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Blockchain could create efficiencies for markets

Craig S. Donohue
September 22, 2016
By Craig S. Donohue, Executive Chairman

In nearly every interview I do I am asked for my thoughts on the future of technology, particularly blockchain.

At OCC, in our role as the foundation for secure markets, we constantly are looking at related activity in the post-trade world, and we are paying close attention to what other people are doing in the world of fintech.

We also are doing our own work internally to adopt 'use cases' where we can try to see into discrete parts of our business where distributed ledger principles could be beneficial to how we and our clearing member firms interface as one of the leading systemically important clearing houses operating in today's dynamic financial markets. Any kind of large-scale chain appears to be some number of years away, but it holds a certain amount of potential value, and efficiencies will certainly be created.

Anything that has the potential to create efficiencies for market participants must be examined. We see two main forms of value creation: 1) creating new ecosystems where cost previously has been prohibitive; and 2) creating new efficiencies in current ecosystems.

There is the value of immediacy. Through blockchain you can have an instantaneous confirmation and finality to a financial transaction as well as the funding and settlement of such a transaction. In futures and options markets we have daily or even twice daily settlements of financial derivative transactions. In cash equities markets however, we still have T+3, which means that securities transactions are settled three business days following execution of orders. In non-cleared markets, settlement may take even longer. Blockchain principles, if successfully applied, could create instantaneous settlement and funding of obligations with immutable records.

Today, financial markets are becoming increasingly complex, and they are wired together through many different systems. Blockchain has the potential to obviate that complexity and create an almost perfect and irrefutable record of every transaction that has occurred. And apart from efficiency gains, blockchain also has the potential to enhance regulators' understanding of complex market dynamics.

A good example would be the Flash Crash in 2010, where the futures markets had an almost instantaneous and perfectly demonstrable audit trail. However, the same could not be said for the cash equities market. Afterwards, the U.S. Securities and Exchange Commission (SEC) has invested significant resources to try and build an audit trail that would enable them to better understand what happens when such market disruptions occur. That is very expensive and very difficult to do, given our current financial infrastructure ecosystem. Over time, blockchain offers the potential to solve such problems for regulators.

One of the challenges facing this technology will be in striking a balance between innovation, security, and the current regulatory framework. Our regulatory system has been built around the existing business system and how it operates. So as blockchain or distributed ledger applications are implemented, our system of regulation will have to adapt. I am encouraged that we have forward-looking regulators at both the SEC and the U.S. Commodity Futures Trading Commission (CFTC) that already recognize the need to facilitate innovation in blockchain applications in our industry. If blockchain technology can ultimately change the way markets work, we will need a strong partnership between regulators and private sector stakeholders.

It is hard to predict how disruptive blockchain will be, but I believe it will become much more significant in financial markets and ultimately in the clearing and settlement arena. It is clear that those firms that have a relentless focus on operational efficiency will be best positioned to win with this technology. For OCC, our job is to be innovative and embrace change, so we will be looking for ways to be part of the blockchain movement, as we want to be a leader in that change.

To learn more about OCC's thought leadership on industry issues, visit OCC's Blog.

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