Distributed ledger technology (DLT) has the potential to positively impact how the financial services industry records assets, transacts, and manages data. Within global payment services, FX post-trade processing stands to benefit from DLT.
There are two sides to an FX transaction: pre-trade and post-trade. Today’s pre-trade experience is highly efficient for banks and their corporate customers. FX trading platforms can stream exchange rates and enable precise, near-instant trade execution.
Once the rate locks in, and the trade occurs, the focus shifts from risk management to multicurrency payment settlement. And that’s where the challenges begin.
Today in the high-volume world of FX, settling trades across bank counterparties creates back-office inefficiencies. Each bank updates its own system of record separately and maintains its own copy of the trade. Even the smallest disagreement on a trade causes additional work to match records between bank counterparties.
Cross-border payments that span multiple currencies and jurisdictions could require hand-offs across two or more correspondent banks, which further slows trade settlement and impedes payment transparency.
Envisioning post-trade transformation
DLT would enable banks to create a single, shared record of an FX transaction by combining three existing technologies:
- Peer-to-peer networking connects participants to data in real-time.
- Distributed data storage provides a shared view of data.
- Cryptography securely validates identity, permissions, transactions, and data.
The application of a shared ledger would allow for near-instantaneous accounting and reconciliation with complete transparency between counterparties. This would virtually eliminate associated credit risk while improving back-office efficiencies. It would bring post-trade FX settlement up to speed with expectations for faster payments, which are already being addressed in the world of consumers.
Change takes time
It is unclear when distributed ledgers will become integrated within the financial services industry. In terms of governance, regulations are needed, including legislation that allows banks to meet compliance requirements under new, more collaborative operating models.
In terms of practical execution, the financial services industry is unlikely to achieve one ubiquitous shared network among all FX market participants in the near term. Central utilities in the clearing and settlement space, such as SWIFT and CLS, already are working on their own versions of DLT. Consortia have formed globally to explore DLT using different platforms.
How to prepare
Key to realizing the long-term vision for FX post-trade transformation is achieving interoperability across distributed ledgers.
Enabling connectivity between networks is one potential area of opportunity among many for fintechs looking to support FX industry developments. More generally, fintechs should keep close tabs on financial services applications, including in the payments space, to determine whether an investment in DLT can create value.
Given the high profile of distributed ledger technology, many technology companies are wondering whether, when and how to invest. Given the transformational possibilities for distributed ledgers, the technology warrants careful research and monitoring by technology firms to understand its potential application to solving customer problems and address industry needs.