This article was first published in the Global Investor Group Collateral Guide 2023
The current challenges to ledger interoperability stem primarily from the way distributed ledger technology has evolved. The combination of different data structures, technology stacks and approaches to achieving consensus has resulted in a variety of ecosystems being designed across the financial services sector.
Achieving consensus is one specific challenge for interoperability across private blockchain networks. Hand off workflows need to be agreed and orchestrated, transition states need to be perfectly aligned and synchronised, and resilience levels need to remain intact across all aspects of the transaction flow.
None of these items are impossible to solve. But for transactions at HQLAᵡ where billions of dollars of securities can be exchanged at precise moments in time, these are specific touchpoints that need to be assessed and implemented diligently if participants are to gain confidence in future interoperable use cases.
Legal compatibility is also critical to facilitating interoperability across ledgers as rulebooks will need to ensure alignment on scenarios such as insolvency and default as well as other edge cases. The good news here is that HQLAᵡ is making great progress on addressing these challenges with the specific ledgers that it has chosen to partner with.
However, one size doesn’t necessarily fit all and although many of the challenges to ledger interoperability can be resolved with standardisation, this doesn’t mean that we should all move towards a single blockchain solution. In the securities finance space, the industry is aiming to reach common agreement on three key themes.
The first is the development of cross chain standards that would allow different DLT networks to share data more easily. Many blockchain technology providers recognise this and enterprise level cross chain specifications - leveraging either peer-to-peer or intermediary solutions - have begun to evolve in earnest as a result.
The second key theme is to develop multi-asset or multi-token transaction solutions. At HQLAᵡ the initial set of use cases has focused on the development of a delivery vs delivery mechanism that allows the ownership of baskets of securities held at different locations to be transferred at precise moments in time on a single ledger.
As we move forward with our solution maturity, we have noted that clients are encouraging us to explore use cases where a basket of collateral on one ledger can be exchanged for a basket of collateral or cash on another, thereby increasing the reach and benefit of our digital collateral records.
Finally, we also think that getting more clarity around the regulation and governance of DLT networks will help the industry achieve higher adoption levels and greater interoperability.
All firms building out a digital strategy are focused on two objectives:
Whilst existing single ledger solutions can achieve both of these objectives, we feel that interoperability between networks and across ledgers will reach a level of maturity over the next five years that will enable enterprise transaction volumes to grow with greater certainty and momentum.
In the securities finance space, this will certainly evolve rapidly between private chains, in particular those that have common sets of investors with matching ambitions, as well as across specialist ledgers with complementary use cases.
In the next two to three years specifically, we feel that clients will intensify their focus on ledger solutions that are able to offer multi-product compatibility and therefore maximise benefit vs spend for stakeholders. This in turn will see many single ledger solution providers consider interoperability arrangements as a matter of priority.
From a macro-political perspective, regulators will continue to play a role in how quickly DLT technology is adopted across a wider range of firms, in particular if further clarity is offered around the treatment of digital technology as well as digital assets. This will undoubtedly influence the number of interoperating ledgers and the related network effect.
In the collateral management space, most banks are focused on optimising their inventory as efficiently as possible whilst ensuring control over costs. For this reason, we feel that solutions like those offered by HQLAᵡ will increase collateral velocity for participants as well as help to reduce the number of cross-custodian realignments.
As new interoperability opportunities arise, firms will recognise that they have the ability to manage decentralised pools of collateral and liquidity using a single wallet system. This in turn will provide firms with more visibility over asset usage and availability which in turn will create even more opportunities to mobilise assets on a same-day or even an intra-day basis as these markets start to develop.