Blockchain is set to revolutionize trading of and the transactions relating to money market securities following a recent successful piloting project on a commercial scale. The pilot tested the idea and demonstrated the benefits of blockchain in this industry, over conventional technology.
Siemens, together with two partners who include a German-based banking and financial services company called Commerzbank and a technology company called Continental, recently concluded a money market securities transaction piloting in Frankfurt, Munich, using blockchain. Together, they attested that the technology carries a clear advantage over conventional tech in the trading of money markets securities, although there are a few challenges relating to its use in this market.
The testing is important because it is the first or among the first in the practical piloting of blockchain use in trading money market securities or related transactions.
Money market securities are short term assets such as Treasury Bills (T-bills), eurodollar deposits, Commercial Paper, Certificates of Deposit (CDs), and Bankers' Acceptances. They are issued by large, trustworthy organizations including the United States government and are traded on the money market where financial instruments with high liquidity and very short maturities are traded. Being issued by highly trusted organizations lowers the risk.
These instruments have a maturity of one year or less and the payment processing takes two days normally due to a clearing process. For instance, banks usually take time to settle payments between accounts and there always is a time lag. However, the transaction took minutes to complete instead of days during the piloting project.
A Commercial Paper, which is a promissory note sold by a large organization with the minimum size usually set at $100,000, takes a maturity of between one day to several months to settle. Certificates of Deposit, which are securities issued by commercial banks to raise cash for loans and other purposes, have a maturity of from 6 months to 5 years and are sold at face value with interest paid at maturity. Treasury Bills, which are issued by governments in denominations to raise money, have maturities ranging from 13 weeks to one year. They are sold at discount with the full amount recovered at maturity. Bankers’ Acceptances, which are short term loans made to importers and exporters to allow them pay for products with the acceptance, have a maturity lasting to 180 days and can be redeemed by any holder.
All of these securities can be bought and sold in a money market. The conventional money market is basically an informal network of banks, brokers, dealer and financial institutions linked electronically. Therefore, there is no formal money market. The market provides an opportunities for companies to not only sell these securities, but to also invest in the short-term instruments.
Companies with short-term need for cash can sell securities or borrow funds on a short-term basis while those with excess cash can actually invest by buying the securities or giving these loans. Hence, if settlements are done same day, it means risks for high risk instruments is reduced and companies can satisfy their need for cash quickly.
Some of other money market participants include mutual funds that invest in different instruments, and individuals are able to access the securities market through these funds. Other options for individuals to participate in these markets include money market account with a bank. Some large corporations also participate in the markets through dealers. Companies and individuals can also purchase some instruments directly, for instance securities from banks.
With blockchain usage, collaboration hurdles, tracking and visibility of transactions between parties, sharing of data, errors, and trust hurdles may as well become a thing of the past.
The first obvious advantage of using blockchain for money markets is the digitization of these securities that must be issued in a digital form to be moved on blockchain. It must be remembered that blockchain tech is acting to facilitate trading and exchange of other securities such as shares and bonds and ordinary assets and property. At least that is not new ideology here. Putting money market securities on blockchain and hence digitization, is a good thing for improving efficiency for front-office and back-office processes as well as facilitating, tracking and expediting legal compliance. The fiat is also converted to digital or e-money to be used on blockchain. Probably, since these need to be done in a legal environment, a security token may act that role but that hasn't been tested yet.
And since blockchain distributed ledger technology replicates and shares same data to all parties at the same time, it allows direct contact between all parties involved in the transaction. This also improves transparency of transactions.
But there is another shift as a result of use of blockchain in money market securities transactions: under traditional or conventional money market security transactions, banks act as central brokers to a transaction that involve moving the security between two parties. However, because it provides direct contact between parties, there is no need for a central broker. Reduction in the number of intermediaries not only improves efficiency but also cost.
During the testing by the three partners, a money market securities transaction worth €100,000 was to be processed between Continental and Siemens using blockchain technology. Continental was the issuer of the money market security and it was issued in the form of a euro-denominated electronic commercial paper as required by Luxembourg law. Siemens subscribed to this security as an investor while Commerzbank provided the Corda-based blockchain platform through its research and development unit known as Main Incubator.
The bank did not act as a central broker. Since it also has a e-money market license, it provided the legal structure and the digital money for direct trading of the money market security (based on e-money as financial collateral, “cash on ledger”). Legal advisory on the transaction was provided by corporate law firm GSK Stockmann. Instead of days it takes to process these kinds of transactions in conventional systems, the transaction was done in a matter of minutes.
The pilot testing by the three partners demonstrated the benefits of using blockchain platform for market securities including improved deal flexibility, efficiency and transparency.
Continental and Siemens said that the project is a major step toward application of blockchain in the trading of securities. The success also may pave way for application of blockchain by Continental and Siemens in their financial transactions as this was one of the main motivating factor for testing blockchain in this transaction.
Siemens' Corporate Treasurer Peter Rathgeb said the blockchain platform, with its "significantly shorter throughput times and faster time-to-market," showed the clear advantages of blockchain technology. He added that the key challenges include security and performance issues and legal issues such as need for consistent European standard and understanding of law on blockchain-based transactions.
Head of Finance & Treasury at Continental Stefan Scholz also said the project proved to be a success. The company said some of the advantages that could accrue in use of the blockchain in their Financial department include providing direct contact including with investors in short-term bonds, flexibility, efficiency, and enhanced transparency.
Roman Schmidt, Commerzbank’s divisional board member for capital market said blockchain can make capital market transactions quicker, more straightforward and more efficient for customers.