The European Central Bank said distributed ledger technology and other fintech innovations may lead to more efficient financial market infrastructure but interoperability could lead to fragmentation.
In a report, The potential impact of DLTs on securities post-trading harmonisation and on the wider EU financial market integration, the ECB’s advisory group on market infrastructures for securities and collateral said that as DLT is adopted, there may interoperability between the different generations of technology.
The ECB warned: “New DLT-based services that do not interoperate with the financial infrastructure we use today may lead to fragmentation.”
The report said the possibility that DLTs may be adopted in the securities post-trade environment has been widely discussed since 2015 but discussions on the potential impact on integration are still at a preliminary stage. The central bank continued that legislation has been aiming towards non-discriminatory access and interoperability for trading, clearing and settlement; and harmonisation and standardisation of current market infrastructures, and the same principles should be applied to new technologies.
The report said interoperability refers to both connections between upstream and downstream services in a value chain, such as trading and clearing, and arrangements between different suppliers that allow their respective customers to transact with each other, such as linkages between central securities depositories.
“Both value chain and lateral interoperability require non-discriminatory access to ensure a level playing field for a range of services offering a choice to consumers,” added the ECB. “Access and interoperability require non-discriminatory access, technical standards and consistent regulations.”
In July last year the TARGET2-Securities project, which aims to harmonise securities settlement across the Eurozone, established a task force on DLT to analyse how such innovation may affect the harmonisation efforts of T2S and also the wider EU financial integration agenda.
“Agreed T2S standards could in principle be kept in the case of DLT adoption, but it does not ensure that developers and adopters of the technology will take a unanimous decision in that respect,” added the ECB.
For example, the ECB said DLT solutions currently under development appear to be diverging from standards agreed in the T2S community for numbering securities and cash accounts. For payments in fiat currency outside a DLT network used for securities settlement, there should be a link between the securities delivery instruction entered into the distributed ledger and the cash payment.
“Creating a post-trade environment where the accounts of different DLT networks would merely coexist without interoperating is not an optimal outcome, as it would create a fragmented post-trade landscape,” added the ECB.
Delivery versus payment settlement is currently used to limit risk in the post-trading of securities transactions. The ECB said the same opportunity can be made available in a DLT environment, either by issuing cash in the same type of distributed ledger adopted by the relevant securities settlement system or by allowing a seamless interaction between such a ledger and non-DLT payment system.
“The provision of cash to be used for DvP settlement of securities transactions is an opportunity insofar as DLT adoption is considered to be an opportunity for the securities leg and the related asset servicing activities,“ added the ECB. “This is conditional on the realisation of potential benefits, which DLTs might be able to deliver only if the necessary harmonisation and interoperability among DLT solutions were achieved.”