlement we mean all three steps. Trade is real time today. Payments is moving to real time. So it is the Clearing step that has to play catch up.
Real Time Gross Settlement (RTGS) has been running for a long time. It is done bank-to-bank, using central banks when it is cross border. Today RTGS is only for large amounts. However there is no reason with Moore’s Law making computer transactions so cheap, why this same technology cannot be done in near real time. When computer cycles are expensive, it make sense to net transactions between banks. When computer cycles become cheap, there is no reason why netting is a prerequisite because each transaction can be settled independently.
The biggest intermediary is SWIFT. They operate globally with 9,000 member banks. They are clearly looking at Blockchain as this Call for Proposals demonstrates. Whether they use Blockchain or something like the ISO 20022 standard message format (or maybe some combo (such as the ISO 20022 standard message format between Blockchains) is unclear. However they have the market power to make the transition to near real time capital markets settlement happen.
It is fashionable to say that Correspondent Banking is dead. This conflates the current incarnation of Correspondent Banking which is batch based with the concept of Correspondent Banking itself (which is simply based on the reality of how clearing takes place between banks). At some point SWIFT will go real time. Those 9,000 member banks will keep the human relationships and just switch over to a new system.
The first venture we spotted in this space was Clearmatics, an Anglo Swiss venture (London and Geneva) who we met in Geneva in March 2015 when they were in stealth mode. Clearmatics, which is working with UBS, recently raised its first round of funding.
Another startup in this space is Ripple, with backing from Banco Santander and others with their recently released Interledger.
Chain, with backing from Visa., Nasdaq and Citi Ventures is another player.
Over The Counter is different
There are many derivative securities that are traded Over The Counter (OTC) and these may be more suitable to Blockchain solutions because these markets are already decentralized in the same way that Blockchain is decentralized.
A startup called Equibit is focussed on Equity derivatives
Banks want OTC markets to remain OTC and not move to Exchanges, Blockchain systems may enable OTC market makers to satisfy regulatory demands for transparency without moving to Exchanges.
Coming at this from a different perspective, NASDAQ Linq is using Blockchain to trade private company shares which cannot be traded on a conventional exchange.
If anybody knows of any other startups or interesting initiatives in this space please tell us in comments.
Daily Fintech Advisers provide strategic consulting to organizations with business and investment interests in Fintech.