Currently UK stocks are settled and cleared using a system developed in a world of paper-based systems that has changed little since 1968. It is costly and inefficient and SCOTEX sees an opportunity to look find a better way of operating the market for the benefit of investors and companies using a new approach to data management and sharing that is being proposed as a solution to many of the inefficiencies afflicting the industry. The prize on offer is a new architecture, where all capital market participants work from common datasets, in near real-time, and where supporting operations are either streamlined or made redundant.
Using a distributed ledger – a term which describes a database architecture where all nodes in a system collaborate to reach a consensus on the correct state of a shared data resource and where there is no critical central master database – will mean transforming the recording of transactions from electronic certificates and databases to an audited record of the lineage of ownership of private securities. The system will act as a central repository for details of all SCOTEX trades, validated based on a mathematical formula running on the computers of participants, allowing assets to be transferred without using a centralised agency such as a bank or a clearing house. Decisions on what goes into the ledger are based on cryptography and consensus mechanisms.
We are calling the new post-trade system STARS: Secure Transaction Affirmation and Reporting System. It will mean:
- Trades will settle almost immediately with no need for post-trade clearing (guaranteeing) of trades.
- Trading will be much cheaper for everyone as users will be charged a low flat fee to access the ledger rather than being charged per transaction in a captive system.
- Sellers will get their money almost instantly and no later than 15 minutes after executing a stock sale.
- No need for post-trade affirmation or confirmation and central clearing during the settlement cycle.
- Reduced scope for data errors, disputes and reconciliation lags, speeding up the end-to-end trading process since all participants operate from their own local version of the golden source.
In the current system each link the chain between investor and company is a cost met by investors and companies alike:
SCOTEX intends to disintermediate the parties that make up the costly and inefficient link that currently exists between investor and company:
In our target operating model SCOTEX and STARS is the only link between investor and company:
There is no mass demand placed on any central authority, reducing the risk of it being overloaded. Counterparties can bilaterally reveal information to each other without querying the centre. With no central authority, there is no single point of failure. Trades are irrevocable once agreed, so there is a reduced risk of manipulation.
The industry would no longer operate at the speed of the slowest trade: the investor selling to a counterparty without the funds to complete the trade when it is executed has to wait until that counterparty has either been loaned the money or is able to liquidate other assets. Likewise the investor buying from a counterparty who has loaned her or his stock to another party has to wait for the completion of another transaction before the deal is able to finalise. Long term investors and debt-averse investors are effectively penalised while frequent investors who are able to use the existing system for their own short term benefits are the effective winners from this system.
We also move away from CCP risk: the current CCP model forces investors to trust in the risk models employed by the CCP. This pooling of risk is unavoidable for investors and creates an additional risk to investing. CCPs are risk poolers, not insurance providers. S.T.A.R.S. removes this risk: buyers unable to come up with the money to complete a transaction are not able to enter a price into the market in the first place; likewise sellers without the shares they have promised to deliver are not able to enter a selling price for those shares. Therefore no individual investor takes on the risks of any other investor defaulting on an agreement or not being able to deliver securities for sale.
Don’t just take our word for it. Here is what leaders in the exchange and equities world say about distributed ledgers:
“I am a big believer in the ability of technology to effect fundamental change in the infrastructure of the financial services industry. Clearing houses are a wonderful invention, but if you have a public ledger that is trusted, you can evolve back to a bilateral (trading) world but proceed with instantaneous settlement. We currently settle at T+3 (three days after the trade occurs). Why not settle in 5-10 minutes?” (Bob Greifeld, CEO Nasdaq)
We’re now building a beta version of a clearing and settlement platform (using a distributed ledger) for equities… There are about $4 billion to $5 billion of cost in the system. Those are paid for by listed companies and investors. In that number, I’m adding up the exchanges, clearinghouse, CSDs, the registries, the depositories, data vendors, platform providers, technology providers – everybody in the system. We think there is an opportunity to look at that cost and ask ourselves if there is a better way for the market to be operating… The post trade environment has not had the investment in innovation that the trading environment has had over the last five to 10 years. We’re still sitting on 20- and 30-year-old systems. We think it’s time to see what we can do there. (Australian Stock Exchange deputy CEO Peter Hiom)
We believe blockchain could drive greater efficiencies in the US cash equities market, primarily through streamlining the post-trade settlement and clearing processes. By reducing the duplicative, often manual affirmation and reconciliation of trades across buy-side clients, broker-dealers, trust/custody banks, and the Depository Trust & Clearing Corporation (DTCC), we believe blockchain could result in an estimated ~$2 bn in annual cost savings in the US (both explicit and economic costs). On a global basis, the benefits would likely exceed $6bn in annual savings assuming costs are proportionate to market cap. (Goldman Sachs)
You can argue the blockchain is a Copernican moment in finance; that the concept of a mutual distributed ledger, with truth and trust being the responsibility for the whole community, shifts finance from a system dominated by large, centralised institutions to one which is more diverse, and much more based on peer to peer transactions. (Bank of America Merrill Lynch)
How is all this possible? Yes – via Digitally Distributed Ledgers
SCOTEX: Potentially the first out of the gate
The uses for distributed ledgers don’t just apply to transactions in financial markets. In a World Economic Forum survey, 73.1% of respondents noted that they expect taxes to be collected using a blockchain by 2025, while 57.9% said they expect 10% of global GDP to be stored on blockchains by this time. There have been more than 150 venture capital-backed deals in distributed ledgers companies in the past two years as investors realise the potential rewards of getting solutions to market. Without a legacy system to migrate over from, the potential value to SCOTEX of being the first out of the gate to run a regulated stock exchange with a distributed post trade ledger could be significant. SCOTEX shareholders will share in all IP generated from the STARS system.