While there were concerns over security and throughput, there was a surprisingly common consensus among the senior executives of the Australian Securities Exchange (ASX), about what, at the time, looked to be a potentially controversial and sensitive decision: replacing its aging Clearing House Electronic Subregister System (CHESS) with a blockchain solution.
That sensitivity seemed to be on show again recently, when the ASX’s CEO, Dominic Stevens, avoided any reference to blockchain (and especially Bitcoin), in a speech to shareholders at the company’s annual general meeting about its plans. Throughout his speech, he preferred the term distributed ledger technology (DLT) instead.
That’s hardly surprising, say project insiders, since regulators are a cautious bunch. And while Bitcoin — the world’s most sophisticated application of blockchain — has nothing to do with the ASX implementation, Stevens’s wariness of even mentioning blockchain suggests there is still no appetite at the Exchange to be closely linked to the cryptocurrency.
Shortly after Steven’s speech, the ASX flagged the date for the initial implementation would be March 2021, a slight delay on the original plan of late 2020. The change was the result of feedback from stakeholders during a formal review process, according to a report by George Nott in CIO.
In putting this story together, executives spoke to us anonymously as they were not authorised to comment on the project.
One executive noted that the ASX’s decision already looks prescient, with a number of other exchanges in the region — including Singapore and Shanghai — recently announcing their own initiatives.
For its part, the ASX estimates that the cost of equity clearing and settlement to industry participants is about $100 million — which is a worthwhile problem to address, though hardly world-changing.
But, noted Stevens, “The total cost of the super industry alone, according to Rainmaker, is $23 billion. This makes the opportunity to be an ‘enabler to the bigger picture’ a big one. If the value of what we can deliver by providing an enriched, real-time source of true information to the industry ultimately allows the industry to offer new services that create only five per cent incremental revenue or cost savings to end issuers and investors, we think it’s absolutely worth pursuing.”
According to the ASX chief, “The equity market is not the only place where ASX can help create this type of value for customers. The same is true for the settlement of bonds through Austraclear, or for other asset classes that financial institutions still manage on legacy technology and with manual processes. These represent another large potential opportunity. And if all of these improvements were based on a common technology, this should allow our customers who span these different markets to simplify their businesses even further.”
These are the real opportunities the ASX hopes to address with blockchain — or, as it prefers, DLT.
Brave, but not controversial
It would be a mistake to describe the selection of blockchain technology as controversial. It was, however, brave. The decision was made several years ago when blockchain was very much an emerging technology and the taint of all those Bitcoin stories about drug dealers and arms traders were not so far removed in the minds of many in the industry.
There were very few debates, at least at the most senior levels, according to those with whom Which-50 spoke.
The program was initially driven by executives including Elmer Funke Kupper, along with Peter Hiom the Deputy CEO, Tim Hogben, COO, and the then-CIO Tim Thurman.
An executive told Which-50, “Everyone was very excited we were leading the charge from an exchange point of view — [the] board was also very supportive of the project as well as ASIC.”
But while the decision to pursue blockchain was not controversial internally, it was not without concern. Key obstacles included concerns over security and in particular what was going to be published into the nodes — which is why the ASX approach is a “private ledger.”
“The ASX controls it much as it does today with CHESS. The biggest objection was throughput (transactions per second). Traditional blockchain is very slow due to the mining so the implementation of the ASX model had to be much faster — this was the challenge and Digital Asset and the ASX Tech delivered,” says a project insider.
Ultimately blockchain’s advantages — that it can be used to solve many problems and run many asset classes — proved attractive to the ASX, which wanted to future-proof its systems. And of course, CHESS itself was considered groundbreaking when it was first implemented in 1996, almost five years after the initial concept work began.
Stevens in his speech described the work the ASX is about to begin as “a foundational piece of technology, not only for ASX but for the whole Australian issuing and investment community.”
Given how critical the work is, perhaps one of the surprising things about the project was how easily the decision seems to have been made.
Which-50 spoke to insiders at the ASX with first-hand knowledge of the project that commenced under former CEO Elmer Funke Kupper. He left the ASX in 2016 after allegations surfaced of bribery by officials at Tabcorp when he was the CEO. That case is still ongoing and Funke Kupper denies any wrongdoing.
Whatever the merits or otherwise of the case against Funke Kupper, according to those involved, he was instrumental and a visionary in guiding the organisation towards the distributed ledger technology-based solution strategy and gave the team the flexibility and time to “have some fun with it.”
It is difficult to say when the actual decision to process ahead with a blockchain-based system was made. Instead, it seemed to emerge organically, according to those involved. They told Which-50, “We evolved the technology over many months and many proof of concepts.”
According to one executive with direct knowledge of the decision making, “We knew we needed to replace CHESS. It was an aging technology as you can imagine.”
The ASX was using Nasdaq Genium for derivatives and this seemed like a natural fit to use for cash equities. And as CHESS was working well it gave the ASX time to look at other opportunities, said the executive.
Interestingly, blockchain wasn’t viewed as necessarily a superior solution. The attraction was that it offered the chance to deliver an innovative model — especially around the other business streams the ASX might potentially build off the technology.
“The ASX has a very proud history of doing things a little different, like CHESS, and there is nothing like it on the planet so why not look at the future and do it again,” according to one observer.
“At this time blockchain was the hype and we had time, so why not run a few POCs?”
Business and technology teams set themselves the task of investigating DTL vendors, finally selecting Digital Assets, a New York-based outfit founded by Don Wilson and Sunil Hirani.
One of those who worked for the ASX on the project told Which-50, “Digital Assets are an awesome team and [they were] very willing to help us solve our problems.”
That’s an important point to remember in the ASX’s decision making, say insiders. “Keep in mind — we had a problem to solve where all the other proof of concepts around the world didn’t.”
In his ASX speech to shareholders, Stevens provided a detailed and surprisingly accessible outline of the project.
He started by describing the changes he said DLT brings and how that can be used by the industry.
“If we look at CHESS today, we see that it sits centrally as the source of truth. All-day, every day, participants send messages back and forth to the CHESS database to make sure they are perfectly reconciled with it. This process is prone to errors and expensive to fix. The databases of participants can also be different, meaning there are multiple versions of software essentially doing the same thing.”
He contrasted that to what he described as the “DLT world”.
“Instead of sending messages back and forth to reconcile the many and varied databases, participants who choose to connect by having a ‘node’ are linked via the distributed ledger that forms a perfect chain of title that cannot be altered.”
“Put simply, the ‘node’ is part of the source of truth database held by ASX. DLT-based CHESS will give participants the option of receiving messages, which is similar to what they do today or connecting via a node.”
He also said that the current approach involves participants with many disparate databases that are expensive to support, upgrade and maintain and he contrasted this to the expected outcomes of DLT where participants’ databases are harmonised with ASX and with each other. Under such a model, applications written for one participant will now work for other participants — further reducing risk, cost and complexity, he said.
The third advantage is that it replaces a world of multiple applications, in multiple versions, written in multiple languages, sitting on multiple databases, and governed by complex manual processes where none of the participants’ systems can easily talk to each other, but only to CHESS, with standard, easy-to-use smart contract modeling language that sits on a harmonised database.
“Processes and services can be built to operate multilaterally across the system — that is, between one participant and another, not just between a participant and ASX. This means you can create multi-party automated and simplified workflows across industry participants, not just within one.”
This should result in significant service innovation for the market compared to the situation today were an innovation by service providers is slow and expensive, he said.
And finally, according to Stevens, under current models, the end-users ultimately pay for all of the complexity inherent in the system.
“If end users use multiple intermediaries, they will have to deal with many different systems, data formats, and processes.”
He said that with DLT, intermediaries and other providers will be able to deliver enhanced services to issuers and investors that will sit directly on the source of truth — accelerating the efficient delivery of existing services, while also unleashing service innovation across an ecosystem of interconnected users.
He finished his overview by telling shareholders, “ASX’s focus remains squarely on the rollout of DLT as the replacement of CHESS. However, we believe ASX has a huge opportunity to create value in the $20 billion-plus financial services industry and even in other industries over the medium term.”