It’s a challenge to predict how technologies will fare in the universe of securities operations.
For instance, the hype around blockchain/distributed ledger technology (DLT) has been far outpacing the reality of DLT-based systems and applications in production at securities trading firms, causing some to wonder if there will ever be actual results.
However, Commerzbank and Deutsche Börse officials have just released news about a DLT-based system that arguably should have gotten more of the spotlight. If nothing else, it proves that DLT is not dead and that some of the hype may have been justified.
In their announcement, Commerzbank and Deutsche Börse say they “have for the first time successfully used distributed ledger technology to execute a legally binding settlement of a repo transaction. The prototype transaction based on delivery versus payment was executed as part of a joint proof of concept examining the possible use of blockchain technology in securities settlement.”
The German duo used digital tokens for the transaction, “generated for both commercial bank money (cash tokens) and securities (securities tokens).”
In addition, the repo transaction was based upon “a public note of KfW Bank Group (ISIN DE000A2LQSP7) amounting to EUR 10 million [$11,247,135] and a seven-day term with a negative interest rate of -0.5%,” according to officials. “Repos are collateralized money market instruments, which banks use to cover their short-term liquidity requirement by depositing securities.”
A DLT-based backbone “was used to execute the simultaneous swap of the tokens as a legally binding transaction,” officials from both say. “Deutsche Börse acted as the cash provider, Commerzbank as the borrower and main incubator, Commerzbank’s research and development unit, acted as the blockchain platform operator. The technology used and the underlying legal concept were developed jointly by the partners.”
The transaction proves that “a legally-binding, efficient and transparent movement of tokenized securities and cash on blockchain based on a ‘delivery versus payment’ principle is feasible,” according to officials. “Distributed ledger technology creates an immediate and simultaneous transfer of assets so that the transaction can be settled in real time. The key benefits of this shortened execution time are the reduced counterparty risk and the corresponding reduction of capital costs. This technology also permits the direct and transparent involvement of regulators and oversight authorities.”
“Through the systematic development of blockchain technology, DLT is increasingly gaining in importance for a growing market,” says Michael F. Spitz, CEO of main incubator, the R&D unit of the Commerzbank Group, in a prepared statement. “In past pilots, we have focused on new issue projects; with the transaction between Deutsche Börse and Commerzbank we were now for the first time able to convert existing securities into digital tokens. We are delighted to support the transaction as a platform operator and, together with Deutsche Börse, to have reached such an important milestone in the adaptation of this future technology for the capital market.”
The successful experiment “motivates us to explore the efficiency of distributed ledger technology further,” says Jens Hachmeister, head of DLT, crypto assets and new market structures at Deutsche Börse, in a prepared statement. “Our particular focus here is on the integrated payment function — cash on ledger — which we have successfully demonstrated. The development of different blockchain applications and setting new standards is a high priority for Deutsche Börse Group, and we will push ahead with this process in close exchange with partners, supervisory authorities and central banks.”
This successful “prototype settlement” will give both organizations a new basis “for further developments,” officials say.
“The next steps are linked closely to the creation of underlying legal conditions which are a requirement for a binding assessment of contractual relationships. The parties involved see themselves as trailblazers in this young technology and seek to create cornerstones for the financial market infrastructure,” according to officials.
I suspect that there are other trailblazers out there that are also taking a cautious path to making DLT a new reality for securities operations.