Real Time Equities Settlement will change the global capital markets beyond recognition, impacting every player in the ecosystem. For long a technological pipedream, Real Time Equities Settlement is nudging closer to reality thanks to Blockchain technology. In this research note, we look at the progress being made by two established exchanges (NASDAQ and ASX) and one startup (T0).
This will change everything
Last year we had a research note asking the question:
At a recent conference in Luxembourg of people who really understand the nuances of fund operations and payments, a straw poll indicated overwhelming agreement that real time equities settlement a) would be mainstream within 10 years and b) that it would change the capital markets industry in fundamental ways.
Real Time Equities Settlement won’t incrementally improve processes. It will obliterate processes. Whole swathes of operations simply won’t be needed. This is as disruptive as you can get.
Today’s research note describes some actual projects currently in the innovation pipeline. This latest research enables a more definitive yes to the question – will blockchain enable near real time capital markets settlement? The answer is yes because we can see real projects by companies with the clout to bring this to market.
Defining Real Time Settlement
The key points are:
- Both securities and funds need concurrent settlement. Transfer has to be final & unconditional, without any time lag between the two (any time lag is ripe for fraud). This concurrency requirement is absolute. Just faster (e.g. Getting from T+3 to a few hours or even minutes) does not meet the concurrency requirement, because hours or minutes are eons to a fraudster.
- Must be on a gross (trade for trade) basis. Any attempt at netting creates delay and creates a multi-tier market infrastructure that will impede innovation. We have Real Time Gross Settlement (RTGS) today – between Central Banks. The disruptive change is RTGS between individuals and companies in a permissionless network (ie the way that the Internet works).
That BIS paper was written over 23 years ago in 1992! The requirements have been known a long time. We had to wait all this time for a technology to enable this. Then along came Blockchain….
A more updated paper from BIS in 2012 is here.
The Australian Stock Exchange (ASX) has a clearing and settlement system called CHESS. ASX recently announced investing $10.5 million in Digital Asset Holdings and awarding a contract to them to “radically speed up settlement in Australia’s stock market”.
Why ASX and Australia?
ASX also owns the clearing and settlement system. We think of Exchanges as being about trading – which happens in micro seconds – and then the trade is handed off to a clearing and settlement system that takes days. To put that in consumer terms, Elmer Funke Kupper, chief executive officer of ASX, said:
“A retail investor in Australia should be able to sell their shares, go to the nearest ATM and get their cash out.”
NASDAQ is taking a different tack. Their Linq project is aimed at private equity ie being able to trade, clear and settle stock in private companies. NASDAQ does not own the equities clearing system. That is done by DTCC. So they cannot do what ASX is doing. The focus on private equity could make sense, because private equity is a highly inefficient market where the state of the art is an Excel spreadsheet. It begs the question – “if private markets become super efficient and transparent, what is the difference from public markets?”
T0 is different from NASDAQ and ASX. T0 is a startup, but not a VC funded startup. T0 was created by Patrick Byrne, CEO of US online retailer Overstock.com. The name says it all – T0. This is a startup exclusively focused on real time equities clearing & settlement. There are three reasons to play attention to T0:
- Focus. T0 has no innovators dilemma, no existing revenue lines to protect.
- A technical founder with cash. Patrick Byrne is rich; he is not dependent on VC funding. He is also technical enough to understand how this really works.
- Motivation. As CEO of Overstock, Patrick Byrne has been badly hurt by naked short selling (quite different from ordinary shorting as explained here). Real Time Equities Settlement will eliminate naked shorting.
Translation: who wins
- Banks. A report by Santander said banks could reduce infrastructure costs for cross-border payments, the trading of securities and regulatory compliance by $US15 billion to $US20 billion a year from 2022 by employing blockchains.
- Investors and Issuers. Cost and time will be reduced.
- Any Exchange which owns a clearing & settlement system. Expect some M&A
- Anybody who understands how blockchain and clearing & settlement works.Expect IT vendors and consultancies to scramble to assemble talent.
Translation: who loses
- Vendors selling how to improve processes that will be obliterated by Real Time Equities Settlement.
- Capital markets players that don’t figure out how to add value when Real Time Equities Settlement obliterates their intermediary role.