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Clearing and settlement for global financial institutions
Matthew Bishop, The Economist - Moderator
Charles Cascarilla, itBit
Chris Church, Digital Asset Holdings
Brad Peterson, Nasdaq
Sandra Ro, CME Group
MB: Good evening. Nearly time for a drink, but before that we will have a stimulating conversation about payments and settlement. It's one of the startups coming in and got a banking license, mainstream next to him is Chris Church who is running one of the companies at hte moment that is a startup digital asset holdings. Formally, Brad was at eBay, he came from Silicon Valley and is now at Nasdaq and is at the heart of all the dinosaurs. Lastly we will have Sandra who is at CME which is again one of the old firms in the industry. As I think about this question of how ledger technologies is going to disrupt the mainstream financial services and have in turn how that will effect the broader economy and how this revolution of how we and I guess how we will be part of. I can see three scenarios. I want to ask each to give their thoughts about the likeliness of each scenario. One is the inspirational scenario that many people have become aware of with blockchain hard-core believers, which is that this is to be the chance to be the internet of the digital economy and to really get it right in a way that the first wave of the internet didn't, which allows decentralization and getting rid of intermediaries and allow for massive opening up of how the economy works. The second scenario is .... is out there.. and I will see... probably closed. Into the blockchain or ledger systems that will effectively allow them to get many ... from many... most of the profits and it wont have some of those revolutionary benefits, it might actually stop the broader blockchain systems that everyone is part of from happening. The third scenario is that this all massively overhyped, and in 5 years time we will wonder what it was all about. We know there are massive stakes here. About 1/3rd of all revenue and profits comes from intermediation, and much of that could be wiped out... So I want to start with Brad, as a man who has moved from Silicon Valley to Wall Street, how do you see these scenarios?
BP: Let me take on the third scenario. I don't believe that in 5 years we will say nothing happened. I would take that scenario off the list right off the bat. With the web, everyone was excited about the possibilities. Some of the financial service firms were lagging. The lesson was learned and htis isn't happening again; the financial services firms are doing amazing engagement at all the board levels of all the financial institutions. I think there is going to be and this is an exciting thing I saw at lunch, meeting some of the folks talking about the discussions and so on, I think there are going to be some major business models created that we haven't thought about yet. Amazon created the-- well they had the brick and mortar debate, will the small merchants go away? Well there was certainly a massive company created at Amazon. I think the incumbents like the old merchants, and the web, this will be an opportunity for major overhaul and revitalization. Modern financial companies need a lot of work in overhaul.
MB: So you said the dinosaurs might knock the system down?
BP: I am stealing that from a panel in Washington, there's the risk in regulated industries that there are rules that lock in, and someone who-- there's a risk that you lock in the dinosaurs. This is something that I think the regulators are very engaged in and I hope that the outcome is that this becomes less true.
MB: We will talk about SWIFT. How do you view these scenarioes?
Church: There's a lot of hype. Perhaps it's justified.... there's no smoke without fire. There are tremendous benefits for financial services that ... when it comes to specific financial services, well it's about dinosaurs, a lot of people use the term "disruptive" that it will destroy this or that institution. I think it's different from that. I think it's going to be transformative for financial services. There's a lot of really powerful drivers. It will be disruptive, but to processes, but probably not in the short or medium term to institutions. This is a generality. In 1995, there was a debate about banking and the internet, would it be the death of banks and would the internet takeover? It didn't happen. Every bank has a good online presence now. There's plenty of bricks around. Were there causalties? Sure, blockbuster doesn't exist anymore. Some businesses will go away. Intermedaries that we know of today, we believe they will still exist, the processes will be disrupted and I think the final point is that one of the big drivers behind this is in fact regulation. Regulators have spent a lot of time since 2008 making sure this is a secure reliable sound system, trying to take risk out of the system, and perhaps tomorrow we will hear them tomorrow about-- my belief is that regulation is going ot preserve the institutions, it will take an act of congress to change the roll of DTCC. I think it will still be there. Will their processes be transformed and changed, absolutely. I think many of those older dinosaurs are going out of their way to figure out this paradigm. By the way, I don't work at DTCC. They ran a symposium and invested in a blockchain company, they put out proof-of-concepts. There are people that are looking to see how they can transform. Transfsormation yes, disruption of institutions no, disruptions of processes yes.
BP: As I think about folks that capitalized on the web, well you have USAA. They had a major business porblem, how do they connect with customers? They saw the web as enabling communications to connect with their customers. They were one of the first firms to buy an iphone because they knew that was a new way of connecting way of their customers. They already did the iphone app with scanners and check deposits. They were overcoming their disdadvantages and so on... whereas the big banks with huge ATM networks didn't have that infrastructure. Companies that don't have infrastructure to worry about not cannibalizing, and someone who is sitting in the right position so they can do the USAA or Amazon move, it's going to be a big sweeping movement that will come out. That's a prediction that I would fine tune.
MB: Between my scenario 1 and scenario 2, and the other scenario that most peope - that most of the revenue and most of the profit from intermediation and payments and settlement, whereas scenario 2 is, banking financial system manages to get its act together, it might be able to maintain a lot of its profit and so on.
Church: I think the challenge is that, the revenue is not doing .... cost of capital is going up, regulation is putting up costs too, it's not a great place. This is perhaps one of the reason why bitcoin is taking hold, why everyone in the C-suite is asking, figure out what this is doing to our business. There's a lot of people looking at this. Yes there might be some revenue. Some of those revenue lines may be reduced, but others will increase because just as back in 1995 we didn't know everything about the internet, back in 2015-2016 when people started to wake up to this tech, we also don't know all the revneue possibilities. Some of the financial markets will see the transition to a blockchain environment to a platform with new revenue and new services will be gleamed. We think this will be the case.
MB: Some people say CME is going away, Sandra?
SR: Never in the back decade in banking has there been an opportunity for new entrants to come in, although regulation is very strict and onerous, never have I seen a better opportunity for new players to come into the market and take pieces of lots of pies in banking, trading and financial services. I think the scenario we are going to see is the incumbents who manage to adapt the quickest will get bigger. The ones who don't will end up like Blockbuster or Barnes & Noble. We're going to get new entrants that we don't even have today. Who will become the Amazon of banking or finnacial services? I see the confluence of mobile tech, with the advent of bitcoin, crypto, digital assets, all coming together in a fashion at a time when confidence in the finance sector and the cost structure of financial services sector is suboptimal. To me this is a perfect storm.
MB: Your institution has resisted modernization for a long time with the idea of would the trading floor ever go away. How does an institution like that get someone like you to think about these issues? What is your mandate? How is that process?
SR: I like to say that CME is the ultimate big fintech company. We're $30B market cap. We're 2200 employees. We're writing an engine that runs all of our trades, we do 18 million contracts per day in the futures market. This is something we have already built and keep maintained. We can't manually process 18 million contracts. We're throwing down our pits. You probably heard last year we closed the majority of our pits in July out of the CBOT. We are evolving. We have gone from pit trading to electronisation. About 90%+ is electronic trading. We're going to go from electronic trading to digitization. People trade, no matter what. People like it. That way of trading might change, it might be mobile or something else, people will continue to trade. It's our vested interest to evolve with bitcoin.
MB: Charles, about regulation, why do you need a banking license and how does that change your view?
Charles: I think it's a bit of all three. It's going to make a lot of changes. I think it will be disruptive. Because of the changes. I wouldn't be surprised how little things will change in 5 or 10 years, it's kind of all of these things. I think blockchain is ultimately a database. That's all it is. It wouldn't be a good conversation topic for most conferences, "hey i have a database"- but that's what it is. It's more, but if you really want to be cheeky, that's what you would say. How do you apply this new tool and to what process? Right. And so, the problem that it is going to be applied to are the ones where it can make a difference in near-term, and as it gains credibility and people build faciities, it will apply to bigger problems.
MB: What are the big opportunities now?
Charles: Wall Street works on comp cycles. If you think you're going to change a cycle of adoption over 5-10 year horizon, I think that's a possibility but not necessarily a probability. But if you say you can address processes over the next 12-24 months is a time horizon where firms are interested. They are pressured on a capital basis because of Dodd-Frank. So can you show me examples of implementing this in a way that is cost effective? It's never worked that way, you might get to the point where the world is there, but it wont happen in next couple years.
MB: So what does that logic tell you?
Charles: I think it's individual markets. Where do you want to use it? I think you could use this in healthcare or almost anywhere. You could go on and on. We focus on financial services. We're focused on certain markets already centralized. And so that's an example of where we apply it, it doesn't mean it's the only one. Maybe post-trade, $85 billion market. Change how bonds are issued. As you saw with Delaware today, chairs... big opportunities, lots of ways ot change htings, but if you said the whole world is going to after 5 years... but also you could make a plausible case that it is not going to change much in 5 years...
MB: Personally I think... .... how quickly could it be disrupted when we look at other industries being disrupted? You have this very conservative regulation, and a framework has become more conservative and more onerous post 2008 crash. I mentioned this... how, how important is that in enabling disruption and do you think regulators ... is it faster change?
Charles: The reason why we went for the trust license, which is similar to a bank license for most purposes, marrying a regulated entity with the tech is very useful. It's not necessarily good or bad, it's just how we apply the tech. We can do unique things by having access to the financia system and also having an accounting solution. Your ability to plug into SWIFT or certain repositories like DTCC, these are unique things that we have. This doesn't mean everyone should do it, that's just how we approach it. It's a big world out there, there's lots of ways to do things in this big world, we have taken a unique tact, it took a long time for us to form our trust, over 2 years of processes all over the place. We have regulatory capital, regulatory exams, regulatory filings just like any other regulated financial institution. This is a double-edged sword... while we thinks it's great for our business model, ....
Church: Sending message and takeaway would be, think of this as both basic level and usable, there is a promise of lots of sexy things to come, but not all of those are realizable today. Will they come with time? Probably yes. Will it transform the industry? Absolutely. Can you adopt it now? Absolutely now. We are engaged with the Australian Stock Exchange. They want to replace a part of their clearing and settlement system. They want to do that in a short timeframe. We can take them from their old legacy tech which needs replacement, to using distributed ledger technologies, similar but different. The first phase of distributed ledger tech gives them significant benefit during settlement. This is a reduction of cost of reconciliation because you actualy can have in a neutral database that everyone believes in and does not interfere with, it massively reduces the cost for all the participants involved. It's a new form of database, it reduces cost of reconciliation, but there's much more than that. It increases security. The promises are there for the taking. But for phase 1 and phase 2, let's see what works.
MB: Do you feel regulators will be obstructional or do you think they will drive this forward?
Church: Interestingly, all the regulators are conducting exercises, doing studies, trying to figure out what the implication is of this tech in their respective domains. It's not often that the tech comes along, that can solve so many challenges in a post-trade financial services world. You're not taking about just bitcoin-- which they don't like because they don't control it... Once they realize this is a group of technologists that can bring positive transformative solutions, they get rather excited and interested. There are some Australians, they are very vocal about their beief in this, ASIC one of the regulators have gone .. chair of basic or I-OSCAR... is vocal about the promises that these can bring to financial services. My words not his, I think there's an underlying concern about the unintended consequences.... but is that.... I think that's going to need work.
MB: And... how do you.. any given ..
Church: Australians are right up there with all the jurisdictions you mentioned, Singapore, Canadians are also looking into this, Brits are looking at all sorts of things. I think all of those jurisdictions are on board with something here, we have to do something with bitcoin, and CFTC at the DTCC conference said- take the same approach with internet... whether that's realistic or possible, different regulatory agencies might take another view, I think they are trying to figure it out. Because of the nature of transactions and hte purpose of, I think you could see a transaction happens, but regulators want to see everything. With this tech, you could give people full access, partial access or no access to the underlying data, which is powerful for regulators who want more transparency... and by the way, they are worried about cybersecurity and this adds another layer of security for databases which have perimeters of security, but a distributed ledger has those parameters plus transactions that has another layer of cybersecurity.
MB: What od you see as the... what are the forces?
BP: So what is going to benefit the customer? In the investment world, as an investor, the other side of that is the issuer... that's the part that you play, so companies raised on... and many in the room have gone through that process, you raise money, you raise a series of rounds, you become a public company, that whole process has elongated and there's companies out there-- you look for the kernel of what's going ot motivate a customer to change their behavior, you see companies with great business leaders that thing, maybe they don't want to go public. So we're building a system to keep you private longer, get oyu access to capital, stay private forever.
MB: Is this using smart contracts?
BP: This is just a potential alternative marketplace. You could end up with all of the benefits of a public market but with a private market. The thing that has happened with issuers is that you have ... you got a lot of overhead and a lot of risk by exposing your business plan to everyone. So there's a fundamental shift in one of the main classes, I really want to raise money and build a great company but maybe there's an alternative way than going public. Where I came from at Schwab, which was founded by someone who was looking to benefit the.. very much different from a different approach with tech, I think there's a similar culture to USAA. They focus on benefits for their members. If you want to look for evidence of change, how quickly will these things change? And you need to get the timing right. Everyone else in the middle, everyone ese isn't serving the customer. The end parts wont go away. People need access to capital. And all the rest, anything between, they could be maimed to some extent and be much more efficient.
MB: There's an $87 billion post-trade market. Do you see any changes there?
SR: I think everyone is trading on post-trade ever since-- whether it's settlement or collateral movement or margining, reporting, there's a lot of functions that could be improved. The way that we're approaching this and ooking at these processes and whether we apply blockchain or not to that is the "so what" question. What problem is it solving? What customer experience is it improving? Is it saving money for us or for the client? If it doesn't start answering those questions, then we have to ask so what? And we have looked at a number of different technologies in the distributed ledger space, and there's nothing that could do what we do today which is to move around the amounts of money we do every day, as well as the number of contracts we run each day. So I think we have a long road ahead. But I think we will look at startups and tech firms that have promise, look at the industry bodies looking to commit together the global framework as best we can. We are willing to support that.
MB: Are you involved in hyperledger?
SR: Yes so one group we joined was the Linux Foundation Hyperledger Project. We are one of the governing board members. Why would we do that? For us that's for creating open standards, bringing in services together, bringing in tech firms, in every industry not just financial services. If this grand experiment works, .... but at least we tried. That's what's most important. Try to get the various groups together to create a common fabric.
MB: We are almost out of time. We managed to get through an entire panel without talking about bitcoin too much. What is your view on bitcoin? Is bitcoin something for the history books? just the ledger technology? Does bitcoin still matter?
Charles: Going back to what I said earier, bitcoin is a type of distributed database, it's open public anyone can access it. The price of bitcoin is the price of accessing it. Bitcoin does not purport to solve every use cases. There are some great use cases for this. But not all of them.
MB: Will it be the bitcoin blockchain database? or other sorts?
Charles: Where are most of the assets going to be? Well perhaps there's some design in Bitcoin, but maybe there will be some solutions or something, there are some design solutions for Bitcoin- and they are a public distributed database and I am optimistic they will be solved. I think bitcoin will be the vehicle.
Church: With Bitcoin, I'm not sure, it has a lot of experienced people. I also think that where every bitcoin goes, it will be a catalyst in financial services and also spur discussions with central banks for whether to digitize fiat money. That could be good for bitcoin. That's an open question.
BP: Yes. One of the big opportunities will be internet of things, devices and scare resources not involving people, I think we saw tihs with Lightning team which is here.
SR: I think it goes without saying that where we stand on Bitcoin, we will be launching a Bitcoin reference rate. So that's what we think.