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In recent years, blockchain technology has become ubiquitous and the introduction of blockchain into capital markets has garnered much interest. At present, operations of the capital markets are steeped in complexities owing to the fragmented data and IT architectures. Now the question that arises here is - Can the introduction of blockchain bring about the much needed structural change in the capital markets?
A capital market system based on blockchain is an ideal setup as the data records would be centralized but held in multiple levels of ownership. Asset managers and smart traders are waking up to the possibilities of rendering blockchain technology as an integral part of capital markets. Blockchain simplifies several areas from accounting and asset servicing to administration and allocations, apart from allowing for a shared view of authorized data. Implementation of the blockchain technology has several benefits that sync with the capital markets.
A streamlined trade settlement is the first benefit and has been made possible through the creation of a smart contract wherein it allows for reliable transactions without a third party. Access to the centralized data by all parties can help eliminate the need for manual settlement confirmation due to the transparency benefit of the ledger.
Trading limit violations are significantly reduced with the introduction of the blockchain. Financial firms can incur considerable losses through compliance violation of trading limits. A series of smart contracts and distributed ledger can contribute to the avoidance of the whole trade. Trades occurring over the determined trading limit can be reversed or blocked if the smart contract terms are not met. Any suspicious trading activity that is on the brink of compliance violation can be detected and remedied through a distributed ledger.
Periodic generation of mark to market (MTM) valuation reports is a requirement of regulatory compliance. With the trade data being on the ledger, updated reports on market positions could be generated and positions closed, if the MTM violations existed.
Ideally, the opposite party should be credible and approved to do capital market transactions with financial firms. In order to cover the market risk of the asset that is being traded, an internal credit line is established. The credit line determines the credibility of the company for successful transactions. The shared ledger acts as a centralized depository for the financial institution. So, if the overall credit situation of the company deteriorates an immediate notification would be shared between the bank’s credit risk officers and the trading desk’s credit team. The result would be an improved risk management of the client’s credit situation and the overall credit risk of market instruments to financial institutions.
Blockchain has the potential to bring about a structural change to trade operations in the capital markets. Market risk can be efficiently managed through an overall view of capital markets. In the next few years, efficient management of the activities in the capital markets can be realized through the blockchain technology.
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