Paving the Way for Cash on Ledger in Capital Markets
Euroclear is a particular bank. Founded in 1968 as part of J.P. Morgan &Co. to settle trades, it holds 37,6 trillion euros of assets for its clients today. The company executes 276 million transactions per year, amounting to a value close of 1 quadrillion, explained Glen Fernandes on July 7th at The Banking Scene Afterwork.
Glen is part of the company's Strategy team and joined us to tell a bit more about their collaboration with Fnality to put cash on a ledger. To understand what that means, it is essential to get the basics of Euroclear’s business right.
Euroclear is a Trust Business
Glen: “Euroclear was designed to have a cash and Securities Exchange simultaneously and in an electronic book into a database format.” Euroclear is built to overcome the challenge of long delays and physical transfers of securities and all the risks attached to this.
These basics demonstrate once again that banking is a trust business.
The company was a collaboration of 120 financial institutions, of which most are still today partners and clients.
Glen: “Today, we cover different parts of the entire lifecycle of a bond or equity that goes through the market, right from the time when an entity like a sovereign or a corporate goes to the bank and wants to borrow capital to the time that it starts trading on a stock exchange, or over the counter, to the time that they settle that trade within the Euroclear system; we find very creative ways to finance that settlement as well.“
Needless to say, DLT and blockchain technologies open many new doors to build new services and optimise existing offerings to an institution like Euroclear.
Glen: “Over the years, we've upgraded and mastered the electronic delivery vs payment mechanism super efficiently and very well. Right from the beginning, we always took an approach to do that with our clients, the major banks, to ensure that it's fit for purpose for the industry. Now there's this whole new way of digitalisation with blockchain. The key question is how can it be designed to work efficiently and how can some of its qualities be embedded in our, and our client’s business, like programmability of money.”
Fnality Bringing Cash on a Ledger
One of the solutions Euroclear looked at and is now effectively investing in is Fnality. This all started with the quest of one of their partners.
Glen: “One of the global system banks called in the banking industry and came together to try to solve one problem. At that time, you had a number of the DLT platforms coming up, but the problem was that you didn't have a cash solution for the DLT platform.”
There were many platforms to buy tokenised assets, but the market was, and in a way still is, missing the vault capabilities to store digital cash to pay for them when the actual asset exchange took place. The providers that offered the right technology were not (sufficiently) regulated, had questionable credit worthiness, or missed a clear legal qualification of their offering.
Glen: “So, the banks set themselves up to try to find a solution that could be trusted, would be fully regulated and try to have this sort of achieved gold standard of creditworthiness.”
That is the foundation of Fnality, as we can read on Euroclear’s website: “Founded in 2019, Fnality International is a consortium of global banks that are building regulated payment systems to support the growing industry adoption of tokenised assets and marketplaces. By using distributed ledger technology (DLT), Fnality offers central banks a simpler, faster, safer, and more resilient system for managing payments.”
Glen acknowledged that today there is no one solution that has all the answers, but he considers Fnality the best possible solution. Across the world, banks are testing more initiatives, which often fail because they lack scale. They are built, for example, for the primary market but don’t take into account the secondary market with its consequences on the liquidity of the securities involved. Another point of failure is that blockchain solutions cannot co-exist with existing solutions, and you need interoperability to serve the entire ecosystem.
Paving the Way for Cash on a Ledger
Glen: “There's a huge opportunity with Fnality to do the same thing that we did many years ago, to experiment to learn and hopefully create something with a positive impact for the industry.” The opportunities of the programmability of money are one area that requires further education and experimentation within the context of wholesale payments.
Does this mean we can think of a future without companies like Euroclear? Glen doesn’t believe so. According to him, transactions are always 2 elements: the securities trade and the cash being exchanged. Euroclear stands in the middle to do the bookkeeping.
As Glen explained: “The role of Euroclear is to ensure that there is legal certainty that you get what you were entitled to, also when things become very complicated. We also provide full flexibility, where the banks choose which of our channels to use and which technology.”
Fnality will not replace Euroclear; it will simply improve its cash and payments arm to deliver better services and higher trust. Glen: “Trust is the central thing, and at the moment, Euroclear and Fnality provide the trust necessary to make all of this work.”
A big milestone in building this trusted service is Fnality’s omnibus account at the Bank of England, starting on October 22. Fnality aims to create a global network, to the nature of CLS and Swift. The omnibus account grants them an account at the central bank. This means their clients have their money at the Central Bank, fully protected from potential bankruptcy.
It was fascinating and oftentimes difficult to hear how Euroclear’s business has grown to what it is today. This session was another excellent example of a blockchain use case that has the potential to incremental improvements of existing business models instead of disrupting them.
Glen was humble enough to explain multiple times that the industry still has a long path to go with experimentation and learning DLT’s full potential, and I cannot wait to hear further developments in the future.