Capital market digitalisation efforts speeding up

Technological overhauls will have impacts on disintermediation, automation, risk, new products and local currency capital markets, writes Lewis McLellan, editor, Digital Monetary Institute.

The impetus for change and the trajectory of development are never simple matters. The existence of a superior technology is not automatically enough to displace a functioning system. That much will be obvious to many who work in capital markets and find themselves sending or receiving term sheets by fax machine. Legacy systems that have long since been outstripped can still cling on for the simple reason that they work.

Nevertheless, momentum around digitalisation, bolstered by the arrival of distributed ledger technology, is finally building and, according to OMFIF’s survey, participants now see a major technological overhaul of the bond market as a matter of time.

Attempts to upgrade the digital technologies underpinning capital markets have, perhaps understandably, focused on a desire to disintermediate. After all, if each additional party in the chain extracts value, a simple way to persuade those holding the purse strings that innovation will mean efficiency savings is to promise to render one or more of those parties obsolete. And, of course, disintermediation has always been a core part of the value proposition of blockchain.

Fintechs once believed that they could disintermediate dealer banks — connecting issuers directly to investors and rendering the distribution functions of banks unnecessary by providing a slick and efficient platform. That idea was swiftly abandoned. Underwriting deals is hard, capital-intensive work and it rapidly became clear that bankers do a great deal more than simply find willing investors. Their advice to issuers and ability to generate ideas for investors keep capital markets operating in ways that cannot easily be replicated by technology.

Since then, focus has moved to the disintermediation of custodians, paying agents and central securities depositories. But, so far, incumbents are putting up a stern fight. Throughout this report, a returning theme is that, though the role of such institutions may change and the technology used to perform their functions may differ, institutions themselves are adapting and growing with the new technologies.

Rather than disintermediating, technologists are instead focusing on reducing repetitive, manual processes that take up market participants’ time without adding value (examined in Chapters 1 and 2). Once the data on which digitalised capital markets will function is efficiently structured, a host of benefits around instant settlement and automation of lifecycles becomes available, reducing counterparty risk and allowing market participants to save on collateral (Chapter 4). Already, attention is turning to the ways these better systems can be applied to create new products, particularly in ESG (Chapter 5), while development banks are keen to ensure innovations channel more investment into local currency capital markets (Chapter 3).

Whether this is most efficiently done in a centralised or decentralised way is a debate that has not yet been settled. The outcome is most likely to indicate that there is a range of options.

The world has gone through a period of frothy excitement, with attempts made to revolutionise almost every business practice with blockchain, but the real possibilities are becoming clear as technologies mature. Over the next three years, around half of our survey respondents will have tried their own experiments with blockchain bonds. It will not be long before this technology moves from the purview of research and development to become a fixture of capital markets desks.