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Distributed ledgers: what Bitcoin’s legacy could really mean for the future of banking

The blockchain revolution

14 December 2018

Blockchain – the technology which underpins the crypto currency Bitcoin – is set to revolutionise financial services. Using databases distributed across a number of participants – and which can only be amended with the consent of them all – blockchain and other types of distributed ledger technology (DLT) create a secure and transparent environment for transactions, reduce counterparty risk and improve efficiency.

Financial institutions and fintech firms are keen to capitalise on these potential benefits, and a number of pilot schemes including interbank payments, trade finance, transfers of securities and the issuance and settlement of catastrophe swaps, have been announced in the last 18 months.

The UK is leading the way in looking at the practical challenges that this new technology presents through the FCA’s Innovation Hub and regulatory sandbox and the Chief Scientific Adviser’s report on DLT which was published earlier this year. Meanwhile, the European Securities and Markets Authority (ESMA), has been analysing virtual currencies since 2013 and recently published a discussion paper on the use of DLT in securities markets.

The BBA has worked closely with Clifford Chance to put together a detailed response to ESMA’s paper and our view is that DLT has the potential to significantly improve the securities markets and regulatory compliance and reporting. However, there are a number of legal and regulatory issues that will need to be addressed. These include:

  • Structural legal considerations, that directly affect the viability of certain uses of DLT. For example, the interplay between property law and characterisation of assets recorded on a DLT. The nature of the assets will determine what rights and liabilities attach to them and may impose conditions to transfer or the granting of security.
  • Regulatory incompatibility. For example, the current Central Securities Depositories (CSDs) Regulation may not permit any settlement of securities transactions without the use of a CSD, potentially obviating some of the benefits of using a distributed infrastructure.
  • Risk and compliance barriers. For example, where data privacy rules require the permission of individuals for the storage of personal data on a DLT, the means of obtaining consents or considering alternative arrangements whereby personal data is stored off DLT.

Given that the use of DLT in the securities markets is still at an early stage of development, the BBA proposes that a number of things need to be considered when putting in place any legal or regulatory framework governing its use. These include:

  • Taking a flexible and pragmatic approach. It is important that regulation doesn’t limit the ability of firms to test and develop DLT solutions.
  • Regulating the specific application and not DLT. The BBA thinks that DLT should be recognised as a platform for financial services activities, rather than as an activity in and of itself.
  • Taking a harmonised international approach as the technology is not limited by geographic boundaries or enforcement jurisdictions.

Despite the many challenges that lie ahead for both financial institutions and regulators, it is clear that DLT presents a wealth of opportunities across applications both known and yet to be developed. The open-mindedness of regulators to date has played an important role in fostering such a supportive environment, and whilst this remains we will undoubtedly see continued innovation in this exciting new area.

This article was originally published by BBA and is available here.