Distributed ledger technology and the evolution of post trade

Abstract

The consistent trend towards dematerialisation and business process automation that has been developing around the world over recent years has also shaped the recent evolution of securities markets. The emergence of distributed ledger technologies (DLTs) has the potential to disrupt the present-day business model of security markets based on central securities depositories (CSDs). The transition from centralised analogic infrastructures (such as CSDs) to more distributed digital and protocol-based infrastructures (such as DLTs) has a variety of implications that have only recently started to emerge and raises new questions and unexplored issues. This paper analyses the impact that technological innovations in the field of DLTs have on the business of CSDs, assesses the nature of that impact and figures out what lies ahead for CSDs in an age of technological revolution and transformative changes. It highlights that current infrastructure is functional but complex, fragmented and limited in scale and scope and mainly zooms in on Custody and CSDs whose roles are evolving. The paper discusses how DLTs and digital assets are transforming the securities end-to-end process. On the one hand, the DLT disruption is challenging current constraints of traditional settlement times, operating hours and also national boundaries. The paper discusses how as DLTs disintermediate and ‘decentralise’ the role played by CSDs, the operational and counterparty risks are also reduced. As a result, market participants, while maintaining their critical roles in ensuring fair and effective markets, can now transform themselves and embrace a new operational, technological and regulatory framework. On the other hand, the paper also discusses how this disintermediation can introduce novel types of operational, technological and regulatory risks in security markets and post trade too. These new aspects introduce further re-centralisation and re-intermediation in the industry, mainly in the form of custodians, which are increasing their relevance within a DLT ecosystem to address novel technological and operational risks. More generally, the work discusses how hierarchical, closed and permissioned governance structures are naturally more suited to reduce novel regulatory, technological and operational risks, together with the contextual definition of industry-wide standards, which ensure interoperability between old and new systems, regulatory harmonisation and compliance. In sum, while the decentralisation and disintermediation potentially fostered by DLTs can contribute to the reduction of certain types of risks in post trade the emergence of brand-new risks requires other forms re-centralisation and re-intermediation. This requires the emergence of novel actors and novel architectural solutions. Ultimately, the paper outlines how the collaboration between regulatory authorities and industry participants is becoming a key enabler for wider DLT adoption, especially in heavily regulated industries. This has a direct impact on financial market infrastructures (FMIs) that are challenged to become more client-oriented, to be able to cope with increasing competition and to take advantage of new opportunities to grow through novel business models.