“HARMONISING THE EUROPEAN SECURITIES

LANDSCAPE, ฿IT BY ฿IT”

TO WHAT EXTENT CAN BLOCKCHAIN / DISTRIBUTED LEDGER TECHNOLOGY CONTRIBUTE TO

FURTHER HARMONISATION OF THE EUROPEAN SECURITIES LANDSCAPE ON POST-TRADE

LEVEL?

TIAS SCHOOL FOR BUSINESS AND SOCIETY

MSCBA 2015-2016

FINANCIAL MANAGEMENT

OCTOBER 2016

Supervisor:

Mr. M. Bier, MBA

Director of Analytics

ProService Hawaii

Candidate:

Mr. B.L. Pijnenburg

u644392

CONTENTS

ABBREVIATIONS ................................................................................................................................ I

PREFACE ........................................................................................................................................ II

ABSTRACT ...................................................................................................................................... III

1 RESEARCH PROBLEM ................................................................................................................. 1

1.1 INTRODUCTION ................................................................................................................. 1

1.2 THESIS GOALS .................................................................................................................. 3

1.3 OUTLINE ......................................................................................................................... 3

2 EUROPEAN SECURITIES LANDSCAPE .............................................................................................. 4

2.1 TRADING ......................................................................................................................... 4

2.2 CLEARING ........................................................................................................................ 4

2.3 SETTLEMENT .................................................................................................................... 5

2.4 CUSTODY ......................................................................................................................... 5

2.5 EUROPEAN SECURITIES INFRASTRUCTURE ............................................................................... 6

3 HARMONISATION AND STANDARDISATION ..................................................................................... 9

3.1 SWIFT ........................................................................................................................... 9

3.1.1 MESSAGE STANDARDS .............................................................................................. 10

3.2 FROM LOCAL CUSTODY TO CSDS AND DEMATERIALISATION ..................................................... 11

3.3 MIFID .......................................................................................................................... 12

3.4 TARGET2-SECURITIES ..................................................................................................... 12

3.5 CENTRAL SECURITIES DEPOSITORIES REGULATION .................................................................. 13

4 BLOCKCHAIN & DLT................................................................................................................ 14

4.1 BITCOIN ........................................................................................................................ 14

4.2 UNPERMISSIONED PUBLIC LEDGERS ..................................................................................... 15

4.3 PERMISSIONED SHARED LEDGERS ........................................................................................ 18

4.4 SECURITY ....................................................................................................................... 19

5 LITERATURE REVIEW ............................................................................................................... 20

5.1 HARMONISATION OF THE POST-TRADE SECURITIES LANDSCAPE ................................................. 20

5.2 BLOCKCHAIN/DLT ........................................................................................................... 22

6 RESEARCH METHODOLOGY ....................................................................................................... 27

6.1 DATA COLLECTION ........................................................................................................... 27

6.2 THE INTERVIEWEES SELECTION ........................................................................................... 28

6.3 THE INTERVIEWEES’ ORGANISATIONS ................................................................................... 29

6.4 DATA ANALYSIS .............................................................................................................. 33

7 INTERVIEW FINDINGS .............................................................................................................. 34

7.1 HARMONISATION ............................................................................................................ 34

7.1.1 BENEFITS ............................................................................................................... 34

7.1.2 PROBLEMS AND CHALLENGES ..................................................................................... 34

7.1.3 PERSONAL VIEWS ..................................................................................................... 35

7.2 BLOCKCHAIN/DLT ........................................................................................................... 35

7.2.1 EFFECT .................................................................................................................. 35

7.2.2 NECCESITIES ........................................................................................................... 37

7.3 ALTERNATIVES ................................................................................................................ 38

7.4 OTHER FINDINGS ............................................................................................................. 39

8 DISCUSSION .......................................................................................................................... 41

8.1 HARMONISATION ............................................................................................................ 41

8.2 BLOCKCHAIN/DLT ........................................................................................................... 41

9 CONCLUSIONS AND LIMITATIONS ............................................................................................... 44

9.1 CONCLUSION .................................................................................................................. 44

9.2 LIMITATIONS .................................................................................................................. 46

APPENDICES ................................................................................................................................. 47

APPENDIX I: ON EXCHANGE SECURITIES TRADE ................................................................................ 47

APPENDIX II: THE NETTING PROCESS (BANK OF ENGLAND, 2013)........................................................ 48

APPENDIX III: DISTRIBUTED LEDGER TAXONOMY (GOV.UK, 2016) ..................................................... 49

APPENDIX IV: CONSENSUS MECHANISM DEVELOPMENTS OVER THE YEARS (KPMG, 2016) ....................... 50

APPENDIX V: THREE SCENARIOS HOW DLT MAY AFFECT THE POST-TRADE SECURITIES LANDSCAPE (PINNA &

RUTTENBERG, 2016) .................................................................................................................. 51

SCENARIO 1 .......................................................................................................................... 51

SCENARIO 2 .......................................................................................................................... 52

SCENARIO 3 .......................................................................................................................... 53

APPENDIX VI ............................................................................................................................. 54

BIBLIOGRAPHY .............................................................................................................................. 55

i

ABBREVIATIONS

AFME Association for Financial Markets in Europe

BoE Bank of England

BIS Bank of International Settlements

CCP Central Counterparty

CSD Central Securities Depository

DLT Distributed Ledger Technology

DNB Dutch National Bank / De Nederlandsche Bank

DTCC The Depository Trust & Clearing Corporation

DVP Delivery versus Payment

ECB European Central Bank

EU European Union

ICMA International Capital Market Association

ISIN International Securities Identification Number

ISO International Organisation for Standardisation

MiFID Markets in Financial Instruments Directive

MTF Multilateral Trading Facility

OTC Over The Counter

PoS Proof-of-Stake

PoW Proof-of-Work

RIE Recognised Investment Exchange

T2S TARGET2 Securities

ii

PREFACE

This thesis is original, unpublished, independent work by Barry Pijnenburg, conducted in the

fulfilment of a Master’s degree in Business Administration at TIAS School for Business and Society.

The subject for this thesis was selected, based upon working experience in a post-trade affiliated

department within a financial institution, and personal interest in disruptive financial technology

such as blockchain and other distributed ledger technologies.

The target group for this thesis can be either people working in the post-trade affiliated industry,

interested in disruptive financial technology, people working in fintech interested in the current

securities industry and historical developments or any other person interested in any of the two

subjects. The writing style is supposed to be accessible for a broad group of people, and I would be

very grateful and honoured when this thesis would be broadly distributed amongst many people.

Feel free to share this document to anyone!

For this thesis, I would like to thank Michael Bier for supervising me during the process of writing this

thesis. Many thanks for reserving personal time for advice and guidance. Additionally, I would like to

thank Ben van der Velpen, for providing access to his wide network of post-trade industry players

and for providing additional input and discussion on all subjects covered in this thesis. Finally, I would

like to thank all interviewees and their employers for reserving valuable time for participation in this

research. Thanks to all of you this thesis has been made possible.

I can say that I am more than happy with the result and hope you enjoy reading it!

Barry Pijnenburg, Leiden, October 5th 2016

barrypijnenburg@gmail.com

iii

ABSTRACT

Back in 1996 a group of European financial markets experts was formed, to advise the European

Commission. The Giovannini Group, named after its chairman Alberto Giovannini, identified 15 post-

trade barriers, which maintained inefficiency in cross-border clearing and settlement. Since the

foundation of the Giovannini Group, many harmonisation initiatives have been launched on

European Union (EU) level. However, despite all initiatives, 20 years after the Giovannini Group was

formed, many of the barriers still exist.

In 2008, Satoshi Nakamoto1 released the paper: Bitcoin: A Peer-to-Peer Electronic Cash System, in

which he proposes an alternative electronic payment system, called Bitcoin, based on cryptographic

proof rather than trust, obsoleting the need for a trusted third party and making transactions

computationally, practically irreversible. Since the introduction of the blockchain powered platform

Bitcoin in 2009, many developments have taken, are taking and will be taking place within the area of

the financial services industry.

Recently, in a white paper published by Euroclear2, in cooperation with consulting firm Oliver

Wyman, it is calculated that IT and operations expenditures in capital markets are close to $ 100-150

billion annually among banks. Moreover, post-trade and securities servicing fees are close to $ 100

billion per year. Furthermore, due to delays and inefficiencies in the market infrastructure, significant

capital and liquidity costs are incurred.

In this thesis, the role that blockchain/distributed ledger technology can play in contributing to

further harmonisation of the European securities landscape on post-trade level is examined. This has

been accomplished by:

- Providing a theoretical background on the European securities landscape, harmonisation and

standardisation initiatives and blockchain/distributed ledger technology

- Critically assessing literature on harmonisation on post-trade level and

blockchain/distributed ledger technology

- Interviewing key industry players in London and Amsterdam

- Discussing the interview findings with the literature review findings

1 Pseudonym used by the person or people who designed Bitcoin

2 One of the largest European Central Securities Depositories (CSD)

1

1 RESEARCH PROBLEM

1.1 INTRODUCTION

Back in 1996 a group of European financial markets experts was formed, to advise the European

Commission. The Giovannini Group, named after its chairman Alberto Giovannini, identified 15 post-

trade barriers, which maintained inefficiency in cross-border clearing and settlement. (ECB, 2016)

These barriers were based on the results of a questionnaire that was published on the European

Commission website in 2001. Respondents were institutions involved in post-trade processes, such

as Commercial Banks, Investment Banks, Central Securities Depositories (CSD) and Stock Exchanges.

Furthermore, the barriers were categorised under three headings: Technical Requirements/Market

Practices (10 barriers), Taxation (2 barriers) and Legal (3 barriers). National differences on market

practices, tax procedures and legal treatment as well as the diversity of IT platforms form the core of

the barriers. (The Giovannini Group, 2001)

# Barrier description Type

1 National differences in information technology and interfaces Technical

2 National clearing and settlement restrictions that require the use of multiple systems. Technical

3 Differences in national rules relating to corporate actions, beneficial ownership and custody. Technical

4 Absence of intra-day settlement finality Technical

5 Practical impediments to remote access to national clearing and settlement systems Technical

6 National differences in settlement periods Technical

7 National differences in operating hours/settlement deadlines Technical

8 National differences in securities issuance practice Technical

9 National restrictions on the location of securities Technical

10 National restrictions on the activity of primary dealers and market makers Technical

11 Domestic withholding tax regulations serving to disadvantage foreign intermediaries Taxation

12 Transaction taxes collected through a functionality integrated into a local settlement system Taxation

13 The absence of an EU-wide framework for the treatment of interests in securities Legal

14 National differences in the legal treatment of bilateral netting for financial transactions Legal

15 Uneven application of national conflict of law rules Legal

Table 1-1 The Giovannini Barriers

Since the foundation of the Giovannini Group, many harmonisation initiatives have been launched on

European Union (EU) level. These initiatives have all been striving towards further realisation of the

European Single Market. This market refers to the EU as one territory where goods and services can

move freely due to the absence of internal borders or other regulatory obstacles. (European

2

Commission, 2016) One currently relevant harmonisation initiative, TARGET2 Securities (T2S), is

aiming to create a single rule book for post-trade processes and to contribute to financial integration

in Europe. However, despite all initiatives, 20 years after the Giovannini Group was formed, many of

the barriers still exist. (ECB, 2016)

In 2008, Satoshi Nakamoto3 released the paper: Bitcoin: A Peer-to-Peer Electronic Cash System, in

which he states that financial institutions are almost exclusively serving as trusted third parties with

regards to electronic payment processing. As an alternative, Nakamoto proposes an electronic

payment system, called Bitcoin, based on cryptographic proof rather than trust, obsoleting the need

for a trusted third party and making transactions computationally, practically irreversible. Electronic

coins are defined as a chain of digital signatures. This database structure of time stamped blocks of

items forming a chain is what is known today as the blockchain, a form of distributed ledger

technology. (Nakamoto, 2008)

In a white paper published by Euroclear4, in cooperation with consulting firm Oliver Wyman, it is

calculated that IT and operations expenditures in capital markets are close to $ 100-150 billion

annually among banks. Additionally, post-trade and securities servicing fees are close to $ 100 billion

per year. Furthermore, due to delays and inefficiencies in the market infrastructure, significant

capital and liquidity costs are incurred. Moreover, the role of blockchain technology in reducing

these costs is examined. Direct savings could be realised by decommissioning obsolete systems,

reduced operational overhead and cost sharing across the financial institutions connected to the

blockchain. Three routes are identified to the adoption of the technology:

- Challenger disruptions: developments by parties outside of the core capital markets,

expected in 18-24 months

- Collaborative efforts to shift the current value chain to blockchains, likely to take more than

10 years

- Mandated policy by supervisors directing the industry to introduce a new market

infrastructure (Euroclear, 2016)

3 Pseudonym used by the person or people who designed Bitcoin

4 One of the largest European Central Securities Depositories (CSD)

3

1.2 THESIS GOALS

The goal of this thesis, is to examine the role that blockchain/distributed ledger technology can play

in contributing to further harmonisation of the European securities landscape on post-trade level.

This is accomplished through:

- Providing a theoretical background on the European securities landscape, harmonisation and

standardisation initiatives and blockchain/distributed ledger technology

- Critically assessing literature on harmonisation on post-trade level and

blockchain/distributed ledger technology

- Interviewing key industry players in London and Amsterdam

- Discussing the interview findings with the literature review findings

1.3 OUTLINE

Chapter 2: An overview of the European securities landscape is given by explaining the actors and

their roles

Chapter 3: Different harmonisation and standardisation initiatives that affected the European

securities landscape will be explained

Chapter 4: A theoretical background is given on blockchain and other distributed ledger technologies

Chapter 5: Different sources regarding harmonisation on post-trade level and blockchain/DLT are

critically assessed

Chapter 6: An overview of the research process is given by explaining the interviewees’ selection and

the interview setup and processing

Chapter 7: The interview findings are presented in this chapter

Chapter 8: A discussion between the findings of the interviews and literature review is presented in

this chapter

Chapter 9: The conclusion of the research and the limitations are presented in this chapter

4

2 EUROPEAN SECURITIES LANDSCAPE

To be able to understand the European Securities landscape, the different trade processing stages in

the trading process will be examined in this chapter. These stages are trading, clearing, settlement

and custody, of which the latter three are considered as post-trade. In Appendix I is a figure fully

covering the on exchange securities trade value chain and the participants. In scope for this thesis are

on exchange stock trades, while over-the-counter (OTC) trades are out of scope.

2.1 TRADING

Trading is the activity of buying and selling securities or other financial instruments. (AFME, 2015) To

be able to trade, multiple parties are required. In the first place a buyer and a seller are required, the

buyer will indicate at his bank that he is willing to buy a certain stock and the seller will indicate at his

bank that he is willing to sell a certain stock. However, to be able to trade on a stock exchange,

connectivity to that stock exchange or Multilateral Trading Facility (MTF) is required. (London Stock

Exchange, 2016) Sometimes the banks are connected directly otherwise intermediaries are used for

connectivity. These intermediaries are known as stock brokers, and can execute clients buy and sell

orders on the stock exchange. (Deutsche Boerse, 2016)

2.2 CLEARING

Clearing can be defined as “the preparation through matching, recording and processing instructions

of a transaction for settlement” (Loader, 2014, p. 2) The clearing process is carried out by a

designated function: The Central Counterparty (CCP) sometimes referred to as clearing house. CCPs

perform two clearing functions. Firstly, there is netting by novation, which means that the CCP

becomes the counterparty for each side of the trade; i.e. the buyer to the seller and the seller to the

buyer. In a regular stock trade, this will imply that the buyer pays to the CCP, while the seller delivers

shares to the CCP. Secondly, there is the netting referred to as clearing. Due to its obligatory role

with regards to the clearing of on exchange trades, CCPs net off transactions between multiple

parties for both cash and securities. This results in significantly smaller net exposures than bilateral

netting. (ICMA, 2016) A schematic overview of the netting process can be found in Appendix II. Due

to the novation, CCPs are not only facilitating settlement, but even guaranteeing it. This means that

settlement also will have to be guaranteed in case of default of one of the counterparties involved in

a trade. Margin is used as a risk management tool and sometimes requires additional collateral to be

deposited in case of fluctuations in the market price, enabling the CCP to guarantee settlement, even

in case of default of a trading counterparty. (Loader, 2014)

5

2.3 SETTLEMENT

Settlement can be defined as “The exchange of cash or assets in return for other assets or cash and

transference of the ownership of those assets and cash” and is the subsequent step after clearing.

(Loader, 2014, p. 2) Normally, settlement occurs 2 or 3 business days after trade date, and the period

in between is known as the settlement cycle and mostly referred to as T+n where n stands for the

amount of settlement days, for example: T+2 means a two day settlement cycle. A common

settlement instruction, in which stocks are delivered to a buyer, and money is delivered to the seller,

is called a Delivery Versus Payment (DVP). The settlement instruction of the securities is processed by

the Central Securities Depository (CSD) and the cash settlement is processed by the central bank. If

the buyer and the seller are holding their assets for safekeeping at the same bank – called a

custodian, settlement can be done internally. However, when settlements need to take place

between different custodians, the custodians need to arrange the settlement according to the terms

in the contract. (AFME, 2015) Currently, TARGET2 Securities (T2S) is being implemented, eliminating

differences between cross-border and domestic settlement instructions and centralizing liquidity.

More information with regards to T2S can be found in the subchapter TARGET2-Securities.

2.4 CUSTODY

Another essential step in the post-trade trading process is custody. The Bank of International

Settlements (BIS) defines custody as “the safekeeping and administration of securities or other assets

on behalf of others”. (2015) Immobilisation of securities plays an important role with regards to

safekeeping. When companies are issuing shares, through for example an Initial Public Offering (IPO),

the shares will be issued, thus immobilised5, in a CSD, in this case called the issuer CSD. (BIS, 2012)

Upon issuance, an International Securities Identification Number (ISIN) will be assigned to the

security. Since ISINs are standardized, ISO 6166, and used worldwide for identification of securities,

they contribute in facilitating a reliant clearing and settlement process. ISINs consist of 12

alphanumeric characters and start with a two letter, ISO 3166, country code, referring to the country

of a company’s head office. National securities are issued at local CSDs, and international securities

are issued at International Central Securities Depositories (ICSD), such as Euroclear Bank, these are

identifiable by ISINs starting with “XS”. (ISIN, 2016) Because all shares for a specific security are

issued with the same CSD on the same ISIN, netted settlement instructions between different trading

parties on the same ISIN, are processed on CSD level through book entries between the internally

held securities accounts, called internal settlement. Clients from CSDs are usually financial

5 In chapter 3.2 is a historical overview of the developments from local custody to central securities

depositories and dematerialisation, explaining the concept and background of immobilisation

6

institutions and hold securities accounts, representing the total holdings of their clients and the

banks themselves per ISIN. Client assets are protected for defaults through asset segregation.

2.5 EUROPEAN SECURITIES INFRASTRUCTURE

Based on a simplified illustrative example, exposing the vertical value chain of processing for on

exchange trades within Europe, the European securities infrastructure should become clear. For this

example we will use the German market6, marked in red in Figure 2-1.

We assume two clients, one from Deutsche Bank, wanting to buy shares in Volkswagen and BMW,

and one from Commerzbank owning shares in BMW and Volkswagen. The figure in Appendix I is

useful to follow the different steps in the process.

Client Bank Holdings Share

1 Deutsche

Bank (A)

0 BMW

0 Volkswagen

2 Commerzbank

(B)

10 BMW

10 Volkswagen

Table 2-1 Illustrative example I

Step 1:

Client 1 indicates at Bank A wanting to buy 10 shares of BMW and Volkswagen each

Client 2 indicates at Bank B wanting to sell 10 shares of BMW and Volkswagen each

Step 2:

Bank A brings the buy order directly or through a broker to the Deutsche Börse stock exchange

Bank B brings the sell order directly or through a broker to the Deutsche Börse stock exchange

Step 3:

The orders are matched in the order book on the Deutsche Börse stock exchange and executed

Step 4:

The CCP, Eurex Clearing, will novate the trade and become the counterparty for both sides of the

trade and sends a DvP settlement instruction to the CSD Clearstream Banking Frankfurt

6 The settlement process on the German market has not yet transferred to T2S, which is planned for February

2017

7

Step 5:

The CSD, Clearstream Banking Frankfurt, will settle the trade through an internal settlement by a

transfer of 10 shares Volkswagen and 10 shares BMW from the securities account of Commerzbank

(B) to the securities account of Deutsche Bank (A). The cash will be settled by the Central Bank, the

Deutsche Bundesbank

Figure 2-1 Fragmented European Securities Landscape 2009 – before T2S (ECB, 2009)

In this example, no netting takes place.

8

If both clients would be from the same bank:

Client Bank Holdings Share

1 Deutsche

Bank (A)

0 BMW

0 Volkswagen

2 Deutsche

Bank (A)

10 BMW

10 Volkswagen

Table 2-2 Illustrative example II

… steps 1,2 and 3 would remain the same, but step 4 and 5 would be:

Step 4:

The CCP, Eurex Clearing, will novate the trade and become the counterparty for both sides of the

trade and nets the positional effect for Deutsche Bank to 0, due to the offsetting trades

Step 5:

The CSD, Clearstream Banking Frankfurt, will not have to process the settlement instruction since

there is no effect on the securities account of Deutsche Bank at the CSD. Additionally, the cash

instruction is also netted off.

9

3 HARMONISATION AND STANDARDISATION

Over the last half century many harmonisation initiatives have been launched in the benefit of cross-

border payment and securities transactions. Furthermore, the first barrier that was identified by the

Giovannini Group, speaks of national differences in information technology and interfaces, caused by

non-standardised platforms. Implying that, to take away this barrier and achieve harmonisation,

standardisation is a key element. In this chapter, boundary breaking initiatives that impacted the

European securities landscape will be discussed.

3.1 SWIFT

One of the harmonisation initiatives that is still of great importance to today’s financial services

industry, is the formation of the Society for Worldwide Interbank Financial Telecommunication

(SWIFT) in 1973. 239 banks from 15 countries formed a ruleset for cross-border payments

communication, to replace the until then widespread used Telex technology. In 1977, when SWIFT

went live, 518 institutions from 22 countries were connected to its messaging service. Another

milestone was reached in 1987, when SWIFT entered the securities market, enabling SWIFT to

increase its user base. Today, members in over 200 countries are connected to the SWIFT network

sending more than 5 billion messages each year. (SWIFT, 2016)

Furthermore, as a registration authority (RA) for multiple ISO7 standards, SWIFT plays a key role in

facilitating the effective use of these standards. (ISO, 2016) One of the most important standards

used for communication on the SWIFT network is ISO 9362:2014, known as the Business Identifier

Code (BIC). The role of SWIFT with regards to BICs is twofold: as an RA, SWIFT is responsible for

assigning BICs, while as a service provider, SWIFT is responsible for the operations and identification

of entities connected to the network. To be able to identify entities on the network, BICs consist of

eight to eleven characters. According to the 2014 version, BICs use the following setup: The first four

characters are alphanumerical and define the business party prefix, the second two alphabetical

characters define the ISO 3166 country code, the subsequent two alphanumerical characters define

the business party suffix and finally, the last three optional alphanumerical characters define the

branch code. (SWIFT, 2014) As an example, the main BIC of the European Central Bank is setup as

follows: The business party prefix: ECBF, the country code: DE for Deutschland, the business party

suffix: FF for Frankfurt – in ISO 9362:2009 these fields were used as the location code, most of

today’s existing BICs will contain a reference to the city where the business party is located – and the

optional branch code is not used, resulting in BIC: ECBFDEFF.

7 International Organisation for Standardisation

10

3.1.1 Message standards

After the formation of SWIFT, the need for a more standardised approach for the securities industry

was acknowledged. In the early 1980’s, the securities industry organised itself in a subcommittee

under ISO’s technical committee for Banking, Securities and other related services. In this period, a

series of message types was designed under the ISO 7775 standard. ISO 7775 message types were

implemented incrementally between 1984 and 1997, covering multiple securities related areas such

as: post-trade, pre-settlement, settlement, reconciliation, corporate actions and reporting. Although

ISO 7775 was designed by the securities industry, it did not become the leading industry standard.

The main reasons for this, were that it was developed with support of custodian banks and not

covering the full end-to-end process from the securities industry. Furthermore, the standard was

mainly promoted by SWIFT, which network, at that time, was not open to all securities players. More

critically, the standard embodied a number of shortcomings, leaving too much room for

interpretation. These issues resulted in limited adoption of the standard by the industry and a critical

review of ISO 7775 in 1994. Instead of repairing the existing standard, the community, with a

business-oriented approach, agreed to create a new standard: ISO 15022. The benefits from, the in

1999 introduced, ISO 15022 over 7775 are:

- Unambiguous definitions for individual business elements

- Extreme reduction of narrative fields

- The compliance of fields and messages are guaranteed by the ISO Registration Authority,

facilitating definition and registration of new messages, while bypassing the lengthy ISO

approval process

- A stricter set of syntax rules was applied, improving the predictability and automation

capability of new messages (Eloy & Vandamme, 2003)

The successor of ISO 15022, is ISO 20022, also known as the Universal Financial Industry message

scheme and is the international standard for development of financial message standards. Initially,

eXtensible Mark-up Language (XML) was the preferred communication structure, resulting in XML-

based messaging in the first edition of ISO 20022 in 2004. The second edition, published in May 2013,

also includes the possibility to use Abstract Syntax Notation One (ASN.1) (ISO 20022, 2016)

ISO 20022 has two key aspects to it: it is a methodology for the creation of financial messages, and

secondly, it is a body of content. Furthermore, the methodology identifies three different layers, the

first layer contains financial concepts and the relationships between these concepts. An example of

financial concepts and a relationship between these concepts is: a cash account is a type of account,

each account has a servicer and an owner; a bond is a type of security and has an issuer and holders.

11

The second layer, called the logical layer, can be used for instructions or information purposes in a

business process, the business process uses the conceptual layer for the definitions. For example

with a credit transfer, the instruction needs to embed all concepts that are required. A credit transfer

will require at least two accounts, one for the sending party and one for the receiving party, the

currency and the amount need to be defined and many other fields. The final layer is called the

physical layer and is the technical realisation of the message. This layer defines in what format the

message will be generated, such as XML or ASN.1.8

The second key aspect to ISO 20022, is the formalisation of key concepts and message definitions.

These concepts and definitions can be formally published as part of the ISO 20022 standard, bringing

global consistency for automated business processes. After formalisation, all concepts and definitions

can be used or re-used in a consistent way among the users. Furthermore, changes to the standard

can be initiated by the users and after approval by the Techical Committee, the standard is handed

over to the Registration Authority, which is SWIFT for this standard, for implementation. (SWIFT,

2016)

3.2 FROM LOCAL CUSTODY TO CSDS AND DEMATERIALISATION

In the early beginning of the 17th century, the Dutch East India Company (VOC in Dutch) issued shares

in Amsterdam, incorporating the first stock exchange in the world. The shares were physically printed

securities of which the oldest stock known today dates back to 1606. (The Economist, 2013) Even

until late in the 20th century, shares were still issued physically, therefore a need for safekeeping

existed. This could for example be done at home, or at a safekeeping service provider, mostly the

vaults at banks. These banks are called custodians and are responsible for the settlement of

securities transactions. Securities transactions between clients of different custodians, resulted in

physical exchange of securities from one vault to the other. Due to increasing trading volumes, the

vast amount of physical securities that had to be exchanged between custodians, could cause the risk

of delayed settlement, liquidity issues in the market and fraud. As a solution, Central Securities

Depositories (CSD) were set up to immobilise the securities for an entire market. To achieve this, the

CSD replaced the separated individual vaults of the custodians with a centralized vault containing all

physical securities for a specific market, eliminating the physical movements of securities. The

participants or members of the CSD do have a securities account in which the total securities

holdings are represented and transactions are settled as a “book entry settlement” between them.

Reducing safekeeping to a reconciliation activity. Another milestone within the securities industry,

8 An overview of different ISO 20022 messages can be found on:

https://www.iso20022.org/message_archive.page

12

was the dematerialisation of securities. Due to technological improvements, securities could be

dematerialised, so that they would only exist in electronic form. Denmark was the first European

country dematerializing securities in 1981. For this to be possible, the legislation in countries where

only physical certificates were allowed needed to be changed. This could mean that in some markets

dematerialisation was mandatory and in other markets securities were legally required to be still

issued physically. In that case, physical global certificates were issued, were one certificate is

representing an entire issue. (ECB, 2007)

3.3 MIFID

The Markets in Financial Instruments Directive (MiFID), that was enforced by the EU member

countries in 2007, contributed to further harmonisation of the European securities landscape on

trade level. This was realised by creating a level playing field for three levels of trading services:

Regulated Markets, Multilateral Trading Facilities (MTF) and Systemic Internalisers9. The

“concentration rule”, that was introduced in the 1993 Investment Services Directive (ISD), forcing

retail trading orders to be executed on a regulated market, was removed by MiFID. Considering the

Best Execution principle, more competition on trade level with the Regulated Markets was facilitated

by the formation of MTFs such as Chi-X Europe and Bats. (Degryse, 2009) In 2011, Bats and Chi-X

Europe merged into Bats Europe, became a Recognised Investment Exchange (RIE) in 2013 and is

now the largest European equities exchange based on its market share and value traded. (Bats

Europe, 2016)

3.4 TARGET2-SECURITIES

In 2006, exploratory discussions between the Eurosystem and the European securities market started

on TARGET2-Securities (T2S). With a cost expectation of around € 1 billion, T2S is considered one of

the most prestigious EU projects. It aims to provide a single IT platform for settlement of all heavily

traded European securities, while eliminating any difference between domestic and cross-border

securities transactions. Ten years ago, the securities landscape was still divided and huge differences

existed in the settlement of securities transactions between EU member states. T2S enforces a single

messaging protocol by using the ISO 20022 standard, introduces a single operational schedule for all

connected markets and applies a single harmonised settlement model with DvP instructions in

central bank money for all domestic and cross-border transactions. Allowing market participants to

optimise their liquidity management. (ECB, 2009) With regards to harmonisation of the European

securities landscape on post-trade level, T2S contributes significantly in the removal of the

9 Also known as Market Makers (Financial Times, n.d.)

13

Giovannini barriers by affecting 6 out of 10 technical barriers. (ECB, 2016) The migration of 21

European CSDs to the T2S platform, has been divided amongst 5 waves. Wave 1 launched on 22nd of

June 2015 and successfully migrated 5 CSDs and wave 5, migrating the last 3 CSDs, is currently

planned for September 2017. (ECB, 2016)

3.5 CENTRAL SECURITIES DEPOSITORIES REGULATION

In April 2014, the European Parliament adopted the Central Securities Depositories Regulation

(CSDR). Across the EU, CSDR aims to harmonise the settlement cycle and settlement discipline, and

provides a set of common requirements for CSDs. Furthermore, it will improve legal and operational

conditions for cross-border settlement in the EU. This is realized by:

- Shorter settlement periods within the EU

- Settlement disciplinary measurements – a penalty regime for failed settlement

- Obligatory dematerialisation for most securities

- Prudential and conduct of business rules for CSDs

- Strict access rights to CSD services

- Increased prudential and supervisory requirements for CSDs (ESMA, 2016)

Complementary to T2S, CSDR contributes in the removal of 5 Giovannini barriers, of which the

barrier “National restrictions on the location of securities” is most remarkable. The legal

environment, created by CSDR, will benefit from harmonisation regarding the rules applicable to the

cross border transfers of securities between CSDs that is expected with the future EU Securities Law

Legislation. (ECB, 2016)

14

4 BLOCKCHAIN & DLT

In this chapter an outline will be given with regards to blockchain and other forms of distributed

ledger technology (DLT). Dave Birch, Director of Innovation at Consult Hyperion and an authority with

regards to blockchain and DLT, created a distributed ledger taxonomy (see Appendix III). In which he

identifies 4 types of ledgers:

- Traditional ledgers

- Permissioned private shared ledgers

- Permissioned public shared ledgers

- Unpermissioned10 public ledgers

The latter three ledger types will be discussed in this chapter.

4.1 BITCOIN

The blockchain and the Bitcoin find their origins in Satoshi Nakamoto’s11 2008 paper: Bitcoin: A Peer-

to-Peer Electronic Cash System. He states that financial institutions are almost exclusively serving as

trusted third parties with regards to electronic payment processing. Although the system works

sufficiently for most financial transactions, the system is subject to the inherent weaknesses of the

trust based model. As an example Nakamoto argues that due to dispute mediation by financial

institutions, completely non-reversible transactions are not really possible. The costs involved in

mediation, result in an increase of transaction costs, directly limiting the size of transactions.

Furthermore, due to the possibility of transactions being reversed, the need for trust between

merchant and customer increases. As a solution, Nakamoto proposes an electronic payment system

based on cryptographic proof rather than trust, obsoleting the need for a trusted third party and

making transactions computationally, practically irreversible. Electronic coins are defined as a chain

of digital signatures. Coin owners can transfer to others by digitally signing a hash of the previous

transaction and the public key, as can be seen in figure 4-1. (Nakamoto, 2008)

10

Also known as Permissionless ledgers 11

Pseudonym used by the person or people who designed Bitcoin

15

Figure 4-1 Diagram showing key exchange for Bitcoin transactions (Bitcoin Stack Exchange, 2013)

To prevent owners from double-spending by using private keys multiple times, Bitcoin will not use a

trusted central authority, but instead publicly announces all transactions12 and only records the first

received transaction for a private key. Furthermore, the transactions need to be timestamped and

agreed upon by a majority of nodes in the system. Timestamps are created by a timestamp server

that is taking a hash of a block of items, that have to be timestamped. Importantly, In every new

timestamp, a hash of the previous timestamp is included. Thus altering historical transactions would

also require all subsequent transactions to be changed, taking into account that a majority of the

nodes is required, this is considered practically impossible. (Nakamoto, 2008) Although, the word

blockchain is not explicitly mentioned in Nakamoto’s paper, the database structure of timestamped

blocks of items forming a chain is what is known today as the Blockchain – an unpermissioned public

ledger.

4.2 UNPERMISSIONED PUBLIC LEDGERS

Unpermissioned ledgers cannot be owned by a single party, instead they allow anyone to contribute

data to the ledger while enforcing identical copies throughout the network. Since nodes can leave

and re-join the Bitcoin network at will, Bitcoin is an example of an unpermissioned public ledger. Due

to this censorship resistance, no actor can prevent transactions from being added to the ledger.

Additionally, the integrity of the ledger is maintained by reaching a consensus on its state. (GOV.UK,

2016) This consensus can be reached by applying a consensus mechanism. The basis for such

mechanisms are described in engineer Paul Baran’s paper called: “On Distributed Communications

12

Real-time transactions can be found on: https://blockchain.info/

16

Networks”. In this paper Baran describes the vulnerability and survivability of centralized,

decentralized and distributed networks, by investigating redundancy of connectivity for digital

communication networks, using links with less than perfect reliability. (1962) An extensive overview

of historical developments of consensus mechanisms can be found in Appendix IV.

Figure 4-2 Centralized, Decentralized and Distributed networks (Baran, 1962)

Another important research is The Byzantine Generals Problem. This paper describes an abstract

problem, in which reliable computer systems must cope with one or more failing components. Failing

components can potentially send conflicting information to different parts of the system. As a

metaphor, the writers illustrate a siege of an enemy city by several divisions of the Byzantine army.

Each division is led by its own general, and communication between generals takes place indirectly

by using messengers. After having observed the enemy, a common action plan needs to be decided

upon by the generals. Unfortunately, some of the generals can be considered traitors that do not

want the loyal generals to reach agreement. As a solution, firstly, an algorithm needs to be created

that guarantees that all loyal generals decide upon the same action plan. Secondly, a small number of

traitors cannot cause the loyal generals to adopt a bad plan. The conclusion is, that it is possible to

create such an algorithm when only oral messages are used in case of more than two-thirds of the

generals are loyal. In case unforgeable messages are used, the problem can be solved for any number

of possible generals and possible traitors. (Lamport, et al., 1982) Castro and Liskov describe the

Practical Byzantine Fault Tolerance (PBFT) replication algorithm, tolerating Byzantine faults. With this

algorithm, highly available computer systems could be setup, called replicas, tolerating Byzantine

17

faults such as software bugs, operator mistakes and malicious attacks, as long as less than 1 out of 3

of the replicas are faulty. (1999) An implementation of PBFT, amongst others used for Bitcoin, is

called Proof-of-Work (PoW). Transactions are validated by algorithms run by the nodes, under the

assumption that at least a majority of the system’s computer power is under control of honest nodes

(“loyal generals”). This process is called mining and the nodes computing the algorithms are called

miners. The incentive is that miners are rewarded with Bitcoins or other cryptocurrency in exchange

for the computational power required for verification of transactions. (KPMG, 2016) The mining has

become an industry in itself, dedicated mining hardware specialized in hash calculations is available

(Bitmain, 2016) and miners having gathered in mining pools of which the four largest cover more

than 50% of the total computational power on the blockchain. (Blockchain.info, 2016)

Another consensus mechanism is called Proof-of-Stake (PoS) – a cryptographic proof of ownership.

Where PoW is based on computational power - the more computational power, the more likely it is

to mine a Bitcoin, PoS is based on ownership, the more coins you own, the more likely it is to mine

new coins. With PoS the opportunity costs are moved from outside the system, to inside the system.

This is because the economic incentive is based on “most proven work”, which comes forth of the

ownership. The higher the ownership – proof of stake in the project – the higher the proven work,

the higher the reward. (Poelstra, 2014) A PoS concensus protocol called Casper, uses security-

deposits, similar to collateral, for the validation process. The nodes – called bonded validators – have

to bond themselves to a consensus outcome by placing a security deposit – called bonding. The

bonded validators are forced by Casper to put a lot of their security deposits at stake to reach

consensus. They have to bet their deposits on how they expect the other bonded validators to be

betting their positions. If the bet turns out to be correct, their deposit is earned back as well as a

transaction fee and possibly a token. (Zamfir, 2015)

Besides Bitcoin, there are many other implementations of blockchain technology such as:

- Namecoin – a decentralized name registration database

- Colored coins – a protocol allowing people to create their own cryptocurrencies

- Metacoins – a protocol on top of Bitcoin, to use Bitcoin transactions to store metacoin

transactions – also known as tokens – that can represent assets or commodities

In addition, smart contracts13, in which digital assets can automatically be moved according to pre-

specified rules, play an important role in distributed ledgers. Although the Bitcoin protocol facilitates

13 “…self-executing contract(s), containing electronically drafted provisions which have the ability to automate a

variety of processes, in accordance with the terms of the contract.” (Salmon, 2016)

18

a weak version of smart contracts, there are several limitations to its scripting language. Buterin

speaks of the following limitations:

- Lack of Turing-completeness – the Bitcoin scripting language, does not support “loops” to

avoid infinite loops during transaction verification

- Value-blindness – the Bitcoin script cannot determine a Bitcoin’s relative value towards

another asset for usage within contracts

- Lack of State – the state of transactions is binary: either spent or unspent, therefore not

supporting multi-stage contracts

- Blockchain-blindness – unspent transactions outputs are blind to blockchain data such as the

previous hash

As a solution to build advanced applications on top of cryptocurrency, Buterin identifies three

approaches: building a new blockchain, using scripting on top of Bitcoin and building a meta-protocol

on top of Bitcoin. Out of these approaches, Ethereum emerged. Ethereum is an unpermissioned

public ledger build as a generalized framework, providing the advantages of the three approaches at

the same time. Where Bitcoin uses transactions, Ethereum uses messages. Ethereum messages have

three main differences compared to Bitcoin transactions. First, messages can be created by an

external entity or by a contract with Ethereum, where Bitcoin only supports transactions created

externally. Second, Ethereum messages have an explicit option to contain data. Finally, Ethereum

messages can have functionality embedded, such as a recipient returning a response message.

(Buterin, 2014)

4.3 PERMISSIONED SHARED LEDGERS

Permissioned ledgers have one or many owners. New records are added by using a limited consensus

process, opposite to unpermissioned ledgers, carried out by trusted actors. Richard Brown, former

IBM CTO and currently CTO of the Distributed Ledger Group, speaks of shared ledgers. Shared ledger

is a generic term referring to any database and application, shared by an industry or a private

consortium in case of private ledgers, or open to the public in case of public ledgers. The

permissioned public shared ledger Ripple, used for global financial transactions, uses Unique Node

Validators (UNV) as trusted actors for its validation process. (GOV.UK, 2016) Where in

unpermissioned public ledgers, transactions are validated by anonymous nodes, in permissioned

systems the nodes must be legally known and eligible for validating of transactions. Due to this

setup, there is no need for mining, and consensus can be reached in ways other than PoW or PoS.

The R3 consortium, a financial innovation firm consisting of over 50 global financial institutions, uses

a bilateral consensus mechanism for its distributed ledger called Corda. This bilateral consensus

19

method is called node to node (N2N), and enables two counterparties to validate transactions

between themselves. (KPMG, 2016)

4.4 SECURITY

Due to the high amounts of virtual money moving anonymously on a daily basis through blockchains

and distributed ledgers worldwide, cyber-attacks trying to jeopardise the systems to gain financial

benefits, occur regularly. When executed successfully, criminals can get possession of multimillion

dollar equivalents in cryptocurrency. (Kuchler, 2016) The biggest Bitcoin heist in history took place at

virtual currency exchange Mt. Gox14. The exchange was originally created as a trading platform for

trading cards for the popular trading card game Magic: The Gathering. Back in February 2014, the

platform was allegedly hit by a Distributed Denial-of-Service15 (DDoS) attack, and losing 850,000

Bitcoins, worth almost half a billion dollars at that time, to hackers. (Adelstein, 2016) A more recent

attack took place in August 2016 on the Hong Kong based cryptocurrency exchange Bitfinex. Hackers

were able to steal almost 120,000 Bitcoins representing a value of around $ 78 million. (Gibbs, 2016)

As a solution for the losses, the damage has been divided amongst all users of the platform. This

meant that every user storing Bitcoins through Bitfinex, would lose 36% of their balance for

compensation. In addition, all users would also receive BFX tokens, equal to their personal losses.

Ultimately, these tokens should be exchangeable for either repayment by Bitfinex or shares in the

parent company iFinex Inc. as a compensation. (Baraniuk, 2016) The 2016 heist of the, Ethereum

blockchain based, Decentralized Autonomous Organisation (DAO) was solved totally different. The

hacker was able to steal 3.6 million of Ether, the cryptocurrency used on Ethereum blockchains,

worth around $ 50 million. This was possible due to a loophole in the DAO split function by

combining two exploits. (Koeppelmann, 2016) Instead of dividing the loss over the participants, an

alternative solution was chosen: a hard fork. The hard fork would erase the transactions involved in

the theft and return the funds to their original owners. By a voting process amongst all users, in

which a decision had to be made on what version of the ledger would be adopted, it was decided by

a 97% majority to adopt a new version of the ledger, effectively undoing the theft. This entire

process was possible due to the 27 days creation phase of the DAO. During this period Ether invested

in the fund was immovable. This also meant that the hacker did not have the ability to move the

stolen Ether out of his funds, giving the community 27 days to come with a solution. (Vigna, 2016)

14

Stands for Magic: The Gathering Online eXchange 15

Overwhelming an online service with traffic from multiple sources, such as botnets of infected computers, in an attempt to take it down

20

5 LITERATURE REVIEW

In this literature review, an overview of published work concerning the post-trade environment and

blockchain/DLT, will be provided. Furthermore, the involved benefits, problems and challenges will

be discussed.

5.1 HARMONISATION OF THE POST-TRADE SECURITIES LANDSCAPE

According to the Association for Financial Markets in Europe (AFME), the post-trade processes,

performed subsequent to the execution of a trade, consist of:

- Clearing

- Settlement – including affirmation, confirmation, allocation and matching

- Custody and Asset Servicing

These services are provided by CCPs, Clearing houses, CSDs, custodians and brokers. (AFME, 2015)

Van Wageningen argues that the current setup of post-trade services, with the amount of different

providers and differences in market standards between European countries, has proven to be

complicated. This complexity has resulted in additional costs for cross-border transactions compared

to domestic transactions. (2013) Schaper agrees that the costs of cross-border securities settlement

within Europe are significantly higher than for domestic settlements. (2007) Although, financial

market instruments follow the same basic principle of clearing and settlement throughout markets

worldwide, it is also important to consider that these processes are covered by local conventions.

Furthermore, differences do not only exists amongst various jurisdictions, but also between different

products. (Loader, 2014) NERA Economic Consulting, confirmed in a study that direct clearing and

settlement costs in Europe were significantly higher than in the United States. This difference is

caused by multiple factors:

- Lower volumes in Europe compared to the US Market

- Legal restrictions to non-domestic clearing and settlement

- The non-profit structure for clearing and settlement in the US regarding the member owned

DTCC, compared to the corporate profit post-trade structure in Europe (2004)

These and other issues were already addressed by the Giovannini group and captured in the

Giovannini barriers. (2001) In contributing to the removal of some of the barriers, T2S plays a

significant role by aiming to eliminate differences between domestic and cross-border securities

settlement. Turrel agrees with the benefits of T2S on the European post-trade landscape, but also

mentions that efficiency and cost reduction are not goals by themselves, and should be in balance

21

with robust and scalable markets. (2011) Before costs can be reduced, often investments are initially

required. Garnons-Williams states that participating directly in T2S will require technology

investments. The majority of systems used in the securities industry are still generating ISO 15022

messages, while T2S enforces the use of ISO 20022. (2014) Pierron agrees and argues that significant

investments are required to adapt back office systems to the future environment. Additionally, he

states that additional sources of revenue that could be captured by CSDs for compensation of

declining settlement revenues, are likely to be limited to only a handful of players. (2013)

Furthermore, Van Wageningen argues that the 23 CSDs that are joining the T2S platform, will have to

review their revenue models that currently cover settlement, asset servicing and issuer relations.

When T2S is fully implemented, all participating CSDs will use the T2S settlement engine for cross-

border securities settlement within the participating countries. (2013) Considering the pricelist for

T2S (ECB, 2016), in which no difference is made between domestic and cross-border settlements,

and new competition from the Directly Connected Parties (DCP) versus the participating CSDs (ECB,

2015), less revenues on settlements are inevitable.

With regards to clearing, two main views exist on the harmonisation within the European CCP

industry: consolidation or interoperability. In 2006, the president of the ECB Jean-Claude Trichet,

stated during a speech on a conference regarding CCP Clearing, that the consolidation of the number

of CCPs may have a positive impact on financial stability. He argues that larger CCPs may find it easier

to diversify risks and that post-trading arrangements become more efficient due to network effects.

Although, he also notifies that the failure of large CCPs could have a more disastrous effect than the

default of a small CCP. Furthermore, consolidation might result in a reduction of competition on CCP

level, with negative effects on the efficiency. (2006) Alberto Giovannini amongst others vouching for

consolidation, argued that the majority of operational expenses for CCPs, is fixed costs. Moreover,

they considered the marginal costs of clearing and settlement operations essentially zero. Others

disagreed by countering the claim of marginal costs, by stating they are low but not zero.

Furthermore, this group argues that competition should be the driving force, leading the industry

structure and consolidation. (Evanoff, et al., 2006) Additionally, De Vidts argues that vertical

integration, between stock exchanges, CCPs and CSDs, also reduces competition and may lead to

increased costs and lacking flexibility. (2009) Oppositely, the Depository Trust & Clearing Corporation

in the US, having a monopoly providing clearing, settlement, custody and asset servicing, is reported

to be the most cost-effective settlement system so far. (Lamandini, 2006) Considine (DTCC)

characterises this as a monopoly created by the market. According to her, the market wanted a

monopoly to take advantage of economies of scale within the post-trade industry. Significant cost

22

savings were realised by collateral savings, processing efficiencies as well as reduced business

continuity and technology costs. (Evanoff, et al., 2006)

Besides consolidation, the second view with regards to harmonisation of the European clearing

industry is: interoperability. Tumpel-Gugerell defines interoperability on CCP level as:

“… agreeing on common processes, methods, protocols, and networks to enable cooperation between

central counterparties at the technical level” (2006)

De Meijer acknowledges the importance of interoperability in facilitating direct competition, in order

to create a more efficient and harmonised European securities market. Besides, he identifies a risk of

interoperability not going to happen, due to differences in local legislation and technical setup. This

could be prevented if regulators would take a more prescriptive line. (2010) Duffie and Zhu argue

that counterparty risk can be significantly reduced with interoperability amongst CCPs. Although,

they also identify legal and financial challenges before effective interoperability can be achieved.

(2011) Mägerle and Nellen conclude that fragmentation on clearing system level, with multiple CCPs

is inefficient. Additionally, they illustrate that the inefficiencies associated with fragmentation, can be

resolved by interoperability. This is because traders are enabled to net positions multilaterally across

all CCPs, thus minimising margin requirements and counterparty exposures in the clearing system.

(2011) Barnes argues that interoperability between clearinghouses is a positive development for the

markets. Especially, a CCP with netting for bilateral markets saves significant CSD settlement fees. As

an example Barnes explains that if a stock matches on three platforms, which are not sharing a CCP,

the user pays one net message per CCP, thus three net settlement fees. If these CCPs would be

interoperable, only one net settlement would have to be paid. (2011)

5.2 BLOCKCHAIN/DLT

Since the introduction of the blockchain powered platform Bitcoin in 2009, many developments have

taken, are taking and will be taking place within the area of the financial services industry.

In his speech on the Dutch Blockchain conference in 2016, Berndsen argued, referring to blockchain

technology, that it is wiser to predict that something is possible, rather than the opposite. In this

speech he concluded, with a future vision, that blockchain (possibly) will be the leading technology

for the next generation of financial market infrastructures. Although, he also states that disruption at

the level of financial market infrastructures is not likely, since he expects adoption to be gradual.

Additionally, Berndsen also points out when technology can still be considered blockchain by

identifying three fundamental IT elements. First, a public key infrastructure that provides ownership

of the data, second, fault tolerance that guarantees resilience of the network, finally, consensus

23

algorithms that establish validity of the information in the network. As benefits of blockchain

technology, Berndsen emphasizes the resilience of a distributed network in case of natural disasters

or targeted attacks compared, to centralized or decentralized networks. Another benefit mentioned,

is that the use of smart contracts within a blockchain can have contracts self-executing in case all

conditions are fulfilled, without the use of a separate legal entity, such as a Central Counterparty.

Besides the benefits, Berndsen also identifies three barriers to be overcome:

- Fragmentation – many institutions have started own blockchain initiatives

- Vested interests – some of the current market players have a business model based on

existing inefficiencies

- Interoperability – adoption of new technology will be incremental, hence interoperability

with the existing infrastructure is required for the transition period

To overcome fragmentation, Berndsen suggests a worldwide standard for blockchain, enabling

standardised information exchange between multiple blockchains. Vested interest can only be

overcome when the new technology will lead to a significant cost reduction. (Berndsen, 2016)

On June 16, 2016, Mark Carney – Governor of the Bank of England (BoE), was supposed to give a

speech on the Fintech Transformation. Due to the tragic murder of Member of Parliament Jo Cox on

that same day, the speech was cancelled (The Guardian, 2016) but the text was later published on

the BoE website. In this document, Carney discusses three possible transformation processes within

the financial industry:

- Revolution – financial technologies fundamentally reshaping the financial system by

unbundling of banking into the core functions of settling payments, sharing risk and

allocating capital

- Restoration – financial technologies making incumbent banks more efficient and profitable

- Reformation – financial technologies facilitating a diverse, resilient and effective system for

consumers, where large financial institutions coexist with new entrants

Furthermore, Carney argues that securities settlement is ripe for innovation. He points out that

securities transactions are executed in nanoseconds, but require several days to settle. In a typical

securities settlement chain, multiple intermediaries can be involved, creating single points of failure,

resulting in high costs and operational risk. According to Carney, these issues can be overcome by

using distributed ledger technology (DLT). DLT can cut the inefficiencies by simplifying the settlement

chain, reduce costs, raise speed while increasing the resilience. However, Carney also acknowledges

the challenges that have to be overcome such as reliability, resilience, security and scalability. The

document is finished with a statement of the BoE on what transformation process Fintech will

24

trigger. The BoE will help to enable a sustainable Fintech reformation by widening access to Real

Time Gross Settlement (RTGS) and facilitating technological development. (Carney, 2016)

In an occasional paper issued by the ECB, Pinna and Ruttenberg assess the potential effect of DLT in

the securities post-trading area. Similar to Berndsen and Carney, they try to identify either a

revolution or an evolution on post-trade level. To assess the impact of DLT on post-trade level for

financial institutions, they consider at least three factors applicable:

- The different entities within the post-trade value chain

- The type of governance applicable to the financial institutions

- The willingness and allowance to implement the innovation

Regarding the first factor, the different layers of the value chain, for the clearing layer they foresee

minimum impact in the form of a simplification of the netting and risk management procedures,

when trading platforms and the distributed ledger are separated systems. However, when

transaction messages on a distributed ledger are settlement instructions themselves, then some

procedures – such as affirmation, confirmation and matching – happening between trade capture

and settlement instruction could become obsolete. Furthermore, they argue that DLT has the

potential for close to real-time clearing and settlement, which would be less than T+0 compared to

the current market standard of T+2. This would mean that liquidity and credit risk would be exposed

for seconds or minutes rather than days. On the level of custody, Pinna and Ruttenberg argue that a

distributed ledger could allow securities to be held directly by investors, similar to the way

cryptocurrencies are currently held. With regards to asset servicing, DLT could play an important role

regarding corporate actions. Smart contracts could automatically execute a corporate action such as

coupons, dividends or even stock splits when the contractual obligations and requirements are met.

The second factor is about governance. Adoption of a DLT solution for the post-trade securities

industry would still require standardisation, common business rules and governance arrangements,

the same issues the current market infrastructure is facing. Pinna and Ruttenberg state that a key

decision would be to define the control of the specification of a distributed ledger. It can either be

defined by a single legal entity or by the user group of the distributed ledger. Furthermore, they

point out that already some industry players have joined forces to develop standards, while others

are developing in-house solutions, that might not be interoperable.

As a last factor, the willingness and allowance to implement new technology is also considered an

important point. According to Pinna and Ruttenberg, the consequences for the post-trading

landscape by adoption of DLT, are likely to be determined by the regulated core institutions such as

CSDs, CCPs and custodians. They illustrate this with three possible scenarios (see Appendix V): First,

25

the incumbent financial institutions will embrace the DLT to improve inefficiencies, but the business

practice is not impacted. An example could be multiple financial institutions solving internal issues by

using a distributed ledger with limited interoperability. The second scenario speaks of core players,

such as CSDs, adopting market-wide distributed ledgers, resulting in the redundancy of peripheral

market players. In the final scenario, a new world is depicted in which an automated clearing and

settlement peer-to-peer system replaces the current post-trade processes. Companies, including

SMEs, could issue their financial instruments directly on the ledger, while smart contracts could cater

for automated corporate action execution. They conclude that DLT has potential in improving the

financial industry on post-trade level. However, they also acknowledge that the technology is not yet

mature and legal and operational barriers as well as governance issues are still to be solved.

Additionally, they expect DLT to cause a gradual change in processes, rather than a revolution in the

market. (Pinna & Ruttenberg, 2016)

Next to the already mentioned key factors, there are also more technical aspects that play a relevant

role for adoption of blockchain/DLT within the post-trade securities landscape. Peters and Panayi

argue that unpermissioned blockchains, requiring the repetition of computation on all network

nodes, will run into scalability issues. Permissioned blockchains however, will have a smaller number

of nodes owned by large financial institutions that are more capable of scaling their computer power

to support the number of transactions. (2015) Malm and Wall agree with this view and state that in

unpermissioned blockchains every node has to process every transaction in the same way, causing

the processing time to increase, the larger a blockchain network becomes. Furthermore, they identify

four factors that put load on the nodes in a blockchain network: CPU16 load, memory usage, network

bandwidth and storage capacity. Additionally, they argue that permissioned blockchains can scale

superiorly in terms of efficiency and throughput compared to unpermissioned blockchains. (Malm &

Wall, 2016) An example of this is the Domus Tower Blockchain, described by Creighton as a highly

scalable permissioned blockchain benchmarked at over 1 million transactions per second on

hardware costing less than $ 50 an hour. (2016) Similar to the claimed performance of billions of

transactions a day by SETL’s OpenCSD platform. (2016)

In this chapter the importance of interoperability in both the current post-trade securities value

chain as well as in a future value chain, has been emphasized multiple times. As a Registration

Authority for ISO 20022, SWIFT can be considered an important ambassador in the move to

interoperable securities markets. Considering that ISO 20022 is the market standard within the

financial industry and interoperability is an important factor in adoption of distributed ledger

technology, it could be important for distributed ledgers to be interoperable with the ISO 20022

16

Central Processing Unit also known as the processor

26

standard. In a recently published paper, SWIFT identifies two benefits for reusing reference data

standards and business content from the existing messaging standard ISO 20022. First, in terms of

business definitions, re-inventing the wheel can be avoided. SWIFT has over 40 years of experience in

maintaining and improving standards used widely among the financial industry. Creating a new set of

standards would be time-consuming and could compromise interoperability. Second, by applying the

same reference data standards and business content (see Appendix VI), interoperability would be

much easier to accomplish, contributing to the adoption of new distributed ledger technology.

(SWIFT, 2016)

27

6 RESEARCH METHODOLOGY

The research question for this Master thesis is: “To what extent can blockchain/distributed ledger

technology contribute to further harmonisation of the European Securities Landscape on post-trade

level?” To answer the main question, the positive and negative effects and challenges of

harmonisation initiatives within the European securities industry in general will be examined.

Furthermore, the role of blockchain/DLT in further harmonisation of the European Securities

Landscape on post-trade level will be examined and the necessities for it to be successful. Finally,

alternatives to further harmonisation of the European Securities Landscape on post-trade level will

be discussed. Out of respect for the privacy of the interviewees, direct linkages to individuals have

been avoided as much as possible. However, some information exposure was required to prove that

all interviewees are subject matter experts.

6.1 DATA COLLECTION

For this inductive research, the qualitative research method of interviewing is used for the primary

data collection. Although criticized by Karl Popper, many researchers argue that theory generation

through induction as well as theory testing through deduction, are fundamental parts of the research

process. (Bougie & Sekaran, 2013) Merriam argues that the researcher is enabled by qualitative

research to gain a perspective on the “how” and “why”. (2009) The “how” is important to identify

how blockchain/DLT will affect the harmonisation of the European securities landscape. And the

“why” is important to understand why the securities landscape might be affected. The advantage of

face-to-face interviews, is that they provide rich data and help to explore and understand complex

issues. (Bougie & Sekaran, 2013)

28

To be able to setup a structure for the interviews, one unstructured trial interview was performed

with one of the interviewees that later also was interviewed semi-structured. Out of this trial

interview, a foundation for the final semi-structured interviews was constructed. Each final interview

was built upon three main themes:

- The harmonisation of the European securities landscape in general, covering:

o The benefits of harmonisation

o The problems and challenges of harmonisation

o The personal view of the interviewee

- The role that blockchain/distributed ledger technology could play in further harmonisation of

the European Securities landscape on post-trade level, covering:

o The effect of the technology on further harmonisation of the European Securities

landscape on post-trade level

o The necessities for the technology to be successful

- The alternatives to further harmonisation

6.2 THE INTERVIEWEES SELECTION

The interviewees were selected based upon their high level of expertise in the European post-trade

securities landscape and a high affinity with blockchain/distributed ledger technology. Furthermore,

the organisations they are working for provide a broad range of different views regarding the subject.

Some are part of the securities establishment, others are to be found in the fintech area and there

are also interviewees working for regulating/supervising authorities. Moreover, all participants have

significant experience in public speaking and have shared their knowledge in many ways, such as:

lectures, conferences and discussion panels. Next to participating memberships in industry bodies of

organisations such as SWIFT, The Dutch Advisory Committee Securities Industry (DACSI), the

European Central Bank, The Association for Financial Markets in Europe (AFME), the European

Banking Federation (EBF). The interviewees are part of the professional network of a colleague and

were contacted by email or LinkedIn with a brief description of the thesis project and a request for

participating in an interview. All contacted persons have participated in an interview, except from the

CSD Clearstream Banking and the Dutch Authority for Financial Markets (AFM). Both promised to

participate but never came back with a response on a meeting request. Considering the high quality

of the already participating interviewees, and that another CSD was already participating as well as

the DNB, due to time constraints, after having sent a reminder, no further actions were taken. The

interviews were conducted face-to-face in London and Amsterdam or for convenience reasons by

phone from Amsterdam.

29

Figure 6-1 Interviewees per sector

# Organisation Type # of

interviewees Corporate title Date Location Method

1 SETL Fintech 1 CEO 28/06/2016 London Face-to-face

2 Sapient Global

Markets

Digital transformation practice for Business and Tech

Consultancy 1 Director 28/06/2016 London Face-to-face

3 Euroclear Central Securities Depository 1 Director 08/07/2016 Amsterdam Phone

4 ING Bank N.V. Wholesale Bank 1 Securities Market

Consultant 21/07/2016 Amsterdam

Face-to-face

5 DNB & Tilburg

University Central Bank & University 1 Director & Professor 26/07/2016 Amsterdam Phone

6 RISE Financial Technologies

Fintech 1 Member Advisory Board 28/07/2016 Amsterdam Face-to-face

7 Northern Trust

Corporation

Global Custody & Investment Management

2 Global Head & Senior

Vice President 29/07/2016 Amsterdam Phone

8 KAS Bank N.V. Custodian 2 Director & Network

Manager 05/08/2016 Amsterdam Face-to-face

Table 6-1 list of interviewees

6.3 THE INTERVIEWEES’ ORGANISATIONS

SETL is a fintech company that was founded in 2015 by securities industry key players. Its vision is

that the post-trade environment is over-crowded with intermediaries, and with SETL the ambition is

“…to do to the post-trade environment, what we did to exchange trading with Chi-X.” (Finextra,

2015). As discussed in the harmonisation chapter, after the merger between Bats and Chi-X, Bats

Europe is now the largest European equities exchange, based on its market share and value traded.

(Bats Europe, 2016) On June 1st 2016, SETL announced the launch of its blockchain-powered

OpenCSD platform. With this platform, a permissioned distributed ledger, it is possible for market

participants to exchange cash and securities instantly at a speed of thousands transactions per

second. Given the ambitions of SETL with regards to changing the European securities landscape on

post-trade level, interviewing the CEO of this company was of great value for the research.

Central Bank & University

Central Securities Depository

Custodian

Fintech Innovation consulting

Investment Management

Regulating authority

Wholesale Bank

INTERVIEWEES PER SECTOR

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Sapient Global Markets is a division of formerly NASDAQ listed company Sapient Corporation. It is

servicing investment banks, investment managers, hedge funds, central banks, regulators and a

variety of exchanges and clearing houses. Services provided cover the full project-lifecycle and

consists of 5 components: Advisory, Program Management, Analytics, Technology and Operations.

Sapient helps its clients with growing and enhancing their business and turning challenges into

opportunities (Sapient Global Markets, 2012). The interviewee (PhD) from Sapient Global Markets

had a profound background in the securities industry, before making a career switch to the

innovative Sapient Global Markets. This provided an academic view from the establishment’s

perspective, as well as the innovative perspective.

As one of the largest CSDs in Europe, Euroclear played an important role in the harmonisation of the

European securities landscape. Since the establishment of Sicovam, the French CSD, in 1949 and

currently known as Euroclear France, today, Euroclear plc embodies multiple European CSDs and one

International Central Securities Depository (ICSD), Euroclear Bank SA/NV. In 2009 it launched the

Euroclear Settlement for Euronext-zone Securities (ESES) platform, for standardised cross-border

settlement for the Euronext markets in France, Belgium and the Netherlands. The ESES platform

realised substantial savings for cross-border settlement costs, dropping to domestic level. (Euroclear,

2016) The interviewee from Euroclear has a track record in change and strategic management, areas

that form important factors in successful implementation of new technologies.

Figure 6-2 Structure of Euroclear plc (2016)

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Out of 2000 public companies, based on assets, ING (#29) is the largest Dutch public company in

Forbes’ The World’s Biggest Public Companies. (Forbes, 2016) ING has a market leader position in

Belgium, the Netherlands and Luxembourg for both retail and wholesale banking. Furthermore, ING

can be considered one of the first fintech companies with the ING Direct model. In the USA, this

internet-only banking formula, was launched in 2000. Unfortunately due to the financial crisis and

the Dutch government support that was provided to ING, ING was forced to sell the profitable ING

Direct business to Capital One in 2012. (ING, 2016) Currently, the Direct model is used in multiple

European countries, Australia and Asia. Additionally, ING’s international wholesale banking network

covers more than 40 countries. (ING, 2016) The interviewee from ING, working more than 30 years

for ING, is currently active as a securities market consultant and is considered an ambassador of

market standards in Europe. Furthermore, has been contributing to harmonisation by both

representing ING, as well as advising independently, through active memberships of national and

international industry bodies regarding the securities post-trade market. Having witnessed physical

securities settlement, the process of dematerialisation, decreasing settlement cycles from T+14 to

T+2, and now being on the verge of a transformation towards – close to – real-time securities

settlement, valuable insights were gathered for the research.

The Dutch National Bank or De Nederlansche Bank (DNB) is the central bank of the Netherlands. Its

duties consist of:

- Financial Stability – maintaining a smoothly operating financial system that is resilient to

shocks

- Monetary Policy – creating price stability to protect the purchasing power of the Euro

- Payments – safeguarding a secure and reliable payment system without disruptions

- Supervision – supervising financial institutions for a reliable financial system

- Economic advice – DNB advises the Dutch government as well as performing active roles in

consultative bodies, with independent economic advice

- Research – scientific research is performed at DNB enabling it to perform its duties

adequately with cutting-edge knowledge and information (DNB, 2016)

The interviewee from DNB is an expert in payment, securities clearing and settlement systems, and

currently leading the department focussed on the market infrastructure for cash and payment

systems. Furthermore, since 2011, fulfilling the role as a professor at Tilburg University, holding the

endowed chair of Financial Market Infrastructures and Systemic Risk. (Tilburg University, 2016) In his

June 2016 speech “If Blockchain is the answer, what is the question?” (Berndsen, 2016), a lot of thesis

topics were already covered, which provided clear statements during the interview.

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RISE Financial Technologies is a fintech company providing custom built decentral ledger technology

for multi-asset and multi-currency settlement and safekeeping. The company is funded by

investments of a group of post-trade industry veterans. Furthermore, RISE also provides post-trade

and blockchain technology advice from experts, such as educational programs, strategy

development, assessing business scenarios and prototyping. (RISE, 2016) The interviewee from RISE,

is currently an advisory board member and previously held positions at the European Banking

Federation, SWIFT and a custody and clearing bank. Due to high levels of experience and expertise on

both post-trade and fintech, a constructive view was provided during the interview.

Northern Trust was founded in 1889 in Chicago, today its activities are spread across 20 countries,

servicing sovereign wealth funds, wealthy individuals and families, hedge funds and corporate

brands. The core activities consist of investment management and global custody. As of June 30,

2016, Northern Trust’s assets under custody were $ 6.4 trillion and $ 906 billion in assets under

management. (Northern Trust, 2016) Both interviewees from Northern Trust have been working for

the company for up to a decade, besides having had other management positions in the financial

industry and information technology. Currently, they are working at the department that is

responsible for market advocacy and innovation research. Considering that Northern Trust is an

established financial institution, having survived every crisis and change ever since the Great

Depression, combined with the extensive knowledge levels of the interviewees on both the post-

trade industry and innovation technology, formed a great source of input for the research.

KAS Bank is a European custodian bank that was founded in 1806 and is listed on the Euronext

Amsterdam stock exchange. It services pension funds, insurers, asset managers, banks and

investment companies. The core markets are the Netherlands, the UK and Germany where also their

offices are based. Furthermore, KAS Bank services over 90 markets. One of the interviewees is a

senior director with over 30 years of experience in post-trade operations, and is currently focused on

changes in the market infrastructures and regulations. The other interviewee is a junior global

custody network manager and with a focus on the technological developments regarding to the

financial industry. This formed a perfect combination for an open discussion during the interview,

where many different insights were gathered.

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6.4 DATA ANALYSIS

For proper data analysis, during the interviews notes were taken and for post-processing purposes all

interviews were recorded with the consent of the interviewees and with the agreement to have all

recordings deleted after finalisation of the thesis project. The outcomes of the interviews were

processed in a framework as visible in Table 6-2. By using this framework it became easier to identify

on what topics a consensus view existed and on what topics a more diverted view existed.

Furthermore, the content of prior interviews, that was processed in the framework, was used as

input for the later interviews. This made it possible to confront the interviewees with views of the

other interviewees in a structured way and obtain their input on specific items.

Categories Subcategories Findings per interview

Harmonisation Benefits

Problems/Challenges

Personal view

Block chain / DLT Effect

Necessary for success

Alternatives

Other findings

Table 6-2 Framework used to process the interview findings

Finally, after all interviews were conducted, the interviewees were requested to provide their

feedback and approval on the interview findings by email. In addition, their view on an interesting

finding that emerged during the process, was requested as well. This will be discussed in the next

chapter, covering the interview findings.

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7 INTERVIEW FINDINGS

In this chapter the interview findings will be discussed. The main themes Harmonisation,

Blockchain/DLT and Alternatives will be covered, as well as other findings that came out of the

interviews.

7.1 HARMONISATION

7.1.1 Benefits

There was much consensus between the different interviewees regarding the benefits of

harmonisation on the securities landscape on post-trade level. It was mentioned multiple times, that

further harmonisation by removal of the remaining Giovannini barriers would be beneficial for

alignment between the currently different market standards on post-trade level. Another important

benefit of further harmonisation that was mentioned, is cost reduction. As an example, the ECB’s

€1bn project ,T2S, was mentioned as a big contributor to cost savings. Cross-border settlement costs

drop drastically and will reach domestic settlement cost levels. Additionally, T2S centralises the

liquidity and enforces standardised settlement instructions on the platform by obligatory use of the

ISO 20022 standard. Moreover, this example made also clear that standardisation comes before

harmonisation. Another benefit of harmonisation is that it provides transparency. Due to the level

playing field that comes with harmonisation, it becomes transparent for all participants what the set

of rules is that applies to them.

7.1.2 Problems and challenges

Despite the benefits, there are also downsides for harmonisation. One of the comments that was

heard often, stated that harmonisation is more theory than practice. A lot of arguments were given

as reasons why harmonisation fails in reality. One important challenge that was discussed in many

interviews, is protectionism. This can either be coming from the established oligopolistic players in

the post-trade market, creating friction in the value chain by trying to defend their profitable

business models and capital investments against any disruptive force. Or from governments playing

political power play against other EU member states to protect their national interest. Moreover,

prioritisation and cultural differences can form a serious factor as well. European countries with a

struggling economy, might have other issues having to be dealt with first, before budgeting for

harmonisation initiatives. Some interviewees even stated that harmonisation is costly, painful and

time consuming. All true statements, when taking into consideration that most Giovannini barriers

are still standing strong 15 years after identification and billions of Euros invested in harmonisation

35

and standardisation. Furthermore, it is not always clear for whom harmonisation is beneficial,

therefore not all stakeholders will show the same levels of devotion towards successful

harmonisation. An example of this, is the delay of wave 3 of the T2S migration plan. Furthermore,

most interviewees agreed that successful harmonisation needs to be implemented incrementally and

is more successful when it is business driven rather than regulatory driven.

7.1.3 Personal views

Another view that was discussed during the interview, was that the post-trade world, as it exists

today, is just a digitalized version of the physical securities settlement process. The concepts of

clearing, settlement and safekeeping are still the same, only the way they are handled today are

different. For example, over the last decades, the settlement cycle changed from T+14 to T+2, but

the process itself didn’t change. This could well be caused by the essential requirement of

interoperability. With every change in the post-trade landscape, legacy systems needed to stay

compatible with the new systems. Even when securities were dematerialized, the concepts of

clearing, settlement and custody prevailed. Never has there been a re-imagination of the value chain.

7.2 BLOCKCHAIN/DLT

7.2.1 Effect

On the potential effect of blockchain and distributed ledger technology on further harmonisation of

the European securities landscape, the interviewees were divided. The expectations varied from no

intrinsic difference, since it is just a new technology, to the emergence of a completely new value

chain in which the market is doing what it is supposed to be doing: efficiently facilitating supply and

demand. An example of this could be a shift from T+2, to close to real-time DvP on a blockchain/DLT.

This would have serious impact on the business model of central counterparties that would require a

lot less or even close to zero collateral, to cover for the counterparty risk during the settlement cycle.

Furthermore, the role of central counterparty could become obsolete with blockchain/DLT, due to

instant delivery versus payment in smart contracts in which both legs of a trade have to be fulfilled

for it to be executed and becoming an immutable transaction. This is possible because

Blockchain/DLT creates a level playing field by enforcing the same rules and standards for all

participants. Another interesting finding from the interviews was that Know Your Customer (KYC) and

Anti Money Laundering (AML) policies could benefit from the use of blockchain/DLT. This is because,

with the right setup, transactions and ownership on a blockchain/DLT are trackable anytime.

Moreover, to be able to be connected to a blockchain/DLT, counterparties could be screened before

becoming eligible members. And even use their eligible status on other platforms as well, without

36

having to be screened again. Considering that globally, banks yearly are spending billions on KYC and

AML, next to having been fined in the past for billions for lacking KYC and AML, the costs savings

potential of blockchain/DLT looks promising.

Besides the diverging views, there was consensus amongst the interviewees that the technology

might work as an accelerator for other harmonisation initiatives. As an argument the amount of

money invested in the T2S project was mentioned, for it not being likely that these big investments

by the participants would be put aside easily, to completely adopt new technology. It is more likely

that existing harmonisation plans will be rolled out earlier to be able to compete with the threat of

new technologies that require a re-imagination of the value chain. It was also mentioned that a lot of

parties are now working on all kinds of blockchain/DLT initiatives, driven by the “fear of missing out”.

One interviewee mentioned that this could be an effect of the current state of blockchain technology

in the Gartner’s Hype Cycle for Emerging Technologies. In the 2016 Hype Cycle, blockchain is situated

in the “Peak of inflated Expectations” and with an indicator of “years to mainstream adoption”

between 5 – 10 years. If the hype cycle is to be correct about blockchain, the next few years will be

“trough of disillusionment” before reaching the “slope of enlightenment” and finally the “plateau of

productivity”.

Figure 7-1 Gartner Hype Cycle for Emerging Technologies (2016)

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7.2.2 Neccesities

During the interviews also the necessities for blockchain/DLT to become successful were discussed.

On this segment there was a lot of consensus. Regulator support was mentioned unanimously as a

irrefutable requirement for the technology to be successful. On the other hand, one interviewee

mentioned that the roles of regulators are conflicting. Regulators have to support new technologies,

while also guaranteeing financial stability but also encouraging competition. Especially when

considering the disruptive character of some new financial technologies, supporting these new

technologies and simultaneously safeguarding financial stability seems a paradox. Another

interviewee mentioned, that there was already a successful IPO by the company Overstock.com on a

blockchain with the approval of the US Securities and Exchange Comission (SEC). Also the blockchain

initiative of the Australian Securities Exchange (ASX) was mentioned, that is aiming for close to real-

time settlement and reducing post-trade costs by ultimately replacing its current clearing and

settlement systems. Considering that the ASX already has a vertically integrated model to service

trading, clearing, settlement and custody, implementing blockchain/DLT seems to be a logical step.

Oppositely, the European securities market is much less vertically integrated and implementation of

new technology would be more challenging.

Other important factors for blockchain/DLT to be successfully implemented are interoperability and

interconnectivity. Most interviewees mentioned that it is important that the new technology works

together with existing technology. Again the argument for investments in current harmonisation

initiatives play an important role here. As already mentioned, these investments are not likely to be

put aside. So for new technology to be successful, it should be compatible with the existing

technology. One interviewee called this a hybrid form of old and new technology, existing together

to ultimately overcome the legacy systems. Additionally, operating speed and capacity were

mentioned as key factors of success. Securities are traded in high volumes and at high rates per

second, blockchain/DLT should be capable of processing these amounts without disruptions. One

interviewee mentioned that blockchain technology is not particularly scalable, as can be seen with

the Bitcoin, and that a permissioned ledger, which is scalable, would be the best option for the post-

trade industry. Next to speed and capacity, perhaps an even more important aspect is costs. All

interviewees agreed that the new technology should be significantly cheaper than the current

situation, for parties being willing to adopt it.

Finally, during the interviews it was also discussed how the process of implementation and adoption

by the market would take place. All interviewees, except one, more or less agreed that change will

start small and evolve incrementally over time and is most potentially successful, when driven by the

business. One interviewee called this a proof of value, which is the next step after proof of concept.

38

According to this interviewee, most fintech start-ups only have an idea or a proof of concept to

exploit. And for change to be successfully embraced, proof of value is required. Oppositely to proof

of concept, with proof of value of a new technology, the essential “what’s in it for me” question is

answered. Once there is a proof of value, i.e. a small start, other parties will want to follow the

success, resulting in incremental but exponential growth. Totally opposite, one interviewee strongly

disagreed with this view. This interviewee stated that change will occur revolutionary and a big bang

is created by risk taking pioneers. This implies that the oligopolistic post-trade landscape would be

reshaped in a short matter of time, at least skipping the phase of “trough of disillusionment” within

the Gartner Hype cycle.

7.3 ALTERNATIVES

As a last step, the alternatives to blockchain/DLT with regards to further harmonisation of the

European securities landscape on post-trade level were discussed. As stated earlier, blockchain/DLT

might work as an accelerator for existing harmonisation initiatives. Most interviewees agreed with an

improvement in the standard settlement cycle from T+2 to T+0 as an alternative. Currently, T+2 is a

market standard, but technically T+0 is already possible. For example for OTC trades, intraday

settlement is already possible and applied. Another thing that was mentioned, is that as of January

1st 2016, the European Central Securities Depositories Association (ECSDA) had 41 CSD members

across Europe of which 21 CSDs in the Euro area alone. Mergers and acquisitions amongst these CSDs

is a likely step to happen in the near future and contributes to further harmonisation.

Figure 7-2 CSDs across Europe (ECSDA, 2016)

39

Another option could be the creation of a single European CSD similar to the United States’

Depository Trust & Clearing Corporation (DTCC) model. This would mean that clearing, settlement

and custody would all be vertically integrated within one corporation. Considering the amount of

CSDs in Europe this is not a likely option, and most interviewees stated this would only be possible

when it would be government enforced. Moreover, the contrary might even happen. Due to the

Central Securities Depositories Regulation (CSDR), the same set of rules will apply for all CSDs in the

EU. Due to CSDR, issuers are able to issue additional shares on a different market than they are

already active on. If one market is more attractive – for example due to a friendly tax regime with

low dividend tax and no financial transaction tax – issuers might choose to issue at a CSD in that

market. Furthermore, when there are multiple CSDs in that market of which one is the most

favourable – due to high reliability, lower costs and high levels of service – this CSD might become

the most attractive CSD for new issuances in the EU. Due to CSDR, the custody business, that

historically has had an oligopolistic character, could now become more competitive.

7.4 OTHER FINDINGS

During the interviews also other topics were discussed, the first two interviews were held on June

28th 2016 in London, a few days after the Brexit referendum. Since the people of Britain voted in

favour of a Brexit, talking about harmonisation felt a bit unreal at that time. Although, this was also

an interesting event for discussion. Most interviewees agreed that the Brexit will have a slowing

effect on further harmonisation, at the same time, the show must go on. The remaining EU member

states will continue with the harmonisation process and even when Great Britain is out of the EU,

applying EU market standards could be beneficial anyhow – similar to other non-EU countries such as

Switzerland. With regards to blockchain and DLT there are also some issues to overcome for the

technology to become widely accepted. Events such as the 2014 Mt Gox Bitcoin exchange theft

worth over $ 350 million, the June 2016 $ 50 million Heist of the Distributed Autonomous

Organisation (DAO) and more recently the Bitfinex Bitcoin hack in August 2016 worth around $ 66

million, are not helping the adoption process of any related technology.

The most interesting finding that was gathered during the interviews, is about the Capital Markets

Union (CMU) project. The project aims to mobilise capital in Europe by deepening financial

integration and increasing competition. Currently, investments in Europe are relying mainly on banks,

different rules and standards apply, investments in shares and corporate bonds occur mainly

domestically and many small and medium enterprises (SME) have limited access to the financial

markets. Moreover, revenues on savings accounts are historically low and close to, sometimes even

below, zero. The CMU aims to diversify the financial system, by complementing the bank financing

40

with developed capital markets, while lowering the costs of funding. This is done by unlocking the

capital around Europe and providing savers cross-border investment opportunities and offering

businesses a greater choice of funding options, at a lower price. (European Commission, 2016) This

can be seen as an example, of what has been discussed during one of the interviews, about the

market doing what it is supposed to be doing: efficiently facilitating supply and demand. In this case

the supply and demand of funding. In line with the CMU, in another interview the potential of a

blockchain/DLT venture capital platform was discussed, that could facilitate the supply and demand

for SMEs with regards to funding. Either by debt issuing, turning savers into investors and providing

more capital access options to companies. Or by shares issuing – against a light prospectus regime –

turning savers into owners. This could be a type of regulated crowd funding by issuing existing

financial market products like shares and bonds, but without the burden of legacy systems and

infrastructures. This could be a perfect use case for a re-imagination of the securities post-trade

value chain, without immediately affecting the existing infrastructure and participants. When this

would turn out to be a success, proof of value, then a re-imagination of the existing securities post-

trade value chain would already be a step closer.

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8 DISCUSSION

In this chapter the views gathered from the literature review and the interview will be compared and

discussed. Any names exposed in this chapter will be referring to the literature review and not to the

interviewees.

8.1 HARMONISATION

Many different sources used in the literature review, pointed out that differences in market

standards as well as the number of different providers in the securities market between European

countries, made the infrastructure overly complex. Not only differences on various jurisdictions exist,

but also between different financial products. This complexity has resulted in additional costs for

cross-border securities transactions compared to domestic transactions. Most interviewees agreed

with the benefits of harmonisations initiatives – such as aligned market standards and cost reduction

– aiming to further removal of the Giovannini barriers. They also agreed with the view of Garnons-

Williams and Pierron, that before costs can be reduced, often investments are initially required.

Furthermore, the interviewees agreed that harmonisation has more chance of success when business

driven, rather than regulatory driven. The literature identifies two main views on harmonisation of

the post-trade industry: consolidation and interoperability. According to Considine, the DTCC is an

example of a successful – business driven – monopoly created by the market and can be considered

as consolidation. With regards to interoperability, some interviewees emphasized that with every

change in the post-trade landscape, new systems require to stay compatible with legacy systems.

8.2 BLOCKCHAIN/DLT

With regards to the effect of blockchain/DLT on the securities industry, Berndsen, Carney and Pinna

& Ruttenberg are all expecting similar effects. Disruption is not likely, and adoption of the technology

will be a gradual process of sustainable reformation rather than a revolution. A vast majority of the

interviewees agrees with this view, and is not expecting a revolution. One of the main arguments

that was mentioned, is that current harmonisation initiatives have already required substantial

investments. They stated that it is unlikely that these investments would be put aside easily to be

replaced by new technology. Besides, new technology will also require investments. Additionally,

financial institutions are not likely to give up their vested interests based on a business model

benefiting from existing inefficiencies. However, the interviewees do expect other harmonisation and

standardisation initiatives to be accelerated, with the new technology in its wake. Examples could be

the decrease in the settlement cycle from T+2 to T+0, a consolidation on CSD level by mergers and

42

acquisitions, or more drastically: one European CSD similar to the DTCC model. Considering the place

of Blockchain in the Gartner Hype Cycle, at the peak of inflated expectations, many institutions have

started their own blockchain initiatives. One of the interviewees named the “fear-of-missing-out” as

the main driver for this behaviour. Berndsen identified this fragmentation even as a barrier for

successful adoption of the technology and argues that this could be solved by a worldwide standard

for blockchain technology. Another important barrier for successful adoption mentioned by

Berndsen is interoperability. Especially when taking the vested interests and the investments in

harmonisation initiatives into account, new technology being interconnectable and interoperable

with the existing infrastructure is more likely to be adopted. One interviewee called this a hybrid

form of old and new technology existing together to ultimately overcome the legacy systems. One

interviewee went even a step further by stating that blockchain/distributed ledger technology is

capable of both facilitating consolidation and interoperability. The already vertically integrated

Australian Securities exchange is an example of a potentially consolidated interoperable marketplace

using blockchain/distributed ledger technology. The essence of interoperability has also been

emphasized by SWIFT as a Registration Authority for the ISO 20022 standard. ISO 20022 is the

current market standard used broadly within the financial industry. Rather than re-inventing the

wheel, SWIFT encourages parties to apply the existing standards setup in distributed ledgers. This will

both save time and contribute to interoperability simultaneously.

The unanimously mentioned factor for successful adoption of distributed ledger technology, is

regulator support. Although, one interviewee emphasized the conflicting role of regulators.

Regulators have to support new technologies and encourage competition, but on the other hand also

guarantee financial stability. To a certain extent this is visible in the conclusion of Carney’s published

speech, where he illustrates three possible transformation processes for the financial industry:

revolution, restoration and reformation. However, in the conclusion – by stating that the BoE will

help to enable a sustainable Fintech reformation – it becomes clear that the BoE not only is

supporting the Fintech industry, but at the same time wants to prevent disruption of the industry.

Technical aspects play also an important role in successful adoption. Operating speed, capacity and

scalability were named specifically as key factors. Although, one interviewee also stated that

blockchain technology is not particularly scalable, Peters & Panayi as well as Malm & Wall agree with

this view. A solution would be a permissioned distributed ledger that is much more scalable and able

to process millions of transactions per second as illustrated by Creighton’s Domus Tower blockchain,

that caters for operating speed, capacity and scalability. Considering the trading volumes in the

securities industry and its requirement for scale, operating speed and capacity, a permissioned

distributed ledger would suit this industry best. More importantly, permissioned distributed ledgers

43

are considered to be much more safe compared to unpermissioned ledgers, due to the use of

validated nodes to validate transactions, rather than validation through PoW or PoS consensus

mechanisms. After all, the successful attacks, where multimillion dollar equivalents were obscured,

have all taken place on unpermissioned distributed ledgers. Finally, one of the most important

factors – unanimously agreed upon by the interviewees – is that the new technology should be

significantly cheaper than the technology it is aimed to replace.

44

9 CONCLUSIONS AND LIMITATIONS

The goal of this thesis, was to examine the role that blockchain/distributed ledger technology can

play in contributing to further harmonisation of the European securities landscape on post-trade

level.

This has been accomplished through:

- Providing a theoretical background on the European securities landscape, harmonisation and

standardisation initiatives and blockchain/distributed ledger technology

- Critically assessing literature on harmonisation on post-trade level and

blockchain/distributed ledger technology

- Interviewing key industry players in London and Amsterdam

- Discussing the interview findings with the literature review findings

9.1 CONCLUSION The research question for this Master thesis is: “To what extent can blockchain/distributed ledger

technology contribute to further harmonisation of the European Securities Landscape on post-trade

level?”

The contribution of blockchain/DLT to further harmonisation of the European securities landscape on

post-trade level, can be divided into two categories: direct contribution and indirect contribution.

According to the Gartner hype cycle, blockchain technology is at the “Peak of inflated expectations”

with an expected time to adoption of 5-10 years. Therefore, direct contribution will most likely

consist of the incumbent financial institutions embracing blockchain/DLT to improve inefficiencies

without impacting the business practice – as illustrated in Scenario 1. Market players can improve

multiple internal processes by using blockchain/DLT, without affecting existing business models.

More importantly, post-trade parties have already invested massively in current harmonisation

initiatives and market standards, such as T2S and ISO 20022, making it unlikely that these

investments will be put aside easily for technology that yet has to mature. Although, due to the fear-

of-missing-out effect, many parties have been developing in-house blockchain/DLT solutions, without

thinking of interoperability with the external world. This non-interoperability, might potentially form

a barrier of adoption of blockchain/DLT.

Indirect contribution, is mainly based on the accelerating effect of DLT on the rollout of existing and

planned harmonisation initiatives. These initiatives are either to be found in the area of

interoperability or in the area of consolidation. However, considering that business driven

45

harmonisation is generally more successful than regulatory driven harmonisation, the path of

interoperability seems to be most logical. Interoperability allows the incumbent financial institutions

to, at least partially, hold on to their business models. Moreover, interoperable blockchains/DLTs,

fully compatible with the existing market standards, such as ISO 20022, are more likely to be adopted

and less threatening to the incumbent financial institutions. This is especially important since

harmonisation is often considered more theory than practice. A practice in which unwilling market

players can have great influence on the adoption of new technology. In this scenario, blockchain/DLT

will not overtake an entire industry, but will be much more like an asset to the existing infrastructure.

There are also important necessities for DLT to be adopted. Technical requirements are operating

speed, capacity and scalability. All aspects better catered for by permissioned distributed ledgers

than unpermissioned distributed ledgers, due to its much more efficient consensus mechanisms.

Furthermore, due to the use of trusted nodes in permissioned distributed ledgers, safety is also

facilitated better compared to unpermissioned distributed ledgers. Another necessity is regulator

support, although regulators do have conflicting roles. On one hand they have to maintain financial

stability, while on the other hand regulators have to support new initiatives.

Conclusively, disruption by blockchain/DLT on the post-trade environment is not likely, and adoption

of the technology will be a gradual process of sustainable reformation rather than a revolution. Most

important reasons are that the incumbent post-trade market players, have invested heavily in

current harmonisation initiatives and do not want to lose their current business models.

Furthermore, blockchain/DLT interoperable with the current market standards, is much more likely

to be adopted. Additionally, regulators want to maintain financial stability and will therefore not

support entirely disruptive initiatives.

Therefore:

“HARMONISING THE EUROPEAN SECURITIES LANDSCAPE, ฿IT BY ฿IT”

46

9.2 LIMITATIONS The limitations of this thesis are that important aspects such as legal and tax requirements have been

left out of scope. Furthermore this thesis only focussed on the on exchange stock trade related post-

trade environment. Blockchain and DLT could also have an impact on OTC trading and on other asset

classes such as foreign exchange, money markets, capital markets, repurchase agreements, securities

borrowing/lending, interest rate derivatives and many others.

Suggestions for further research in the area of financial markets would be:

- Investigating the legal or tax implications of blockchain/DLT

- Investigating the effect of blockchain/DLT on the OTC trade environment, especially the use

of smart contracts

- Investigating the effect of blockchain/DLT on different asset classes

- Investigating the potential of blockchain/DLT with regards to the Capital Markets Union

- Investigating the potential of blockchain/DLT with regards to CSD Regulation

47

APPENDICES

APPENDIX I: ON EXCHANGE SECURITIES TRADE

$

$ $

Buyer

Bank A

Exchange/MTF

Seller

Bank B

Broker X

Central

Counter Party

Bank B

€

Bank A

Bank A

Bank B

Securities

Central Securities

Depository

Cash

National Central Bank

On Exchange

Broker Y

48

APPENDIX II: THE NETTING PROCESS (BANK OF ENGLAND, 2013)

49

APPENDIX III: DISTRIBUTED LEDGER TAXONOMY (GOV.UK, 2016)

50

APPENDIX IV: CONSENSUS MECHANISM DEVELOPMENTS OVER THE YEARS (KPMG, 2016)

51

APPENDIX V: THREE SCENARIOS HOW DLT MAY AFFECT THE POST-TRADE SECURITIES LANDSCAPE

(PINNA & RUTTENBERG, 2016)

Scenario 1

The incumbent institutions embrace the new technology to improve cluster/internal efficiency,

leaving business practice “as it is”.

52

Scenario 2

Core players, such as CSDs, adopt market-wide distributed ledgers. In this “adoption model”

scenario, at least some peripheral players might become redundant.

53

Scenario 3

Issuing companies, governments or fintech companies take the lead in implementing peer-to-peer

systems for securities transactions, thus taking the post-trade industry into a “new world”

54

APPENDIX VI

Shared business definition requirements between ISO 20022 and DLT for interoperability (SWIFT,

2016)

55

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