David Wright, IOSCO
The blockchain technology used in bitcoin is attracting attention from regulators who hope that it could knit together disperse data on world derivatives markets and slash the amount of collateral needed to trade, the head of the International Organization of Securities Commissions said.
A blockchain, also known as a distributed ledger, is an encrypted sequential record of transactions replicated simultaneously across a network of computers. Key to the bitcoin cryptocurrency, its potential for producing instantaneous trades without any need for verification - because both parties get the same information at the same time - has drawn increasing mainstream interest, with leading banks announcing in September that they would develop protocols for its use in corporate bond markets.
Regulators hope that it could revolutionize financial infrastructure, potentially providing them with an omniscient and instant picture of every trade in a market, complete with information about price and the identity of all parties involved.
"The blockchain is coming down the tube fast," IOSCO Secretary General David Wright told SNL Financial in a late November interview, adding that the technology would almost certainly be discussed at the organization's next board meeting in February 2016.
Regulators are attracted by the potential for instantaneous exchange of cash for title, cutting out multiple transactions that are all possible sources of error, as well as by blockchain's capacity to trace ownership of securities back through trades. It can provide a real-time overview of financial market activity, Wright told SNL in his Madrid offices.
"You know who's bought the particular product, so that's good from a market abuse perspective, of controlling market abuse," he said.
Blockchain could solve the problem caused by the failure of the world's trade repositories to aggregate separately collected data on derivatives as efforts continue to agree on standardized tags for trades, products and parties, Wright said.
"One of the big failures of global financial reform has been the trade repositories," he said. "In the middle of those 29 trade repository complexes, you've got commercial interests, privacy issues, data protection, distrust among regulators and no harmonization of the underlying data."
Moreover, said Wright, blockchain could slash the need for collateral held against trades.
"If you have a much more rapid system of connecting up an exchange of cash for title, your margin requirements could change because your risks are much lower," he said.
Blockchain also looks set to reduce costs in other parts of the financial system, with a report from Banco Santander's Santander InnoVentures pegging the potential infrastructure savings to banks at $20 billion a year by 2022, according to a report.
Although some blockchain proponents have argued that it could even replace central counterparties, because trades would no longer have to be registered by intermediaries, clearing houses aim to start utilizing the technology before it displaces them. At least one leading clearing house has told Wright that Blockchain could eliminate mistakes that occur when the documentation for two sides of a deal fails to coincide.
"The real expense is trying to mend trades that don't match up; that's hugely expensive," Wright said. "I think all of the clearing houses will be looking very carefully at these technologies. Whatever happens in the future has to be systemically sound, but do we think these technologies are interesting for the future? Yes we do."
Although blockchain represents a significant opportunity for financial markets, other aspects of technological change are less benign. Cybercrime is now a significant risk, and Wright is also unsure of whether high-frequency trading is fair.
But Wright argued that one key economic player, the European Commission, has missed a chance to take advantage of transformative technology in its plans for Capital Markets Union and the accompanying prospectus directive. These aim to spur sluggish EU growth by facilitating financing especially for smaller and medium-sized companies.
"I think the concept [of Capital Markets Union] is entirely right; what I think is missing . … is a broader look at how technology and digitalization and new types of market structure, e-commerce linked to capital markets, can help the financing of capital markets in particular," Wright said. "You've got to look at not just crowd funding, but Alibaba-type models linking e-commerce to capital markets, transaction-rated like the eBay model."
Such electronic marketplaces might also take a different approach to credit risk, he said, adding that several years of a business's loan payment history, which would be of great interest to a bank, might be of less importance to e-commerce participants than the rating provided by those that have done business with them in the marketplace.
"Twiddling with the prospectus directive to make it slightly easier for small firms to access stock markets is not the way you're going to finance small companies. Digital technology is the way to do it," Wright said.
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