Financial technology firm Cobalt DL has commenced beta testing with a number of unspecified FX participants on a private peer-to-peer network that it claims will significantly cut post-trade cost and risk.
Cobalt DL uses distributed ledger – or blockchain – technology, eliminating multiple trade records for buyer, seller, broker, clearer and third parties from each transaction. By presenting a shared view of a trade, Cobalt DL frees up back- and middle-office resources that are currently overwhelmed by the need for continuous reconciliation across multiple systems.
Andy Coyne, Cobalt
The firm has spent a year designing and testing the technology already, and has completed a proof-of-concept with a large FX market making bank. Beta testing is now set to continue for the rest of the year and into next, with the platform slated for launch some time in 2017.
Cobalt says eight leading institutional FX participants have already committed to the service.
The technology is designed to integrate seamlessly with all trading sources and venues, providing immediate efficiency benefits. However, while the ledger will be interoperable with existing trading infrastructure, it is also designed to be a full-service offering.
Greater savings will be achievable over time as institutions migrate away from legacy infrastructure and onto the platform, says Andy Coyne, co-founder of Cobalt DL.
“Banks have a lot of bespoke technology in their back offices, risk and payments infrastructure, risk analytics and other functions, all of which link together in different ways,” says Coyne.
“It is highly complex and the savings they can achieve from a shared ledger depend on how they currently operate and what functions they migrate onto the system. The quicker they unplug their legacy infrastructure, the greater the savings.”
It will also become more efficient as more institutions use the ledger, he adds.
One consultant who has analysed the blockchainization of the FX post-trade process says the potential savings of this kind of solution are huge.
Consider that it costs banks 10 US cents per message transmitted through the Thomson Reuters post-trade messaging platform for flow FX confirmations. Most banks send thousands – if not tens of thousands – of these messages every day. And the Thomson Reuters settlements confirmation platform is just one of several post-trade platforms used by the FX market for processing confirmations and settlements for flow FX trades.
Taken together, this means “the cost for the flow FX segment of the market can run into an estimated millions or tens of millions for the whole of the marketplace on an annual basis”, says the consultant.
Other parts of the market, such as the FX derivatives space, are even more complex, he notes, meaning significant additional costs associated with their confirmation and post-trade settlement.
The blockchain journey is likely to be long and the outcome is uncertain, but a consensus is forming that it is the real deal. Disregarding it is a risk
- Oliver Wyman and JPMorgan report
Banks have been under considerable pressure to focus on the bottom line since the financial crisis, as regulatory compliance costs have escalated. The fact each FX trading institution manages its own back- and middle-office infrastructure means a lot of their post-execution, pre-settlement work is duplicated. In theory, a shared ledger used by multiple institutions can cut costs for all.
The advantages could extend even further.
“As well as delivering cost savings, a more collaborative approach increases mutually beneficial regulatory compliance and transparency,” says Cobalt's Coyne.
Blockchain has inspired a group of enthusiasts within the industry, keen to find practical uses for the technology. The hype around the technology, and any advances made in encouraging a more collaborative approach among banks, will invite pressure to expand the scope of the system to new areas.
The consultant can even envisage the function of CLS — the FX industry’s largest cash settlement service, becoming blockchainized — but this would be a step into the dark. It would only work if the majority of CLS's users were willing to collectivize their settlement risk inside a new non-physical, unregulated organization, in which they share equal responsibility for the upkeep and management of the ledger.
“I do not expect that CLS's place in the orderly functioning of the spot FX marketplace will be usurped any time soon,” he says.
It is even harder to see a distributed ledger taking on this role in the FX derivatives market, says the consultant. The technology could conceivably “combine the confirmations and settlement functionality of Traiana [a trade processing and risk-management firm] and the risk warehousing capability of a clearing house,” he says.
“But there ultimately must still be some entity at the end of it capable of making good on failed trades and offsetting risk across layers of complexity that cannot simply be collectivized across the simple majority of market participants.”
Cobalt is not thinking any further than using the beta testing to prove the technology works for its intended purpose, but admits banks with similar challenges in other asset classes could find solutions using a such an approach.
However, the blockchain's potential extends far beyond FX trade settlement. In recent weeks, R3, a company formed by a consortium of banks looking to develop commercial applications for distributed and shared ledger technology in the finance industry, announced prototypes for using the technology to address challenges in the $45 billion global trade finance industry.
R3 says its prototypes, on its Corda distributed ledger platform, could reduce operational and compliance costs of paper-based trade financing by 10% to 15%.
Oliver Wyman and JPMorgan recently published a report titled Unlocking Economic Advantage with Blockchain, aimed at asset managers, which drew conclusions that are applicable well beyond the buy side – and the FX industry.
“There is a growing realization that distributed ledger technology – popularly known as blockchain – will bring a radical shift in the way we think about financial assets and the way the financial industry will operate in the future,” the report states.
“The blockchain journey is likely to be long and the outcome is uncertain, but a consensus is forming that it is the real deal. Disregarding it is a risk.”
Coyne says: “For many firms, blockchain is a solution looking for a problem, but we came at this from the other side, looking at the problems and working out what the best solution was to solve it.
"There are many people, and a lot of ledger companies, with a lot of fixed ideas about blockchain and how it works. We wanted to unpick a lot of those elements that people can get hung up on, and in reality it is much simpler than it is sometimes made out to be.”