The Promise of Blockchain Technology for Global Securities and Derivatives Markets: The New Financial Ecosystem and the 'Holy Grail' of Systemic Risk Containment

Abstract

Weaknesses in warehousing systemic risk in modern Financial Market Infrastructure (FMI) are the result of a combination of market failures and of structural flaws deeply ingrained in modern financial markets. The same applies to investor control over their investments over the custodial chain. Yet the utility of complex FMI comprising long custodial chains and large global Central Counterparties (CCPs) for the operation of modern markets seems undisputable. A shift in the technology paradigm with the introduction of DLT systems for securities and derivatives FMI, could, however, increase investor control, the efficiency of systemic risk distribution, and create a more diverse and resilient financial ecosystem. This cross-disciplinary paper explores all these claims and identifies a multitude of welfare-enhancing reasons favouring a paradigm shift in FMI technology. It also proposes a comprehensive blockchain-based framework for the development of permission-based platforms for derivatives clearing and settlement and the handling of liquidity shortages within DLT systems. Arguably, the impact of technological change will lead to a reduction of industry rents for the benefit of end investors and end users of finance (entrepreneurs and businesses) enhancing market welfare. It may also signal a shift in market behaviour from short-term/speculative finance towards long-term/committed finance. Therefore, the use of blockchain technology in FMI can prove genuinely transformative for the structure and future direction of the financial services industry as whole.