Blockchain & DLT – just like the early railways or good for T+1?

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Blockchain & DLT – just like the early railways or good for T+1?

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Blockchain & DLT – just like the early railways or good for T+1? You decide

By Tony Freeman

In the early 1800’s railway pioneers across Great Britain and Ireland were busy developing this amazing new form of transport. Imagine the transformational impact of moving from horse speed to a steam-driven locomotive capable of 25kmh. Coal carrying trains shortly became the engine of the Industrial Revolution which, literally, changed the world. It must have been very exciting.

However, there was a problem. The early railways were very disconnected, so they did not need to be standardized or interoperable. As a result, the gauge (the distance between the rails) varied from 1.37m to 1.88m. As the railways grew and a national network became feasible the issue became a severe problem and led, ultimately, to the “gauge wars.” Eventually the matter was settled, and “standard gauge” was adopted. It measured 1.435m. How did this standardization happen? Well, it was not an accident. It took a Royal Commission (a “major ad-hoc formal public inquiry” according to Wikipedia) and a new law: the Regulating the Gauge of Railways Act 1846.  In plain speak it took a lot of discussion followed by new mandatory rules.

In the automotive sector a very similar evolution took place with the standardization of petrol/gasoline. Most people take for granted that fuel is interoperable: if the tank in my car is half-full of BP petrol it makes no difference if I fill it up with Esso fuel.

A similar process of evolution is now underway in the Electric Vehicle segment. There is no battery standardization and, in the UK where I live, there are at least three incompatible charging standards. (I predict the Tesla model will win the “Charging War,” but it will take some years to happen.)

Why am I talking about these issues? Because my journalist friends tell me that their inboxes are full of PR hype about T+0 settlement. In 2015 when the Blockchain hype cycle hit its peak I was working at DTCC. As the world’s biggest equity CSD, well known for its ongoing use of legacy technology, we were an obvious target for the swivel-eyed advocates of this interesting new tech. It could apparently solve any problem. I used to joke with colleagues that our office was not in the City of London – we were actually working in Jurassic Park.

DTCC thankfully adopted a dignified silence and hoped the hype would dissipate. It did not. As one of the principal spokespeople I was forced to adopt a positive but slightly skeptical tone. I was itching to tell the many so-called experts they did not understand what they were talking about. In polite DTCC-speak I would focus on the “it’s much more complex to run a CSD than most people imagine” approach. In particular, I explained, literally hundreds of times, that efficient risk reduction is not a technology driven process.

Yes, DTCC might still use Cobol programming, but it is proven to be safe and ultra-reliable. Secondly, what DTCC does is very highly regulated, the firm is designated as systemically important. As a key component of the US capital markets it cannot fall over. Thirdly, and perhaps most tellingly, not a single client ever asked me when we would adopt Blockchain.

I was responsible for the operation of the firms Advisory Council in the US/Canada, Europe, Asia-Pacific and Australia and we relentlessly put the issue on the agenda to judge the mood of our clients. (It was especially pertinent in Australia where ASX was starting a multi-year program to replace its ageing CHESS system with a wholly new DLT platform. We all know how that went!). What clients want is reliability, standardization of process, a connected community, effective governance, and fair pricing. The underlying tech platform was not relevant. Almost 10 years later, and 4 years since I left the firm, I believe their viewpoint would be largely unchanged.

In response to the Blockchain wave DTCC, hedging its bets, joined a consortium to invest in one the most promising DLT startup’s. It also issued a whitepaper entitled “Embracing Disruption.” It very subtly took apart all the arguments for an immediate deep dive into the new tech world. One seasoned analyst told me it was a masterful exercise in appearing to bathe the baby but actually drowning it instead. So, mission accomplished.

The hype died down – and we at DTCC got on with the job. We experimented with DLT and adopted it for some peripheral activities that were not well automated, known as “blue oceans,” and left the “red oceans” (because there was blood in the water) well alone.

Now, due to the move to T+1, the debate appears to have re-ignited. A considerable number of people appear to believe that T+1 is a temporary stepping-stone to T+0 or a move to T+0 is possible now. Neither position is credible. The regulators and policymakers in the US, UK and EU have, rightly, ruled it out at this time.

The US move to T+2 in 2017 took 3 years to achieve. It was considerably less complex than the move to T+1: according to AFME a 1-day settlement cycle removes 83% of the time available to complete all necessary post-trade activities. Research performed by ISITC Europe revealed that overnight batch processing is still widely used. The move to T+2 did not, unfortunately, spur a market-wide overhaul of legacy tech. T+1 forces everyone to adopt real-time same-day processing. Easily said – hard to do, especially if you are a smaller player. And if you are in a distant time-zone and dependent on the FX markets the task is even more daunting. A small number of big global firms do have 24-hour processing capability and can “follow the sun”. But the vast majority of small & medium sized investors do not. An investment manager recently told a London conference that they have good systems, but they only have two staff in their settlement department. And they are located in London. How do they solve this issue without adding cost and complexity?

Whilst conducting the ISITC Europe research we also heard about a custody bank in Luxembourg that receives 50,000 fax instructions per month. Yes, that is not a typo. 50,000. And yes, I did say the F word. Is anyone seriously saying that the firms sending the faxes, who apparently regard this as an automated process, are all going to simultaneously adopt DLT? Good luck with that one. And, by the way, I have some magic beans that I am sure you want to buy.

I hope my viewpoint is realistic – not cynical. The post-trade segment is slow to change – for very good reasons it does not embrace disruption. But, like cholesterol, there is good disruption and bad disruption. Elon Musk and SpaceX think it is feasible to travel to Mars. I am OK with the plan as long as he is not spending my money or disrupting any of my activities. This is good disruption. But I am an investor, and my pension fund has a lot of exposure to US, UK, and EU stocks. I do not want the markets to be disrupted because a new technology promises a nirvana.

More to come in part 2 of this piece – which will focus on the practical issues of T+0 settlement.

And I would love to hear your views. Send me a fax.