The European Union stress test of clearing houses for derivatives will be published on April 29 according to Reuters. Our clearing houses serve the role of being a buyer to every seller and a seller to every buyer. This way if either the buyer or seller fail to meet their commitment then there is a financial guarantee that the transaction will be completed.

The customers of the clearing house are the broker dealers. Broker dealers guarantee the accounts that they clear. They ensure that the corporations, and individuals who have accounts meet their financial obligations. If one of their accounts fails to meet margin, or its financial commitments then the broker dealer is then responsible. This is why Broker Dealers have capital requirements above and beyond the individual account requirements.  (See Basel III for more information.)

In the event that an account fails, then the Broker Dealer is responsible for the transactions.

In the event that a Broker Dealer fails, then the clearing house steps in and covers the transactions.

This system of guarantees has grown out of market regulations. It has served our investment community well through the failure of broker dealers like MF Global and Peregrine Financial Group.

Furthermore, our system of regulation is setup to protect the end investor. For example: “The mission of the Commodity Futures Trading Commission (CFTC) is to foster open, transparent, competitive, and financially sound markets, to avoid systemic risk, and to protect the market users and their funds, consumers, and the public from fraud, manipulation, and abusive practices…”

So what is big deal with Block Chain?  As many of you know Block Chain grew out of the BitCoin technology. BitCoin was essentially a peer to peer trading environment. If a single account failed to meet its obligations it was unclear who was guaranteeing the transaction. The market was unregulated and there was no clearing house.

Finextra reported that the US Federal reserve board believes  “that the Fed's engagement with the industry over the application of blockchain technology would be guided by the same principles of efficiency, safety and integrity, and financial stability applied in earlier eras of technological upheaval.”

There will be challenges related to distributed ledgers. Data security and information flows between distributed ledgers are just a couple of issues that will need to be worked through. Highly skilled, innovative technologists will solve these problems.

Yet the biggest challenge to Block Chain may be the regulations and not the technology. How will the markets that adopt Block Chain meet their regulatory obligations? Should  clearing houses be involved?  What is the role of the broker dealer? Who is supervising the trading environment? Which regulators, and which self-regulatory organizations have jurisdiction?

In the issue of the regulations it will be FINTECH experts and financial industry innovators who provide the solutions.