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These are difficult days on Wall Street. Regulations, concerns about global growth and slim returns on equity are driving executives to find ways to be leaner, more efficient and more profitable. One emerging technology that could have a huge impact is the distributed ledger technology called blockchain.
Some people know blockchain as the underlying technology behind the controversial digital currency Bitcoin. However, blockchain is so much more; it’s incredibly innovative and its promise is far reaching. This technology is a secure and transparent way to digitally track the ownership of assets before, during and after transactions, and it has the potential to ultimately transform everything from how stock exchanges operate all the way to how proxies are voted. From Wall Street to Estonia, financial firms are investing in and testing blockchain to put it to the test.
McKinsey & Co. wrote that blockchain will “dramatically reshape the capital markets industry,” but that “the blockchain revolution will not happen overnight.” Nasdaq Chief Executive Bob Greifeld said, “Blockchain will bring levels of efficiency to the financial markets that we’ve never seen before.” I agree and view blockchain as something that, like the internet in the early 90s, has the potential to fundamentally transform our inherently complex financial system.
Our strategy is to invest organically, as well as through leading innovators in this space. In January, Broadridge made a minority investment in Digital Asset Holdings, a start-up led by former J.P. Morgan executive Blythe Masters, which is working to use distributed ledger technology to settle short-term lending arrangements between dealers known as repos, among other things. We also recently joined the Hyperledger Project, an open-source project advancing common blockchain standards. We’re not the only ones exploring this technology. Aite Group forecasts that capital markets firms will spend about $400 million annually by 2019 developing blockchain-enabled solutions, up from just $75 million last year.
Blockchain will have a short-, medium- and longer-term impact on the financial services industry.
In the short-term, distributed ledger technology can process sophisticated transactions with complex structures — high-value trades with low volumes – such as syndicated loans, which take over 20 days to settle in a highly manual process. Blockchain has the potential to speed processing, cut legal costs, and reduce closing fees for these types of instruments. Such improvements would add liquidity to loan markets. Blockchain could also improve efficiency and liquidity for over-the-counter derivative trades such as credit-default swaps and private stock transactions. In these markets, blockchain can make a significant impact within 3-5 years.
Bank of America Merrill Lynch, Citigroup Inc., Credit Suisse AG, the Depository Trust & Clearing Corp. (DTCC), J.P. Morgan Chase & Co., and Markit successfully completed a test using blockchain to process credit-default swaps. DTCC, which maintains records of these over-the-counter trades, is discussing if the technology can be used for live trades.
Estonia is experimenting with blockchain to improve securityholder authentication and streamline proxy voting. The experiment builds on Estonia’s e-Residency program — a transnational digital identity available to everyone globally.
In the medium term (within 5-10 years) blockchain could standardize reference data — used to describe counterparty and security identifiers — a huge cost for major global banks that each maintain that information. However, this data is so crucial to financial markets that the industry will need to see some success before embracing blockchain as the central repository for something so vital.
Over the long run (the next 10 years or more) blockchain could be used in cash equities and fixed income markets, where there is huge trade volume and relatively efficient systems. While blockchain could reduce settlement times and enable more efficient asset servicing on these securities, it will have to be a widely accepted technology before being adopted in the largest markets. Nearer term, Digital Asset is already eyeing equities, working with the Australian Stock Exchange (ASX) to use distributed ledger technology to replace its current platform for clearing and settlement.
Learning how blockchain functions in the self-contained Australian market is one thing, but using it for more complex markets such as the United States with its myriad exchanges is another thing entirely. While blockchain can certainly transform discreet markets such as loans, derivatives or even Australian stocks, for it to meaningfully change incredibly central functions such as U.S. stock exchanges, all firms would have to invest heavily and commit to adopting the new approach in lock step. Such a seismic shift would require true industry leadership, significant investment and years of planning. A recent McKinsey report, “Beyond the Hype: Blockchains in Capital Markets,” said developing blockchain will be challenging. “The most pressing difficulties relate to the technology itself, as well as market, legal and operational protocols and challenges specific to current banking practice.”
Given the incredible complexity of something of this vast nature, it would need to be an evolutionary shift, tackled uniformly and in discreet phases.
But the payoff could be significant. Autonomous Research says blockchain could cut settlement costs by a third, or $16 billion a year, and cut capital requirements by $120 billion. However, the McKinsey report notes that adopting blockchain, “will require cooperation among market participants, regulators and technologists.” We are already seeing that cooperation in action. Our investment in Digital Asset was made alongside many top firms — ABN AMRO, Accenture, ASX Limited, BNP Paribas, Citi, CME Ventures, Deutsche Borse Group, DTCC, IBM, ICAP, Goldman Sachs, J.P. Morgan, Santander InnoVentures, and PNC Financial. Likewise, the recent credit-default swap test among four banks was a good example of the type of cooperation needed before blockchain’s widespread deployment.
Blockchain is the next generation of enablement in transaction processing, and we’re excited and committed to accelerating this innovation in financial services. We’ve seen leaps in Wall Street technology before. In 1968, the New York Stock Exchange had such difficulty processing trades of about 15 million shares daily that it closed on Wednesdays from June to December to catch up on the paperwork. Now, on a busy day, the NYSE processes more than 2 billion shares daily, matching a brisk 1968 day of trading volume roughly every three minutes.
In the near term, Broadridge will make more investments in new start-ups and in proprietary initiatives and, hopefully we and others will create next-generation solutions using transformative technology to improve efficiency, benefitting us all.