Implementation Of Distributed Ledger Technology In OTC Markets
The proposal to use distributed ledger technology (DLT), such as blockchain, to address challenges in non-listed and over-the-counter (OTC) markets has received mixed opinions from industry players who recognize the benefits but remain concerned about their implementation. For the move last November, the Securities Commission Malaysia (SC) unveiled its blueprint Capital Market Architecture Blueprint in a Decentralized World. Its objective is to encourage industry players in the unlisted market to provide more access to information for investors.
Unlisted and OTC securities include those issued by peer-to-peer (P2P) financing and equity crowdfunding (ECF) platforms, bonds, sukuk, OTC swaps and assets such as property, according to the blueprint. The purpose of the blueprint is to address weaknesses in these markets, such as lack of liquidity and transparency, reliance on intermediaries to connect buyers and sellers, inefficiencies in matching and price discovery, and complex settlement processes.
The blueprint suggests that market operators keep a distributed book so that it is accessible to trustees and regulatory authorities. This would create a single recording system so that all market participants have a full copy of the relevant transaction information. The system is expected to be updated almost in real time so that retail investors can access information such as the last transacted asset price.
Other proposals include the use of intelligent contracts to perform transactions triggered by certain conditions and the adoption of cryptographic encryption and data security techniques. This is not the first time that DLT has been used to improve supervision and simplify the issuance process in the OTC market. Last year, the World Bank launched bond-I, the first bond issuance that was created, allocated, transferred and managed using blockchain technology throughout its life cycle.
Elain Lockman, co-founder of the Ata Plus ECF platform, says that the proposed measures can solve a critical problem faced by platform operators, namely the lack of liquidity in the secondary market in particular. Blockchain is already used internally for record keeping purposes. It will also include blockchain in the secondary market, to be launched later this year.
Elain said “At Ata Plus, there are limitations to getting a wider pool of investors because there are no definitive exit plans offered by the issuers. The prospect of having an unlisted or closed secondary market would imply that at the very least, investors would be able to sell the stake they acquired at the primary listing, whether at a premium or even a loss.”
A decentralized exchange could exist when the measures proposed under the blueprint are implemented, enabling investors to trade their securities, says Kyri Andreou, co- founder and manager of Ata Plus. Andreou said “The problem of dealing with individual operators in a secondary market is that there will not be a single consolidated market that is liquid. Blockchain comes into place by making it a decentralised exchange, where protocols could be set up by the regulators and operators can just provide the customer experience. The underlying technology that supports trading does not belong to any specific party.”
He adds that the use of blockchain and intelligent contracts can automate investment, trading and settlement, and reduce delays caused by slow handling between several parties. Increased transparency will inspire investors’ trust and spur more investment through ECF platforms.
Elain further said “Blockchain allows us to be independent from any form of third-party applications or, in this case, servers. When you store information on a blockchain, especially a public blockchain, it is really hard to change it. And even if anything goes wrong with the system, it will not affect the previous records or history. That builds trust among the people investing via the platform because the technology has proven to be useful and trustworthy.”
Investors won’t need to grasp the technical aspects of blockchain as they only interact with the ECF interface. “It is like when you sell a car, you do not have to explain to people how the engine works.”
Umar Munshi, founder of EthisCrowd, a Singapore-based Islamic real estate crowdfunding platform operating in Malaysia, believes that some of the problems in the Islamic finance industry will be resolved by DLT.
Umar Munshi said “From my understanding, the problem right now is the cost and scalability of blockchain. But I believe this will be solved in the near future. As it is right now, there have been very few large-scale implementations of this technology. Blockchain should theoretically be able to solve these problems as long as the cost goes down and the technology becomes more practical in its application.”
The potential to include DLT in Islamic finances was highlighted in last year’s report by S&P Global Ratings Inc. It noted that the technology could improve the global sukuk industry by increasing the information supply to investors. Al Hilal Bank, based in Abu Dhabi, was the first to sell sukuk on the secondary market last November by using blockchain.
Umar opined “The technology can automate a lot of processes, tighten information flow and direct the way transactions are done so there is less room for human error or misinformation. This will make the market much more dynamic. The issue will be how to implement and regulate it as well as how the private sector can get involved because I believe this kind of initiative should be run by the private sector, with the regulators providing guidelines or foundations for us to build on.”
But obstacles to implementation remain. It will not be effective unless everyone in the ecosystem is on the same page and structural challenges, such as existing disjointed market and red tape processes, are resolved, Elain says.
“DLT is at a nascent and experimental stage. Also, it does not guarantee the adoption and delivery of benefits to end users, especially as the services offered in the fundraising ecosystem is widely fragmented. Unless you have your own technology team with strong blockchain developers, implementing and streamlining the DLT system into business logic can be costly with little or no immediate return on investment.”
Kristine Ng, director and founding CEO of the Fundaztic P2P platform, agrees. She says that adopting the system would be a challenge for all parties involved. For one thing, many platforms and companies already have their own systems that conform to the guidelines of the regulator.
Kristine Ng said “For P2P players, I think the systems and guidelines we have in place are already very comprehensive to avoid a meltdown like the one in China. From day one, the money is put in a trust. So, the third party has the obligation to ensure that the money is not misappropriated by the platform. Before the platform even goes live, we share the trust deed with the SC so that it is privy to the arrangements and under what circumstances money will be moved between the platform, trustees and investors.”
Some investors may be hesitant to accept it because they may associate DLT with cryptocurrencies, says Ng. “Many investors have been burnt by such investments. That is why the timing [for launching these guidelines] is crucial because the people who were burnt will take a wait-and-see approach.”
Fundaztic plans to launch a secondary market in line with the regulatory guidelines this year. However, Ng does not see the need for blockchain to improve its transparency right now.
Ng further said “As far as our platform is concerned, we are very transparent. Even without joining as a member, you can see all the statistics and prices.”
Players in non-listed markets do not yet have to adopt the DLT, as the blueprint has been created to show market players the advantages of technology implementation.