Assume we have this scenario. Buyer K wants to purchase Berkshire Hathaway stock and Seller L wants to sell it. Both agree to conduct the transaction. Settlement Risk occurs when Buyer K is not willing or able to complete the purchase the stock. Vice versa, Seller L is not willing or able to complete the sale of the stock.
To minimise this risk, the transaction goes through Delivery versus Payment method (DvP), or transacting it through a third party, in this case a Central Clearing House.
Now let’s define DLT. It describes technologies that have derived from the Bitcoin blockchain.
DLT offers an alternative to the current risk mitigation technique. The cash and stock transfer between the two sources are linked and jointly recorded in DLT. This Atomic transaction is successful when both actions are completed or fail when either action is incomplete or both actions are incomplete. In English, the Atomic transaction is only recorded in the DLT when Buyer K receives the Berkshire Hathaway stock and Seller L receives the cash. This is similar to DvP method. This is better than the current process because no one can erase the settled transaction, the immutability characteristic of a DLT, and reduces the amount of reconciliation effort, a decentralised ledger.
This is all good but what are the downsides? Now assume, Buyer K wants to negate her obligation because the price of the stock has gone down after she committed the purchase with Seller L. The same scenario applies to Seller L, when the price of the stock has jumped up after the commitment. If the Atomic transaction has not settled yet at this time, she could fork the DLT. This eliminates the transaction. If the transaction has settled, she has to replace all transactions that have settled since the settlement.
Overall, DLT presents a different approach to reduce Settlement Risk. Use Cases have been produced to show Atomic transactions in DLT work in configured setups, but not in real life. Time will tell if DLT provides another beneficial tool to people and organisations in the Settlement Risk topic.
On a side note, you still need to have someone or something that facilitates the matching between Buyer K and Seller L. For individual investors, you may get away from this. However, for institutional investors with huge amount of stocks to trade, to me this is a requirement rather than a nice to have. Unless this topic is addressed, third parties such as broker dealers or Central Clearing Houses will still be around in the coming years with or without DLT.
If you liked this post, it would be great if you could leave a comment or hit the share button.
Jumpa lagi / See you later / Hasta la próxima / Bis bald
Global Professional 