To tap tomorrow's distributed ledger tech, firms must act now

WITH all the noise surrounding distributed ledger technology (DLT), you'd expect participants in financial markets to be racing full-bore to get ready for it. But many are not. With DLT, the ledger has one shared and constantly updated vision of the truth, synchronised across multiple sites. That changes the need for a central intermediary. DLT generates a secure, immutable historical record and a full audit trail. A blockchain is a type of distributed ledger.

Presented almost daily with new claims about DLT's disruptive and revolutionary potential, some executives have begun to wonder when they'll actually begin to see some benefits from the technology.

Financial market participants know DLT is coming. About 80 per cent of executives at financial institutions surveyed by Bain & Company believe the technology will be transformative, and a similar percentage expect their organisations to begin using it before 2020.

Yet, at the same time, they're hesitant to commit resources now. Among the market participants Bain surveyed, 38 per cent said they've adopted a wait-and-see approach.

WHAT'S HOLDING THEM BACK?

First, uncertainty. It is hard to predict exactly which DLT applications will reach scale. It's also unclear how the regulatory environment will evolve in different markets. Second, getting ready for DLT requires substantial investment at a time when many firms are facing financial constraints, and it can involve working through tricky and expensive issues with legacy IT systems. Third, some firms, in an attempt to preserve near-term competitive positions, are trying to delay industrywide adoption.

Yet companies that are willing to be proactive and strategic about it, even in such a challenging climate, can gain an edge.

DLT has the potential to broadly affect financial markets, but the most significant near-term impact is likely to be on settlement and clearing. While a trader can now execute a transaction at lightning speed, it can take as long as three days for that transaction to settle.

With DLT, execution, clearing and settlement could occur simultaneously, minimising cost and credit risks. Bain estimates that across global financial markets, annual expense and capital cost savings from DLT could amount to one to 3 basis points of total global assets under management, or about US$15 billion to US$35 billion.

Certain asset classes and activities are ripe for early adoption. For example, Euroclear and Paxos have piloted a DLT settlement service for gold bullion trading in London. The Depository Trust & Clearing Corporation and a consortium that includes IBM, Axoni and R3 have successfully tested a system using DLT and smart contracts to manage post-trade services in the US$11 trillion OTC market for cleared and bilateral credit derivatives.

DLT can eventually also play a role in improving reference data, including benchmark interest rates like Libor, replacing existing survey processes that are opaque and subject to abuse. A DLT-based benchmark-setting mechanism, possibly administered by trading venues and industrywide utilities, could directly capture data from spot transactions.

Beyond trading, DLT has the potential to change the way firms interact with their clients in areas such as proxy voting, digital identity management and Know Your Customer. Broadridge, a global leader in proxy communication services, is developing a system to help make US proxy voting more efficient, secure and transparent. Regulators are also working on DLT solutions: The state of Delaware is developing laws that would allow the use of DLT to manage corporate records.

HOW TO GET GOING

As financial markets evolve with respect to DLT, companies will face game-theory-type decisions. If they promote the early adoption of DLT across the ecosystem, they may benefit, but they may also end up disrupting their own economics and competitive positions. Yet if they're slow to embrace it, they run the risk of being left behind. The most valuable DLT innovations can't be developed in isolation; they require collaboration among participants, exchanges and regulators.

With so many participants involved across so many jurisdictions and asset classes, the adoption process will be messy and piecemeal - and this is the heart of the challenge. It may make more sense to share the costs as well as the benefits through industry utilities.

One way or another, firms that want to reap the benefits will have to make significant changes to their processes, policies and IT architecture. As part of their efforts to make their IT systems ready, leading companies are taking some early steps that will be necessary for DLT.

Once a company has a perspective on how DLT is likely to evolve in the areas in which it does business, it can develop a systematic approach and a multi-year roadmap.

Whether a company prospers or flounders in the DLT-dominated markets of the future will depend on strategic decisions it makes today. Once a firm defines a DLT-readiness posture and a high-level roadmap, its next step is to outline specific no-regrets initiatives.

Many of the investments a firm makes, especially in IT, can bring benefits regardless of the pace or shape of DLT adoption. Those market participants that thrive with DLT will spend less energy on making excuses for inaction and more on developing a strategic and longer-term approach that's consistent with who they are, what they do and where they operate. They'll focus on driving themselves and the entire industry toward a more efficient ecosystem. The winners in DLT will be those that push the pace of change, rather than resist it.