Every week now brings another announcement from the banking industry of a new distributed-ledger initiative seeking to transform the core operations of the global financial system.
At Sibos in Toronto last week, for example, IBM unveiled a new blockchain banking solution designed to reduce settlement times and costs for banks in processing cross-border payments.
The technology firm is partnering with Silicon Valley based Stellar.org and KlickEx, a New Zealand-based foreign exchange processing platform focused on often illiquid south Pacific cross-border payment corridors.
IBM has convened an initial group of banks including Banco Bilbao Vizcaya Argentaria, Bank Danamon Indonesia, Bank Mandiri, Bank Negara Indonesia, Bank Permata, Bank Rakyat Indonesia, Kasikornbank Thailand, Mizuho Financial Group, National Australia Bank, Rizal Commercial Banking Corp. (RCBC) Philippines, Sumitomo Mitsui Financial Group, TD Bank, Wizdraw (HK) of WorldCom Finance, as well as other financial institutions.
The vision is that in the future, the new network could make it possible for a farmer in Samoa to enter into a trade contract with a buyer in Indonesia. The blockchain would be used to record the terms of the contract, manage trade documentation, allow the farmer to put up collateral, obtain letters of credit and finalize transaction terms with immediate payment.
It is not all big hopes for the future. The network is currently in use by members of Advanced Pacific Financial Infrastructure for Inclusion (APFII), a public-private partnership initially funded by the United Nations and Swift.
The new solution is already processing live transactions in 12 currency corridors across the Pacific Islands and Australia, New Zealand and the United Kingdom.
“This is the first time anyone has made blockchain work at an institutionally viable scale,” claims Robert Bell, chairman of APFII and founder of KlickEx Group. “Through KlickEx, the Pacific has had relatively low-cost, real-time, multi-currency payments for most of the past decade, and this project was a natural next step following our work to create seamless and borderless payments across the Pacific. We look forward to the results with using IBM Blockchain as we continue to push forward with our mission to remove payment friction across borders.”
Not the blockchain
Slightly less fanfare attached to another announcement, just two days later, of a new venture between an established financial market structure platform and a new provider of technology for faster payments also focused on foreign exchange. Perhaps it attracted less notice because, unusually these days, it is not built on blockchain. But it may yet prove to be the more important of the two.
NEX Group, formerly called Icap, the publicly quoted electronic markets and post-trade business headed by chief executive Michael Spencer, has announced that Baton Systems, a new high-speed payments infrastructure provider, will be the first third-party provider to offer its services through the NEX Optimisation market structure platform.
NEX Optimisation and Baton have been working in partnership with one of the largest – as yet unnamed – global banks to deliver a new post-trade solution for FX spot transactions delivered through the NEX Infinity platform. The solution will go live in the first quarter of next year.
Euromoney catches up with Arjun Jayaram, founder and chief executive of Baton Systems, a venture capital-backed company, founded as Ubixi in 2016 and based in Fremont California, to try and get a better sense of what Baton does.
|Arjun Jayaram, Baton Systems|
“I’ve been a technologist all my career,” Jayaram tells Euromoney, “and my strength lies in spending a lot of time to fully understand a problem before attempting any solution. At Twitter, I learned how to build highly scalable, real time systems and at Dwolla I learned a lot about payments.”
What were his key findings?
“In over-the-counter bilateral markets, there are huge capital and operational inefficiencies in clearing and settlement, as well as high costs in moving assets,” he says. “Most innovation in capital markets has come in the front office, which now operates in close to real time. But at many banks and in many markets the back-office tasks of reconciliation and settlement still operate by end-of- day and next-day batch processing. That means that the more trades a bank puts on, the more risk it stacks up. And that hurts right now, especially with interest rates rising and the cost of pre-funding settlement going up. “
That was the problem the founders of Baton Systems set out to solve.
“Does the blockchain actually solve that problem, when it comes to payments?” asks Jayaram. “I would say it does not. I would add that when we started Baton Systems almost two years ago in January 2016, it already appeared obvious that most of the new blockchain companies will go bust.”
Jayaram sketches on a piece of paper the original problem.
Two banks seeking to exchange payments each operate their own siloed ledgers, as does the clearing counterparty between them – the Federal Reserve for dollar payments, the Bank of England for sterling.
“Blockchain tries to solve for the fact the three ledgers don’t talk to each other by creating a fourth, shared ledger. But money is not moving on that; rather exchange of digital tokens representing currency is being recorded and all parties have to trust that these tokens – like IOUs – will be equivalent to and exchangeable for the represented currency.”
Baton does something different.
“We offer software as a service that integrates into those separate bank ledgers and translates between them,” says Jayaram. “We don’t change the ledgers. We don’t tokenize money or assets.”
The technology allows tamper-resistant post-trade business workflows to be built and executed on the Baton platform that will result in payments being made from settlement banks and custody banks between participants.
Baton synchronizes simultaneous clearing with settlement finality between heterogeneous ledgers. When assets move there is real-time visibility and guarantee of good funds. This greatly reduces risk for participants.
It sounds rather like what Ripple does on its distributed ledger payments system. The notion behind Baton Systems’ offering is clearly inspired by blockchain. It even offers bank users a back-up ledger of record. But it does not depend on blockchain.
“We have been talking to many banks and central banks. Some are calling us the non-blockchain blockchain,” says Jayaram, who explains that establishing the translation software across a large bank might take three months. “Every bank’s ledgers talk a slightly different dialect, so we can be thought of as a universal ledger language translator by translating terms into precisely the same fields.”
If it takes off – and Jayaram says Baton Systems is close to announcing agreements with the FX divisions of two of the world’s largest banks and one broker dealer division – it will almost be a case of payments jumping to a post-blockchain world.
Baton Systems has been gearing up for a big push, explaining itself to (and, according to Jayaram, getting a good hearing from) large central banks. In September, it appointed Lewis B. Kaden, a former vice-chairman of Citibank, to its advisory board.
This followed a busy six months in which the technology went live and was adopted by two of the world’s five largest foreign-exchange trading banks, a top futures commission merchant, as well as a large global clearing house.
“We estimate that together the world’s largest banks might at any moment have over $100 billion tied up in on-balance sheet pre-funding payments at a cost of 200 basis points,” says Jayaram. “That could simply be unlocked by taking settlement down from 24 to 48 hours to minutes. These are big potential savings at a time when banks are under pressure to cut costs. And they can achieve these savings in a matter of months with their existing infrastructure.”
The potential speed at which this transformation might come about is crucial. In September, Bank of America Merrill Lynch banking analysts presented their latest findings on how technology is transforming investment banking. Investors are not exactly rushing to incorporate any savings from widespread adaptation of blockchain into their forecasts for bank earnings.
Rather, after the hype around proof of concepts last year, analysts Andrew Stimpson, Michael Helsby and Alastrair Ryan report: “Investors in the capital markets space have become a bit jaded about the technology”.
In fact, a closer look at the survey results shows that while 40% of investors in bank equity surveyed by BAML expect that timeframe, close to 25% think it will take more than five years and 35% think it will be 10 years or longer.
The BAML analysts agree that cost savings might be substantial from greater automation of back-office functions including post-trade reconciliation and settlement, but point to the US Depositary Trust and Clearing Corporation whitepaper last year, concluding: “Shifting towards real-time settlement does not require blockchain technology.”
If a patch translation solution can achieve greater efficiency, reduced settlement risk and speedier, cheaper payments using existing systems, might banks that have loudly trumpeted modest investments in blockchain prototypes, yet shrink from full-scale adoption?