Blockchain. Settlements. Banking-as-a-Platform (BaaP). Three famous words.
Blockchain, just in Q1 2016 garnered investments in excess of half a billion dollars. With over a 100 companies in this segment, the focus of these companies is not just limited to Banking and Financial Services.
If I stick to Fintech – What could Blockchain – Distributed Ledger technology offer to the Settlement and Custody business? Some practical thoughts and how does Banking as a Platform (BaaP) fits in or rather slides between practical application and underlying technology.
Legacy systems are what provides services and security amongst the institutional client base. Even with all the ‘will’ in the world, it will be difficult to instantaneously displace the existing infrastructure, so we take the builders practical advice and build what? Flyovers. To remove congestion on the existing setup and charge toll to improve the legacy systems. You get the scene.
Banking as a Platform (BaaP) is your flyover or rather the new platform integration layer. How does it work for Custody and Settlements? What role does Blockchain/Distributed Ledger play?
The existing systems hold the data, process and record the transactions today. If we took that as a starting point, we would be looking at creating an ecosystem. If a custodian bank started to view its client base as ‘digital dots’ in the system you could have anonymised encryption of each client as an identification. The concept of Distributed Ledger technology relies on this information as a basis. This potentially makes the KYC process an automated one from node-to-node across Blockchains. First application on the BaaP layer?
The assets held by each client are the blocks (appear as a stacked chart in my head) that reside on the systems today in different accounts by different asset classes. The application of storing each layer of assets and updating the valuations (prices) is something that could conveniently be fed into the chain of the ledger.
The prices will likely come from a different ecosystem on mutually agreed parameters and could feed into the other processes such as Fund administration, Collateral management, Securities lending.
The issue of Settlements. Trading can take place in fractions of a second but Settlement takes forever (comparatively speaking). Why? Is it because Trading is the front-end and Settlement back-end or because of the inherent structure of the market?
Simply put, the front-end has a job which is to essentially trade and put up margin (collateral as securities) if they don’t have cash along with using the uncommitted over draft lines. If Blockchain/Distributed ledger has to work for Settlements then as a starting point we need to systemically prove –
a) Trading and Settlements are instant, which means all parties are cash rich, no brokers needed
b) How is the system going to handle cancellations of trade, who stumps up the price arbitrage
c) Domestic exchanges and regulation allows for fails and liquidity ramifications thereof
Settlements is possibly (my view) the most tricky aspect to solve for in the Blockchain scenario as you would need multiple applications (from your client’s different service providers) on the BaaP model and sorting out the entire liquidity conundrum.
Smart Contracts and Payment engine applications can enforce multi currency payment rules and integrate asset-cash movement protocols. The move from applications to functions is critical and needs to be understood. With such applications creation of virtual functions is almost a given, for example, Treasury function can be automated to reflect multi-legal entity views.
Domestic exchanges report the dividend yield and income payments for listed instruments but it is essentially a core custodian activity whereby proceeds are electronically transferred to the shareholders. In the Blockchain scenario this would be multiple Distributed Ledger ecosystems contracting, contacting and liaising to move the blocks of the chain.
What do we need here to make it happen? A Banking-as-a-Platform (BaaP) layer that provides every ecosystem a security layer of data filtration but yet the ability to move the stack about.
Starting to see the pattern in the abstract? Banking-as-a-Platform (BaaP) layer can be the interface between the legacy systems and the ledger technology applications. The solution will likely carefully tailored amalgamation of –
i) Regulatory reporting and managing the liquidity requirements where multiple ecosystems communicate on a predefined set of protocols and cryptography
ii) The integration of pricing data feeds, role of Stock exchanges and connectivity with Asset manufacturers in the domestic market and reporting of the same at a Global Custodian (aggregated) level
iii) Collaboration between functions to utilise the platform integration layer and reflect the audit trail of data, actions and regulatory compliance.
Seems to boil down to – data (Custody), application (via BaaP) and encrypted information exchange. What happens to Messaging Infrastructure, Balance Sheet management? More to come.