One of the most exciting developments in the world of finance is the advent of cryptocurrencies such as bitcoin. These are digital currency that operates without central supervision and promise to change the way payments are made in the future.
But the technology underpinning digital currencies, blockchain, has the potential to transform several aspects of the financial industry — one of the being how brokerages carry out the clearing and settlement process for trades.
Currently, hundreds of thousands of people across the world — many based out of India — are employed in back offices where they verify, match and settle trades carried out across financial markets and asset classes in a timely manner. Using blockchain, this job can be done with far less people.
In an interview with CNBC-TV18, Gurvinder Singh, Founder and CEO of Indus Valley Partners, a firm focused exclusively on the alternative asset management industry, explains why blockchain technology can bring about a paradigm shift in the financial services industry, and outlines the impact this may have on jobs.
Q: How does the current clearing and settlement process works in financial institutions?
A: Current processes of settlement and clearing requires money and securities to end up in what is known as a clearing corporation that will validate the terms and conditions of contracts before debiting/crediting money/securities simultaneously in a depositary.
This system has served the financial community well as it has allowed anyone to trade with anyone else on the exchange with the clearing corporation guaranteeing a clean settlement of the transaction or a clean failure (i.e. if no shares delivered, then no money debited).
This process is also largely automated for liquid instruments today but is semi-automated/manually for OTC instruments such as FX Forwards/Spots, Swaps, FX Options and even the most well-known OTC instrument that is used by exporters/importers – the letter of credit.
This requires banks to manually check every word of these documents from both sides before they will move the money and is also prone to “fraudulent” presentation of documents.
Q: How will blockchain help with the automation process?
A: Blockchain through its distributed ledger and peer-to-peer (P2P) open verification will allow a bank to immediately get verification of every previous amendment via the encrypted ledger and through the hash get the confidence that it has not been altered which should move settlement time for OTC transactions from months (bank loans), weeks to instant settlement.
It can enable near instant settlement of public equities but the big challenge is getting the participation levels right.
Blythe Masters (inventor of the infamous CDS contract) and many other fintech executives are trying to build technologies to enable this infrastructure and become operating systems of this new settlement paradigm if/when it takes off (Digital Asset Holdings, R3CEV are some of the firms building solutions to enable this tech in financial world).
Q: What will be blockchain’s impact on back office jobs? Will it help automate some part of the clearing/settlement process and help increase efficiencies?
A: It will transform how operations/settlements is done on non-standard/OTC products, it will help reduce embedded risks for transactions “in flight” i.e. completed but not settled and reduce overall embedded risks in the financial system. Perverse effect also will be because now you will not have these “shock absorbers” the volatility will rise and liquidity may dry really fast during turbulent times.
Jobs will most certainly reduce dramatically in back office operations but the shift will also create higher value, higher paying jobs as well.
Q: What challenges come along with implementation of blockchain?
A: Blockchain right now is a tech in search of a solution in many respects but if central clearing venues start embracing it they can seed a network of servers that can start building up a user base.
ASX for example already announced it, Barclays recently negotiated/settled a Letter of Credit using blockchain so you can see some use cases emerging already.
Organizations need to be assessing the impact of leveraging this on internal processes, dealing with counterparties and eventually at an ecosystem level.
There is large potential for significant cost savings and innovations using this underlying technology which will give asset managers who implement this first significant advantage over their competitors.