Inside the ASX’s blockchain play: Exchange operator prepares to challenge tech giants

ASX is not just using blockchain-inspired technology to replace one of its core systems, it also wants to use the technology to host third party applications

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There’s been a misapprehension that ASX is trying to use its position as the operator of the Australian Securities Exchange and its foray into blockchain to potentially squeeze out other businesses, such as share registries, according to Cliff Richards.

As executive general manager, equity post-trade services, Richards is the executive leading the ASX’s project to replace its aging CHESS post-trade settlement system with a new system that employs blockchain-inspired distributed ledger technology (DLT).

ASX hopes that the underlying infrastructure that will drive the CHESS replacement system will also play host to a range of other applications, including potentially some outside the realm of financial services.

However, Richards said that ASX plans to “stick to its knitting” and “allow the rest of the market to bring their innovation to the equation.”

“Who are we competing with?” he said. “IBM, Microsoft, and Big Tech. We’re a minnow wading into the game with global, overseas big tech companies.”

Richards said there had been some confusion between ASX’s plan to use an application based on Digital Asset Modeling Language (DAML) — an open source ‘smart contract’ language developed by Digital Asset — to replace CHESS, and the underlying platform that the market operator hopes will be embraced by third parties to host a range of blockchain-based applications.

ASX is betting that it will be able to deliver better value than “big tech” with its DLT infrastructure, Richards said. “If we're wrong, guess what? What have we done? We’ve replaced CHESS with a contemporary system for the next 20-odd years that is operating on global standards, has new functions that were requested by the market, and none of the like-for-like costs for clearing and settlement [will] go up.”

“Yes, there’s some costs associated with changing and that's a bit painful,” he added, but those costs should be considered in the context of the life of CHESS and of its replacement. “And the world is very interested in what's going on,” he added. ASX has 30 conversations going on with different firms about building DAML applications for a variety of use cases.

“Why do they think it's valuable for ASX to do this? Because we’re trusted, we’re recognised, the brand’s understood, and we're adults in the room. We’re not hysterical,” Richards said.

ASX in January 2016 announced it had taken a 5 per cent stake in US-based Digital Asset Holdings, which specialises in DLT. (Last week ASX announced it had invested a further US$10 million bringing its total equity investment in Digital Asset to US$30.9 million.)

CHESS is the legal source of truth for the ownership data of the Australian stock market (about 85 per cent of the market capitalisation sits within the CHESS subregister; the remaining 15 per cent sits with the issuer of listed companies).

When CHESS was first rolled out two and a half decades ago, it was a watershed moment for the Australian market. Its 1994 debut facilitated a shift away from paper-based transactions and delivered T+5 settlement; that is, a trade is settled five days after it occurs (in 2016, that was improved to T+2).

ASX in December 2017 confirmed it would use a DLT-based system to replace CHESS. The new system is expected to go live in 2021.

“ASX is liberating the data of who owns what in a safe, secure permissioned fashion,” Richards said. “That is not done anywhere else in the world. So we are leading the world in achieving that objective through the application of this tech.”

The distributed ledger architecture ASX is employing will allow “those for whom the market actually exists” to have “direct control and visibility of their assets, their companies, their investments,” Richards said.

The system will leave untouched the pre-trade world – where a seller is matched with a buyer and a trade is executed. But for the post-trade, settlement world, the difference that DLT can make is significant, ASX believes.

Virtually “nothing” has been invested in the clearing and settlement process for a couple of decades since the effective digitisation of paper-based processes, Richards said.

“We have not taken the opportunity of technology stop thinking about paper and start thinking about doing things that address the problem in markets,” the ASX executive said.

Current settlement processes use message-based systems to send messages to and from a source of truth like CHESS. Occasionally, that can lead to reconciliation (or ‘rec’) breaks when a system has data that differs from the legal source of truth (i.e. CHESS), either because of a message being dropped or a problem with a system’s architecture (incorrectly encoding market rules, for example).

“Rec breaks are the bane of financial markets because they slow the system down,” Richards said.

A significant amount of the “excitement” around blockchain-style systems is the potential to banish rec breaks, he added. “The problem in financial markets today is that message-based technology architectures have a problem of reconciliation and a problem of latency,” Richards said.

When CHESS was built, there were no global messaging standards rich enough to support its functions. As a result, ASX developed its own messages – more than 500 of them. The successor to CHESS is based on the global ISO 20022 standard, whittling those 500+ messages down to 90 new global standard messages.

“This actually puts us in sync with what the RBA is telling the banks, which is the banking industry, for payments, all has to be on ISO 20022 in five years’ time,” Richards said. “So we're really joining the RBA and forcing the securities industry and the payments industry to get contemporary on a global standard of messaging, as well as us introducing the DLT option.”

Today the settlement process takes two days (T+2). At launch, the new system will stick to T+2 as a default, but an ASX consultation paper has foreshadowed the potential to, at some point, offer shorter settlement periods, including possibly intraday, end of trade date or T+1.

Building a ‘global synchronisation layer’

Richards said the opportunity seen by ASX was to take a key piece of centralised market infrastructure and slide under it a blockchain to act as a “global synchronisation layer” that can “share that source of data, via nodes on the blockchain,” to participants in the settlement and clearing processes.

It will provide the same “golden record” of a trade as CHESS, Richards said, “but unlike before, we're not sending and receiving messages around, that have those qualities all those problems of reconciliation and latency, because the entire system is kept in real time, independently provable synchronicity.”

A broker, for example, can be confident that they’re sitting on the same distributed ledger as everyone else in the market and possess a “portion of the golden source of truth, perfectly synchronised and independently provable.”

“That means you never need to reconcile with ASX, [you know] that what you have is true,” Richards said. “Your node and the cryptography — that proves that to you.”

Richards acknowledged that rec breaks are not a huge problem in clearing and settlement on the ASX today. However, he said that a market participant knowing that any other actor in the market will be in “perfect sync” opens up a range of possibilities.

“In a message-based architecture, you’re broadcasting messages out but you don't always get them back,” he said. When everyone is synchronised, the whole ecosystem can know the state of the ledger and state of workflow (though the ‘permissioned’ part of the distributed ledger means only authorised parties have access to private data).

The potential for innovation, ASX believes, is in what happens once parties are on the distributed ledger. Parties all sharing synchronised data in a private, permissioned system can make sophisticated multi-party workflows possible. Currently “it is impossible to orchestrate a multi-party workflow,” Richards said.

He gave the example of a secondary capital raising in the form of a renounceable rights issue: That involves a variety of participants such as a listed company, a share registry, investors who own the stock in the company, asset managers, fund managers, and the clearing and settlement participants.

If all participants are synchronised, then a smart contract language like DAML can help codify and orchestrate the whole process.

“We can codify that workflow once and give it to the market,” Richards said. “And then we can discretely and deterministically allocate a portion of the workflow, the acceptance of the rights issue by the end investor, the processing of that rights issue by settlement participant, the passing of that to ASX to do what it does, and notification back to the listed company that the rights issue has been accepted or not — and then overlay the payment infrastructure in the form of, perhaps, the [New Payments Platform].” That allows participants to to “collapse the timeframe” and take some risk out of the process.

‘Planetary alignment’

Richards told Computerworld that in ASX’s contact with all other exchange operators around the world, every one of them is examining some form of DLT or blockchain technology. All of them either have either completed or have in progress proof-of-concept projects or have production builds underway “either quietly or publicly”.

“Everyone's looking at it, but they're coming up with different use cases and different priorities,” Richards said.

“You’ve got keep in mind that ASX has a system it needs to replace. If you're a market infrastructure and you've just spent $x million updating your core system five years ago, it's a pretty hard ask to go and junk that and write off something that you just took an industry through five years ago when it's still got a natural life of 10 years.”

“I see these furious arguments about how quickly blockchain will get adoption; blockchain will get adoption in the same way that other technologies get adoption,” he added.

“When the value proposition and the network effect takes root in a market, such that it is so obvious that it's better than the way things are being done — then you will see people opting into it. But no-one is going to write-off their three-year-old system.”

He expects adoption in many cases could be seven to 12 years off. In the case of ASX there has been some “planetary alignment” because of ASX’s desire to replace CHESS, as well as the “relatively unfragmented” market in Australia.

“We've got 100 participants: It's easy to have a conversation with hundred participants, rather than thousands, which is the case in Europe and the US. Our regulators: We can get them into the room at the same time and have one conversation rather than having, you know, in the US seven different conversations with federal regulators and then 50 conversations with state regulators depending on the use case.”

“We are blessed with a set of circumstances in Australia that have allowed us to move faster than some other jurisdictions,” he added.

Richards said that for ASX, the “really exciting part” is “addressing the fragmentation and latency of financial markets beyond clearing and settlement – so things like corporate actions, things like share registry services, things like fund management, asset management, things like getting source of truth data out to investors and issuers, because none of those things are clearing and settlement but they're all activities that go on in the stock market.”

ASX’s fees for performing settlement run to around $50 million a year. He contrasts that to the $20 billion a year to run the superannuation system. “So settlement is a tiny portion of the cost of running the stock market because we're very efficient,” Richards said. “Really, what we're doing is we’re saying we can export the efficiency that we've developed in clearing and settlement into other services by making this infrastructure available to the broader market.”

[Read part 2 here: Inside the ASX’s blockchain play: How ASX plans to bring DLT to corporate Australia]

Copyright © 2019 IDG Communications, Inc.

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