EquiLend, the major securities finance platform owned by the industry, is planning to launch a blockchain-based platform, 1Source, to hold the golden record of securities lending transactions. Initially, the goal is to eliminate the reconciliation of securities lending transactions. But as we’ll see, it could be an essential step in reducing securities settlement times.
The EquiLend platform currently processes $2.8 trillion in trades monthly and is backed by the likes of Bank of America, BlackRock, Credit Suisse, Goldman Sachs, JP Morgan, Morgan Stanley, State Street and others.
The business case for DLT in securities lending
Despite EquiLend’s platform being used to agree on securities lending trades digitally, subsequently there are a surprising amount of manual processes when changes are made. Those life cycle events – such as price changes, fee changes, or a partial return of the borrowed securities – are sometimes mismatched.
That’s because the changes are logged separately on each counterparty’s internal records, which means that the two systems must be reconciled. In the meantime, there are frequent contract breaks.
While reconciliation may sound like a boring book-keeping issue, it isn’t just an accounting department problem. Given it’s the traders that make the deal, they’re the ones who have to check what happened. “You have traders that are spending time reconciling items when in reality, they could be chasing alpha. They could be putting on new trades. They could be (providing) value add,” said EquiLend’s Gary Klahr, Director of Strategic Initiatives, who is leading the distributed ledger (DLT) project.
During the time when the data is inaccurate, it can lead to poor trading decisions, for example, if the lending cost is incorrect. Sometimes it results in settlement fails, for instance, if there’s been a switch of details about where the transaction should settle.
The potential savings are not just about cutting time spent on reconciliation but also about reducing the in-house technology footprint at each institution. DLT harnesses both benefits by ensuring changes are validated before being recorded on a shared ledger.
The current state of play
So far, the 1Source project is still in the design phase. Initially, in 2021, a ten-member working group of EquiLend stakeholders and clients came up with a list of potential projects. The goal was to establish what would “make the desk the most efficient. (What) process we can possibly come up with that would truly transform the industry digitally,” said Klahr.
Numerous ideas were floated, but the group decided unanimously to eliminate reconciliation.
Today many changes might happen with a phone call or a Bloomberg message. Klahr gave the example of a rate change. “Today, we both put in our own individual information that goes to the individual systems. We accrue overnight at an incorrect rate. We fix it tomorrow,” he said.
“In the world of 1Source that could not happen. One of us would put through the rate. The other side affirms it.”
Meanwhile, a yet-to-be-announced partner is working on a technology proof of concept with smart contracts, and there’s another workstream exploring the business requirements.
Unsurprisingly the distributed ledger is a permissioned system where only the two counterparts to a contract can view the contract details. Currently, the plan is for EquiLend to host the master node. It may also host nodes for clients that don’t wish to manage their own.
One of the key requirements is to ensure interoperability with all the processes that are upstream and downstream of a securities lending transaction. That sets the scene for future opportunities.
A potential roadmap to T1 settlement
In the U.S., the SEC has started the ball rolling on reducing settlement times from two days (T+2) to one (T+1). Securities lending plays a role in slowing down settlement. Say a broker has lent out some stock, but its client sells it. In order to enable the settlement of the client’s trade, the broker might need to borrow shares. That takes time, mainly because it has to filter through all the systems. Having all the data on-chain is a key step in the future automation of the process.
Other potential future features include passing on beneficial owner information, asset servicing and interoperating with collateral management systems. Asked whether security tokens were on the roadmap, Klahr said the topic had been discussed, but ultimately will depend on whether there is client interest.
Before the group starts thinking about this kind of topic, it needs to get off the drawing board with its first use case, eliminating reconciliations.
After all, “if you were building a securities lending workflow today, you would never allow both sides to have the ability to put details into their own side and not have reconciliation until a later date,” said Klahr.