“Blockchain, I believe, will be the way in which securities transactions clear and settle universally throughout the developed securities markets. The big question is on what-time frame is that going to happen? My personal belief is that these changes are coming a lot faster than many observers in the industry are predicting at this point.”
That from Canadian Securities Exchange CEO Richard Carleton, speaking on the creation of a planned new clearing house that will clear and settle securities trades. This new clearing house would allow companies to issue conventional equity and debt using a digital token that represents a share in a business - a tokenized security.
Image via Canadian Securities Exchange.
Since Stockhouse’s initial report on the project, our editorial team had the chance to interview him about the finer points of how this blockchain clearing house will work and what it will mean for capital markets in Canada and abroad. The major benefit the CSE proposes is that this new blockchain clearing house will save time and money. Carleton explained that when a security trades on an exchange in Canada and elsewhere in the developed world, that transaction would take the rest of the day, plus two more to clear and settle, or T+2 as it is called. The money would be deducted, and an account would be credited with securities for a purchase, or the opposite for a seller.
“It seems for a lot of people that are used to using their debit card to buy a coffee in the morning, you tap it on the terminal at your favorite coffee vendor, you get a coffee immediately and your account is deducted immediately, it seems sort of crazy that the industry that prides itself on its technological sophistication and ability to adapt to new technologies is still wrapped up in this T+2 paradigm,” Carleton added. “It is one of the areas that has been very difficult for people to innovate because in many respects the clearing and settlement systems are utilities they are deeply ingrained into the workflow and business process of the dealers and various others involved in the securities industry. It’s not the first place that people would look to applying disrupted technologies like blockchain.”
While blockchain can cut the clearing and settling time from days to near immediacy, how can this save money? When it comes to securities exchanges, time literally is money. During the “two-plus days of purgatory,” as Carleton calls it that the transaction sits idle, a dealer must post capital to guarantee the buyer that they will deliver either the securities or cash required to settle the trade.
“When you add it up across the industry, that is a lot of capital that has to be posted against open positions at the clearing house,” Carleton continued. “That capital could be redeployed to other, more productive investments. It is a significant cost centre for the dealers. There is also the idea that the incumbent clearing houses around the world, they actually act as a counter-party. If your broker is RBC and you trade with somebody who’s broker is BMO, for example, you would think that it is RBC and BMO trading, but in point of fact, each side is trading with the clearing house, so that the clearing house is guaranteeing that the other side of the trade will meet its commitments either to deliver stock or provide cash against the securities that you’re delivering. That means that the clearing house itself has to be very heavily capitalized to account for potential problems.”
Those problems can range from operational issues to financial failure that the clearing house must be accountable for. “What we’re talking about is a system that will enable dealers to trade with each other and not the clearing house.” Another area that a clearing house gets involved in is managing corporate actions, such as payments of a dividend. “Presently, that is quite an intensive activity and fairly expensive. Blockchain capability makes it much, much easier, faster and more accurate, the act of a company paying a dividend to its shareholders,” Carleton said.
Beyond using blockchain to alleviate expenses, Carleton emphasized that the CSE wants to provide companies with the ability to use “smart contracts” to issue securitized tokens. “We think that people will have an opportunity to be quite creative in terms of the conditions that can be included,” he said. It won’t necessarily be restricted to common equity type instruments, but we think that convertible instruments, debt instruments of different kinds, royalty streaming securities, warrants, rights, they’re all excellent candidates for tokenization in a security.”
If approved, this could make Canada the first exchange in the world to apply to use tokens for share settlement, though Australia’s Stock Exchange is in the process of converting to a blockchain system for clearing and settlement. This would also challenge the TMX Group Inc., Canada’s largest exchange operator that operates the Toronto Stock Exchange (TSX) and TSX Venture exchanges. TMX has even announced its intent to experiment with a blockchain prototype.
Assisting the CSE with the technical legwork is Vancouver-based blockchain company Kabuni Technologies Inc. who will issue tokens through an STO, trading on the CSE’s equity platform. Kabuni has signed a Memorandum of Understanding (MOU) with the CSE and Carleton said the Company effectively volunteered to clear a securitized token with the BC Securities Commission (BCSC) and intends to seek a listing on the Canadian Securities Exchange for that token, once the project is complete.
Image via Kabuni Technologies Inc.
As for a timeline on when this project comes online, the CSE still has a considerable amount of work ahead of itself before the Ontario Securities Commission (OSC) approves it, along with other provincial regulators.
“It’s not a case of us snapping our fingers and bringing this system into production any time in the next few weeks,” Carleton stated. “We certainly are going to be pushing the recognition process and we certainly want to bring these benefits to the community sooner rathe than later. It will be a lengthy process, I’m hoping we can make this in 2018 achievement, but it’s up to us and obviously the securities commissions to determine that.”