Distributed ledger technology for Central Securities Depository (CSD) | HCLTech

Distributed ledger technology for Central Securities Depository (CSD)

Distributed ledger technology for Central Securities Depository (CSD)
July 20, 2022

Distributed ledger technology (DLT) has been witnessing its share of progress in the Capital Markets landscape. Till now industry’s approach has been fragmented when it comes to business process development on DLT and taking it to production. We are now seeing a shift towards more mature and stable development of applications in a collaborative mode.

Within capital markets, DLT has found applicability in functional areas of client onboarding, issuance, trading, and post-trade processing. Further, consensus has evolved within the Capital Markets community that post-trade life cycle areas comparatively possess more scope for DLT applicability. This reduces large amount of friction that currently exists and will provide real long-term benefits that would positively impact the infrastructure and execution of current processes.

The complex post-trade life cycle is chained through processes provided by multiple intermediaries, with each process adding value in its own way. The intermediaries typically include brokers/dealers, custodians, clearing houses and its members, central securities depositories (CSDs), issuers, transfer agents, and registrars. These intermediaries work on their own siloed ledger and technology, thus, consuming significant time in communication, reconciliation, and risk management.

There is a view that DLT technology would completely make some of the intermediaries redundant, as by nature it has a potential to disrupt the existing infrastructure and business processes

There is a view that DLT technology would completely make some of the intermediaries redundant, as by nature it has a potential to disrupt the existing infrastructure and business processes. CSDs are seen as one of the potential candidates for becoming redundant. CSDs are aware of these changes, and it would be interesting to note the positioning of CSDs against the disrupting technology of DLT, as most of the intermediaries directly interact with CSDs in various capacities.

Impact of DLT on Central Securities Depositories (CSDs)

In the current post-trade setup, CSDs play a key role in securities ownership recording and safekeeping, securities deposits, transfers, withdrawals, title transmissions, settlement process, and asset servicing i.e. corporate action, security lending and borrowing, and pledging. Supporting these core functions are the processes such as onboarding, system administration, account management,fees/charges/penalties, reporting, and communication. This requires a massive amount of communication with the intermediaries and exchange of data over links.

Repositioning CSDs in a DLT setup

Table 1 – A representative view of DLT touch points in a CSD

System Administration

Account Management

Deposits

Transfers

Withdrawals

Title Transmission, Witness

Asset Servicing

Authorized people list for CSD access 

CSD depositors account setup

Securities deposit setup

Securities transfer request process

Securities withdrawal request

Transmission of title on death, bankruptcy, and winding-up

Corporate actions– Voting, bonus, splits, and rights, etc.

CSD tasks access

Account closing, reactivation, suspension, release of suspension of securities

Uploading/entering deposit data, moratorium data. 

Transfer reports generation

Withdrawals reports generation

Witness updations

Security borrowing and lending

User management

Account enquiries- Balance, statement request, intra-day activity report

Deposit reporting–Internal, client

       

Application for CSD tasks

           

CSD Terminal setup and access

           

 

Note: The table shows the processes impacting functionality on DLT (e.g. Asset/Collateral/Cash Ledger, Access Nodes (Terminals/Printers, etc.)

For CSDs to remain relevant, they are already thinking about their future role and the value they can bring in the new DLT-led post-trade setup. For this, they can consider to act as enablers of the business processes and infrastructure. Some of the roles those CSDs can consider, include:

  • Administration of the securities token system and a setup for protecting the private keys and wallets of investors, as losing them would mean losing the ownership of the underlying digital assets.
  • Management of underlined securities, against which the tokens are issued and exchanged
  • Creation and maintenance of smart contracts for the post-trade service scope.
  • Transferring the ownership of the asset through book entry at the CSD is a legally approved and regulated process. Replacing this process with DLT-led ownership might require appropriate amendment to rules and regulations. In either case, CSD can operate as a platform facilitator.
  • The CSDs could act as an authorizing and administrating body for the various participants on to the DLT. They are perceived to be in the best position to act as a guardian of the new system.
  • As the CSD has access to the entire ownership list for securities, they can effectively manage the eProxy voting process over DLT. They can also play a role in other elective corporate actions like right issues.
  • Due to complete view on the asset ledger, the CSD can play an effective role in security collateral mobilization, both locally and globally, and also in collateral ledger maintenance.

The DLT application in CSD functions that will help gain process efficiencies, transparency and predictability are as follows:

  • There would be a common asset/cash/collateral ledger viewable and accessible to the permissioned participants. Thus real-time, common data of the holdings and transactions can be shared with all.
  • All the participants will be on boarded onto the same technology platform, standardized communication protocol and user experience.
  • It can facilitate real-time settlement, ownership transfer and payment transfers between accounts.
  • On DLT, the settlement risk is perceived to be lower due to the use of a single-settlement solution to guarantee the settlement.
  • Various types of reconciliations which are carried out with CSD participants on a regular basis will not be required. Thus, this will bring in efficiency, savings in time and effort and reduced risk.
  • There will be reduced cost in data management activities and back-ups.
  • Possession of end-to-end traceability of securities and money flows.

Conclusion

A distributed ledger provides a new way to record and transfer ownership of securities. Potentially, a CSD can play a significant role as the ultimate custodian and an administrator of the DLT ecosystem. Currently, a CSD has been piloting independently on a limited scope, with a cautious focus on an incremental amount of investment needed on continuously evolving DLT technology.

As CSDs are perceived to be the trusted hand, so to ensure their relevance in the long run, they must build and operate an end-to-end ecosystem. This will act as the backbone for a smooth operation of the post-trade processes. Implementing the technical solution will be complex and a long-term play as it would involve drastic changes in the traditional CSD business processes. This would require commitment from its participants and regulators. Hence, CSDs must have a detailed view of their DLT requirements, target state and operating model.

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