Blockchain technology is poised to disrupt the financial industry in several ways. To shed more light on exactly how the blockchain will change the status quo in banking and finance, the five-part article series ‘Blockchain Disruption in Finance’ delves into the main areas within financial services that will likely experience the most disruptions by this innovative new technology.
In this article, you will discover how securities lending is being disrupted by distributed ledger technology (DLT).
What is Securities Lending?
Securities lending refers to loaning a financial security, such as a stock, bond or an ETF, to an investor. In exchange, the securities lender receives collateral in the form of cash, shares or a letter of credit as well as a small borrowing fee.
Securities holders, such as mutual funds, for example, engage in securities lending to add extra returns to their investment portfolios through borrowing fees while investors typically borrow securities so that they can short the security and bet on a temporary market decline.
Alternatively, banks borrow securities if they need to cover a short or when they need to deliver securities to a client at the point of settlement that they presently do not possess.
Securities Lending on the Blockchain
Currently, in the securities lending market, the process of transferring underlying securities between the involved parties of a trade can take up to several days and involve several intermediaries.
Through the implementation of the blockchain, financial institutions could reduce costs, increase efficiency, and execute transactions instantly and directly between the two transacting parties. Moreover, as the blockchain securely records and stores all transactional data in an immutable and auditable manner, such a platform would also create the level of transparency that regulators want to see in the financial industry.
Boston-based bank State Street has been among the first financial institutions to recognize the value that the blockchain can bring to the securities lending market. Already in 2016, the custodian bank started to test a blockchain-based system that it hopes will streamline the securities lending process.
According to Hu Liang, a senior managing director of the Emerging Technologies Center at State Street, the goal of this blockchain trial was to “enhance the operational aspect of securities lending”. In many cases, there is no automated linkage between accounts that indicate where the collateral should go back to which slows down the process. The blockchain-based platform would reduce manual intervention in the process, which, in turn, would make it faster and create a more transparent record for reporting purposes, Liang added. The aim was to go live with the platform in 2017 but that has not yet happened.
Having said that, State Street is not alone in their plans to put securities lending onto the blockchain.
In May 2017, the Chilean Stock Exchange and IBM announced that they have entered into a partnership to ”deliver the world’s first securities lending blockchain solution”.
The blockchain-based solution, which is based on the Linux Foundation’s Hyperledger Fabric, has been designed to reduce fraud, operational errors, and processing times for securities lending transactions. It also aims to improve transaction management, increase transaction speeds, and should result in lower costs for all involved stakeholders.
Santiago Exchange CIO, Andrés Araya, said: “Incorporating blockchain into our business processes is in line with that purpose and positions us as a forerunner in the financial market,” while IBM Chile General Manager, Francisco Thiermann, stated that “[the] Santiago Exchange is a pioneer in its industry, and the blockchain adoption establishes a transformational precedent in the financial market, not just in Chile but in this region and the world.”
Furthermore, in March 2018, Deutsche Börse Group announced that it has engaged in a partnership with financial technology company HQLAx to develop a blockchain-powered solution for the securities lending market.
The two companies plan to use the Corda blockchain platform, which was developed by blockchain banking consortium R3, to create a fully integrated front-to-back operating model to streamline collateral management for high-quality liquid assets used in securities lending.
Addressing the new partnership, Philippe Seyll, Executive Manager at Deutsche Börse Group, said: “Jointly with our partners, we will address some of the major issues in today’s securities lending markets through innovate means. […] Deutsche Börse is embracing distributed ledger technology and complements it with a neutral and trusted market infrastructure role open to multiple custodians and collateral agents.”
CEO of HQLAx, Guido Stroemer, said: “Our goal is to mobilize liquidity across pools of collateral currently residing in disparate custody accounts around the globe. Partnering with Deutsche Börse Group enables us to maximize the network effect that will drive widespread adoption of the HQLAx platform.
In this partnership, Deutsche Boerse Group will deliver the trading layer from its Eurex Repo trading platform and will take the lead role in the development of the custody agnostic, post-trade processing layer of the new solution. HQLAx will focus on redistributing collateral liquidity more efficiently by enhancing the interoperability of securities pools residing in various settlement systems and locations.
Credit Suisse and ING Execute First Blockchain-Powered Real-World Securities Lending Transaction
In March 2018, Reuters reported that banking giants Credit Suisse and ING successfully executed the first live securities lending transaction worth 25 million euros ($30.48 million) on the blockchain.
The securities lending transaction involved the two European banks swapping baskets of securities using a blockchain-based software created by HQLAx, which was built on top of R3’ Corda blockchain network.
In an interview with Reuters, Charley Cooper, a managing director at R3, said: “This was far more than a proof of concept in a fenced lab. These are regulated institutions in a real market and it is a unique demonstration that blockchain solutions are being deployed in commercial settings.”
“[This new] platform gives us an opportunity to make balance sheet and capital usage much more efficient and timely,” said Emmanuel Aidoo, Credit Suisse’s head of distributed ledger and blockchain strategy.
The companies involved in this project expect the platform to go live by year-end, according to ING’s blockchain initiative lead, Herve Francois.
The Future of Securities Lending Will Likely be on the Blockchain
Given the current state of the securities lending market, it should be no surprise that a range of financial institutions and technology companies are working on putting this entire process onto blockchain.
While some intermediaries who are benefiting from the current model may fight blockchain adoption, it definitely looks like technological innovation will eventually crowd out the intermediaries in the sector for the benefit of the key stakeholders involved in securities lending transactions.
I hope you are enjoying these articles. Don’t miss out on the fourth article next week: Blockchain Disruption in Finance: KYC/AML.
You can find all published articles on: https://medium.com/blockchain-disruption-in-finance