The Banker’s Distributed Ledger, An Alternative Asset Clearing and Settlement System

in blog •  6 months ago


What You Don't Know Can Hurt You!

I am often struck by the general lack of knowledge that the investing public has in relationship to the current clearing and settlement systems used by their financial institutions and brokerage houses for stocks and bonds and even Forex or currency trading. There is this notion quite mistakenly that if you buy a stock from your broker that it belongs to you directly, but this is not entirely true. The current clearing and settlement system can be equated more closely to a trust or fiduciary structure where you are considered a beneficiary of an assets, but do not exercise complete direct control over that asset. There is a renewed push to create, test and implement newer systems which utilize Distributed ledger Technologies (DLT) and government, regulators and banks are pushing this innovation forward in the case of the Jasper Project. It was recently announcement that the 3rd phase of the Jasper Project which is a joint collaborative research initiative involving The Bank of Canada, Payments Canada and the TMX Group has been successfully completed. This initiative aims at balancing the privacy need of market participants “as well integrating other assets onto the same ledger as payments” and this “would provide” an “important benefits for the financial system from the use of a Distributed ledger technology-based wholesale payment system”1. In this post I would like to go over some of my experiences in the international brokerage business, and how in my view the Jasper Project is a key stepping stone for the general dissemination of DLT solutions through the all asset clearing and settlement systems.

The Streets are a Dangerous Place

In my 10 years in the offshore banking world I could count only a few times that a client has asked me to explain how their stocks and bonds are purchased and held by the bank on their behalf. The first time a client asked me this question I had to do some research to ensure that I understood the process accurately rather than go based on some outdated financial textbook explanation. I would see the typical client understand the process as happening via the following steps.

  1. I open a brokerage account and funds it with $1000.00 USD from my bank account which utilizes traditional payment channels.
  2. It takes 3-5 business days for the money to settle in the account.
  3. Once the funds are in the account I place a trade and see the money exit my account and a corresponding number of shares attached to my general ledger appear.

This is just a false perception by the client of the nature of the transaction because in reality the process would go more as follows.

  1. The client sending bank would utilize a payment communication network which include SWIFT, IBAN and Fed Wires ect. to send the payment.
  2. The receiving bank would receive a payment message and credit the client’s account with the funds even before the actual funds arrive. It can take up to 2 weeks or longer before the actual payment arrives.
  3. The funds which were credited based on the payment network message and their promise to pay are deposited into the client’s brokerage account.
  4. Once the funds are in the account the client can now places a trade. The bank uses the client’s funds to execute the trade within the regulatory prescribed limits typically 3 business days
    The shares you think that are in your possession in your brokerage account are not there at all. In a simple sense the bank is acting as a custodian or fiduciary and you as a client are named a beneficiary, and this is what is referred to as a stock being in ‘street name’. further complicating the matter is the fact that your bank itself is not the ultimate custodian of the shares, but rather is itself holding these shares in larger clearing institutions such as Citibank. As explained by the World Bank Treasury department “Citibank, N.A., London Branch (‘‘Citibank’’) is the Global Agent for Notes held through DTC, Euroclear, Clearstream, Luxembourg and such other clearing systems as may be specified in the applicable Final Terms.”2. It is important to note that DTC, Euroclear, Clearstream etc. are they themselves providing clearing and settlement services to the financial markets related to stocks and bonds and other instruments. Such a complex structure creates major transparency issues as it become very difficult to know precisely who is holding your assets as the ultimate custodian bank. Many of these issues can be resolved by using a distributed ledger payment and clearing infrastructure, and in the next section we will show just how the Jasper Project aims to achieve this.

Jasper your Friendly Hope!

The first 2 phases of the Jasper project they have case tested a payment and clearing infrastructure which can facilitate large interbank payment using the DLT. The Third phase of this project shows “that it is possible to deliver payments in a way that has never been done before – by directly swapping cash from buyers to sellers, resulting in instant settlements,”3. This Proof of concept provide much a needed competitive alternative to the overly complex and ambiguous current payment and clearing systems of DTC, Euroclear, Clearstream. The instant settlement feature of DLT would remove many complex processes in clearing asset transfers while still maintaining the privacy of market participants.

Future For Though

Although the DLT will eventually be integrated into every aspect of the financial system, I see this being a slow process which will be resisted by current traditional technology stakeholders. This transition may be likened to the disruption of VHS by DVD technology where market forces and consumer product needs eventually displaced older technologies for newer ones. This is an exciting time to be in the financial business as technology is providing opportunities for small and medium sized firm compete with much larger firms who have dominated these payment and cash settlement infrastructures. Only time will tell if we can rise to the challenge and develop and use the DLT to decentralize financial power with the aim of empowering and growing communities.

Have a great weekend everyone!

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I agree very much. What we don't know can hurt us and that's why Knowledge is power!

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