The threats and opportunities created by blockchain are real enough, says Javier Jara, business innovation manager at the Chilean CSD and vice president of the Americas’ Central Securities Depository Association (ACSDA), and CSDs should be willing to a pay a short-term price to secure a crucial role in ensuring blockchain networks are safely adopted and sensibly governed. But he also thinks CSDs should be technological followers rather than leaders and never take risks with their core systems, which they should entrust to tried and tested technology maintained by committed partners.
“Blockchain is something that could threaten our industry as a whole, or create opportunities for us all, so we should try to figure out together what we can do to protect and improve our services, even though the realities are different in each market,” says Javier Jara, business and legal manager at the Depósito Central de Valores (DCV) in Chile. “As a CSD, you have to consider the possibility that this new technology will change your business model because it will be more efficient and cheaper. So knowing what other CSDs are doing about blockchain, what has worked and what has not, and what we as CSDs can do together, is important work.”
By meeting the bockchain threat CSDs can position themselves to exploit the opportunities
At DCV itself, Jara is pursuing a parallel strategy on blockchain. It is getting involved in blockchain initiatives, both at home and abroad, in order to understand the ways in which the new technology can improve or enhance the existing business or create new products and services for existing clients. “But we also want to be alert to the threats this technology poses to our existing business model,” says Jara. “Anyone running a centralised model could in principle be threatened by the decentralised model blockchain provides. In areas such as crypto-asset custody or central bank digital currencies (CBDCs) we could be disintermediated.”
But he also identifies crypto-assets issued and custodied on a blockchain network as a classic threat-cum-opportunity. “The way securities are issued and invested in, and the way they are traded, cleared and custodied, could all be about to change, so we have to be alert and be prepared,” says Jara. “Today, crypto- is focused on small companies and start-ups, because there are legal barriers and institutional investors are not willing or able to invest in crypto-assets. But in two or three years’ time crypto- could change the whole securities market, and we want to be sure that institutional investors will be looking to CSDs to help them.”
CSDs can facilitate adoption of blockchain technology and govern blockchain networks
He is clear about how CSDs can help. The first is by helping the markets they serve to accommodate the new technology. “We provide services to issuers, investors, stock exchanges, OTC trading platforms, clearing houses, regulators, central banks and government, and have a privileged position in the market,” explains Jara. “We are not normally competitors with other market participants either. So our network is a good channel for the market to incorporate new technologies. We are a neutral facilitator of the adoption of new technologies.”
As well as faciltating the adoption of blockchain technology, CSDs can assume a governing role in private permissioned networks based on the technology. This can include deciding which entities are admitted to the network, and the resolution of disputes between members of it. “CSDs offer issuers and investors trusted intermediation and asset safety and security,” says Jara. “When investors talk about crypto-assets, they tend to ask, `If I have a problem, who do I call to get redress? Who will respond to me if something goes wrong? That is a question that CSDs can help to answer.”
CSDs should be willing to sacrifice short-term revenue in order to meet long term strategic challeges
Jara does not see crypto-assets as an immediate threat. One reason for that is the absence of CBDCs, but he does not see that as a reason for complacency. Jara has kept abreast of the work central banks are doing to test and develop CBDCs. He also points to ID2S, the blockchain-based CSD recently authorised under the European Central Securities Depositories Regulation (CSDR) to support the commercial paper market in France, where the authorities have also created a favourable legal environment. Jara sees these developments as portents of the future.
“If CSDs are to avoid the fate of Kodak and Nokia and Blockbuster, they must be flexible enough to get ahead of the technologies that are threatening them,” says Jara. “Even if adopting new technologies means you must sacrifice some revenue in the short term.” However, keeping pace with new technologies is not easy for frontier and emerging market CSDs in particular, because they do not always have the resources to invest.
Vendor technology can insulate CSDs from the costs of upgrading their platforms
Jara advises them to work with a committed partner – and it is advice DCV has taken itself. Three years ago, the Chilean CSD was planning to replace its core technology platform. After a lengthy review, it was decided to buy a platform from Nasdaq rather than build a new one in-house. The reasoning of Jara and his colleagues was that buying a world-class platform from a vendor clearly committed to the industry – Nasdaq owns CSDs itself – would enable DCV to take advantage of continuing investment in the platform, and the improved services it bought.
“One of the main reasons we chose Nasdaq is because they have the capabilities and financial strength to keep investing to ensure that the system we use is kept up-to-date, in the face of any challenge, whether it is blockchain or any other technology that can be applied to our business, such as artificial intelligence (AI), robotic process automation or data analytics,” explains Jara. “As a small CSD, if you are to compete and keep up with the best solutions, you need a partner who is investing to ensure their technology is always riding at the top of the wave.”
When it comes to core systems CSDs should be followers not early adopters
He knows it is still tempting to build and operate systems in-house, using open source software and Cloud hosting, because they are cheaper than purchasing a licence and maintenance contract from a traditional vendor. “But, considering our critical role as systemically important institutions and the relatively high volumes of transactions we process, CSDs should prefer to be followers rather than pioneers,” says Jara. As he points out, even in a relatively small market such as Chile, DCV holds the equivalent of nearly US$ 400 billion in custody and is settling more than 100,000 transactions a month. These core services cannot be put at risk by switching to untested technology.
That said, Jara is happy for CSDs to experiment with blockchain in non-core areas, such as proxy voting, or data analytics. “Once you have become familiar with the newer technologies in non-core areas, you are in a better position to move to them, even in your core services,” he says. “It is something you should balance against the need to maintain your critical services in all market conditions.” In fact, DCV created last year a new department to investigate, study, analyse and even participate in new digital start-ups at home and abroad, including blockchain projects.
CSDs should learn from each other and identify collaborative projects
By then, DCV had already belonged to the consortium of CSDs set up to develop a blockchain-based proxy voting system for more than a year. Formed in June 2017, the CSD Working Group on Distributed Ledger Technology (DLT) – members include the CSDs of Abu Dhabi, Argentina, Russia, South Africa and Switzerland as well as Chile – settled last year under the umbrella of the International Securities Services Association (ISSA) Working Group on DLT. Jara thinks this group has already done good work in identifying practical use-cases, producing useful papers and in engaging CSDs of different sizes.
The Working Group is an example of the collaborative approach to the blockchain challenge which Jara advocates. With a legal and economic as well as a commercial sales background, and nearly a quarter of a century in the industry at the global and regional as well as local levels, Jara understands how hard it is to balance the responsibilities of being systemically important against limited resources and multiple commercial opportunities. But pooling knowledge and experience constantly and exploiting any opportunities to work together on solving problems, are a large part of his answer.
Wdnesday 10 April 2019
Blockchain: Is it an opportunity or threat and what should CSDs do to embrace the future busines model?
Moderator: Vipin Mahabirsingh, Director, CDS Mauritius
Andre Eduardo Demarco, Director of depository operations, B3, Brazil
Lina Hediah, Executive director, Consensys, Dubai
Woochol Shin, Head of innovative technology team, KSD, Korea
Alexander Chekanov, Chief architect, NSD, Russia
Imothy Hogben, COO, ASX, Australia