Explore whether DLT is evolving capital markets or disrupting them entirely. Faster settlements, reduced costs, and a redefined market future await.
Capital market participants have been relying on legacy infrastructure established decades earlier. Although operational, this infrastructure is fragmented, expensive, and subject to settlement delays of several days.
Further processes, such as reconciliation and compliance, further complicate this and cannot keep up with the modern, high-paced global marketplace. It is against this backdrop that distributed ledger technology (DLT) has become one such likely game-changer. DLT also defies established systems through transparency, automation, and decentralization.
The most important question, however, is: does DLT mark a fundamental transformation that can transform the basis of the post-trade processing of capital markets, or is it rather a change of improvement?
Table of Contents
1. Understanding DLT in Capital Markets
2. DLT vs. Legacy Infrastructure
2.1. Traditional Systems
2.2. Challenges
2.3. How DLT Addresses This
2.4. Case Example
3. DLT as a Disruptor in Post-Trade Processing
3.1. Settlement Cycles
3.2. Reduced Risk
3.3. Automation Through Smart Contracts
3.4. Changing Role of Intermediaries
4. Benefits of DLT for Capital Market Settlement
4.1. Efficiency
4.2. Transparency
4.3. Security
4.4. Liquidity Optimization
4.5. Cross-border Potential
5. Evolution vs. Disruption Debate
5.1. Evolution View
5.2. Disruption View
5.3. Middle Ground
5.4. Regulators’ Role
Conclusion
1. Understanding DLT in Capital Markets
Simply put, Distributed Ledger Technology (DLT) is a type of database shared by participants, used to eliminate a central authority. Unlike conventional centralized databases, DLT allows immutability, transparency, and near-real-time coordination among the parties.
Such capabilities are of particular significance in capital markets, where transactions are extensive and complicated. Smart contracts introduce next-level automation, which optimizes clearing and settlement. Already, use cases are being realized in situations like securities issuances, clearing, settlements, and collateral management.
DLT is not just a theory anymore; it is already being piloted and tested on a massive scale as the core behind next-generation financial infrastructure.
2. DLT vs. Legacy Infrastructure
2.1. Traditional Systems
The system of capital markets is dependent on the multi-party intermediaries like custodians, clearing houses, and registrars. These institutions exist to create order and build trust, but with an overlapping of roles, each transaction ends up duplicating these efforts and passing on these expenses.
2.2. Challenges
There are delays in reconciliations and the prohibitive cost of compliance in traditional infrastructure. Insertion of operational inefficiencies, as it suffers multiple ledger cross-checking, results in errors and mismatches, and cross-border settlement risks due to a lack of standardization in systems.
2.3. How DLT Addresses This
LT provides a single source of truth that is available to everyone. Close real-time updates decrease reconciliation requirements, except that they keep costs down and in a position of correctness. This ledger reduces duplication and helps facilitate quicker settlement cycles.
2.4. Case Example
Some of the CSDs and exchanges are currently piloting their earlier systems of settlement based on DLT. The efforts of Nasdaq and the European Central Bank to test distributed ledgers show that financial systems can be improved by adding blockchain-based technologies.
3. DLT as a Disruptor in Post-Trade Processing
3.1. Settlement Cycles
Regular systems rely on two days (T+2) of settlement so that the trading is finalized after two days. LT can provide near-instantaneous e-settlement, which decreases cases of delayed payments that strain capital and create systemic risk.
3.2. Reduced Risk
Faster settlement has directly reduced counterparty and credit risk exposure. Since the transactions are validated and done in near real time, buffers on credit line and collateral risks are reduced to a minimum, resulting in leaner and efficient financial operations.
3.3. Automation Through Smart Contracts
DLT contains smart contracts that automate processes such as collateral management, margin calls, and clearing. This eliminates the human element, reduces the expenses associated with conducting these tasks, and enhances the accuracy of execution on post-trade operations, reducing operational risk.
3.4. Changing Role of Intermediaries
The role of intermediaries may decline in case the pace of DLT adoption increases. Custodians and clearinghouses will likely be transformed into supervisory/compliance functions, and no longer operations.
4. Benefits of DLT for Capital Market Settlement
4.1. Efficiency
DLT eliminates redundancies and ignorance of reconciliations to increase the efficiency of operations, shorten settlement times, and minimize costs. The liquidity and the smooth operation of capital markets are translated into efficiency gains.
4.2. Transparency
In a shared ledger, regulators and participants get real-time visibility of transactions. This transparency leads to trust, improved surveillance, and ensures that there is a limited possibility of risk or fraud.
4.3. Security
DLT is based on cryptographic principles, and it guarantees the integrity of the data and decreases the probability of data manipulation. System resiliency is also offered by the distributed characteristics of ledgers to system failures and cyberattacks.
4.4. Liquidity Optimization
Faster resolutions allow assets to see the light of day faster, which allows the parties to redeploy resources better. This increases liquidity management, which is vital both in normal trading and during any stressed situation.
4.5. Cross-border Potential
The greatest potential impact is on cross-border settlement. LT is also able to synchronize separate systems, providing an ecosystem that is unified and interoperable. This minimizes the friction, cost, as well as time that may be involved in international trades, but it is opening up the markets to emerging markets.
5. Evolution vs. Disruption Debate
5.1. Evolution View
The majority of industry leaders are sure that DLT will seamlessly enter the current infrastructure. Not all incumbents will be toppled by DLT, such as clearinghouses; instead, they will make use of it to increase efficiency without losing the ability to trust and manage.
5.2. Disruption View
Others say DLT has the potential to fundamentally redefine important functions such as clearing and settlement. By cutting out intermediaries, the market would be in a position to be leaner and faster in processing, though at the expense of traditional power structures.
5.3. Middle Ground
Hybrid models, where incumbents become DLT adopters to modernize without stepping out of the role of gatekeepers, are also taking shape. The models integrate the systems of resilience embraced by oversight systems with the efficiency of decentralized systems.
5.4. Regulators’ Role
Regulatory acceptance is the key to the success of DLT. Regulators should not allow systemic stability, compliance, and risk-control to be sacrificed. The interest in DLT integration by taking regulatory sandboxes around the world reflects the careful yet expanding interest in testing the use of this technology.
Conclusion
DLT presents capital markets with great evolutionary advances and disruptive possibilities. It will rely on regulation, interoperability, and participants’ trust to a significant degree.
The most probable evolution will include a phased revolution where DLT slowly transforms the clearing and settlement industry and the existing players reflect on their roles. What the future holds, whether it is going to evolve or disrupt, is the fact that DLT is no longer on the fringe.
It is a growing pillar of the architecture of the global capital markets.
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