Three ways digital assets will change post-trade

Written by Brian Collings | Apr 5, 2022 6:13:00 AM

Speed, certainty and savings will all be better realised if middle- and back-offices are set up to support digital assets.

Exploration of digital assets has created a wide range of possible outcomes for the future of capital markets structures, including use of the blockchain as an underlying settlement mechanism, smart contracts and the tokenisation of otherwise large block, single assets into multiple tradable securities.

There are also more specific, near-term outcomes which are being driven by the digitalisation of assets but reflect operational goals that banks have been pursuing since before the advent of digital assets. These sit in the post-trade space, an area where efficiency has long been a watchword.

Barriers to post-trade processing efficiency have largely been a product of the historical need to integrate different systems, asset class workflows and infrastructure together, using multiple commercial technology providers.

As digital assets create a far more homogenous post-trade infrastructure, the standard they set is likely to drive change elsewhere, making inefficiency stand out and requiring change.

Faster settlement

The first outcome will be to support reduced settlement periods. Over the past 20 years, capital markets have seen a drive to reduce the speed at which trades are settled, whether through delivery vs delivery (DvD) or delivery versus payment (DvP). The US is currently undergoing a drive to reduce the settlement cycles from a two-day settlement cycle to T+1.

Digital assets in effect use a real-time settlement mechanism. A distributed ledger or blockchain allows the trade to settle at the point of trade and the exchange is codified on the ledger with a cryptographic key to ensure settlement cannot be falsified or manipulated.

From a performance point of view this will create some advantages and challenges. If the DvP cycle is currently T+2, operationally a broker can trade on a client’s account and then settle the trade over the next two days via the client’s custodian account. A shorter settlement cycle may require pre- or full funding of the client’s account pre-trade, based upon the risk profile created by the trade.

To manage this level of risk, the broker will need a real-time risk management tool, which is also tracking any other asset classes in the case of DvP/DvD which might be used as collateral. The movement to T+1 will also drive the need for faster, multi-asset risk management tools.

The end of reconciliation?

The second outcome will be increased certainty of settlement and of asset holdings. Where assets are held on a distributed ledger, the holdings of a firm will be constantly and permanently visible to all possible counterparties.

In theory this removes the necessity of post-trade reconciliation, however, the systems within a bank which track inventory and assess risk will still need to be fed, either directly from these ledgers, or via an internal ledger.

In both cases, the access to data will require better interoperability between internal systems and external ledgers, using open application programming interfaces (APIs) and the capacity to operate in near real time.

As more complex instruments and contract clauses are tracked on distributed ledgers, the value they offer through automating processes will necessitate the reduction of manual processes internally in the middle and back office, functioning at a higher speed than the settlement process.

Collectively these advantages will support the final change.

Lower costs in post-trade

As firms achieve greater levels of automation, faster settlement and more interconnected systems, they can realise a reduction in the legacy architecture that exists today in their back office, and a drop in total costs of ownership (TCO).

This will not be supported instantly. Investment in newer, more effective tools and services will be needed at first, and the changes in processes to support greater efficiency will be gradual.

With this end in sight however, firms will be able to invest in their middle and back office more effectively today, using this roadmap for digital and non-digital assets.

The goal for this investment will be to have fewer but more multi-asset platforms capable of far faster processing and risk management. To support this, Torstone is partnering with digital asset specialist Digivault, to ensure that we can process digital assets as effectively as traditional assets, complementing our existing connectivity with global and local custodians.

Our commitment

By minimising the changes needed on our client side, we intend to facilitate the evolution of post-trade across our user base, with the same plumbing and custody in place for digital assets as exists with traditional custodians and post-trade processing.

For new clients who have existing platforms which are not capable moving into the digital asset space rapidly, then we can sit alongside that architecture and be capable of processing those digital assets in a similar style, such as providing full reconciliation and accounting rules, as is expected for non-digital assets. And ultimately bringing those processing efficiencies to the non-digital assets.

By being capable and ready, service providers can allow the speed of change and future partnerships to be led by customers, while bridging the gaps between the most and least advanced banks. The drive for post-trade efficiency is being improved in several directions and it is key that banks feel supported across them all.