Esma expresses case for and against distributed ledgers in post-trade markets

Esma expresses case for and against distributed ledgers in post-trade markets

The potential benefits of the application of distributed ledger technologies in the securities markets sit squarely in the post-trade environment, according to initial research findings from Esma (European Securities and Markets Authority) following a year-long review of the technology.

Speaking earlier this week at a conference organised by the Bank of England and London Business School, Esma executive director Verena Ross said: We have found that clearing and settlement, collateral management, record of ownership and securities servicing are the areas where the technology is most likely to bring useful changes. It does so through the provision of a unique reference database, instantaneous reconciliation across all participants, immutable shared records and transparent real-time data."

Esma first issued a 'call for evidence' on potential uses of distributed ledger technology in April 2015. While the responses showed a clear consenus that the technology has many possible applications across the lifecycle of the investment chain, Esma also see a number of limitations.

"In particular, we question the ability of the DLT to handle large volumes, to manage privacy issues and to ensure a high level of security," says Ross. "Furthermore, as we anticipate that the DLT is deployed gradually, it will need to demonstrate its ability to interact with certain systems that must continue to co-exist with the DLT, e.g. trade platforms. Similarly, if different ledgers were to be used for different types of instruments, the interoperability of the different networks could be a challenge."

Other worries around the possible emergence of a monopolistic environment and the use of complex encryption techniques that could hinder transparency and regulatory oversight have also surfaced.

Nonetheless, the technology may serve to reduce counterparty, operational and legal risks and decrease the risk of cybercrimes owing to the reduced dependency on a single centralised ledger, says Ross.

"When considering the current EU regulatory framework, it is clear that the activities/segments of the financial markets that are less regulated would allow for an easier implementation of the DLT," Ross concludes. "By contrast, when the legislation imposes the use of authorised central infrastructures like CCPs or CSDs, the deployment of the DLT is likely to be less straightforward.

"ESMA will continue its work on the DLT in an effort to determine whether a regulatory response to the deployment of this technology to financial markets is necessary."

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