Digitizing Financial Markets, The Remix – Ledger Insights

This is a guest post by Jens Hachmeister from Deutsche Börse’s Clearstreamwhere he is head of issuer services and new digital markets.

It is difficult to overestimate the disruptive potential of digitization for any industry. Take the music industry: CD album sales in the US are now 95 percent lower than at their peak in 2000. Why? Because the product is completely digitized. The advent of mp3s and streaming has rendered the physical medium obsolete, providing instant access to anyone, from anywhere in the world at any time – without the risk of losing your favorite songs to a scratched CD.

Digital securities are still relatively nascent, but have just as much potential to change financial markets and associated business models as you see, for example, in the music industry. But for the digitization journey to really take off in the financial industry, it needs a suitable foundation. In other words, the reliable, robust and scalable technical infrastructure now available, supported by appropriate regulatory frameworks. On top of this, current business models will have to be reassessed and new approaches that cater to tomorrow’s markets will have to be developed and implemented – while ensuring market stability.

Regulation Rhapsody

The best music streaming service would fail without a clear legal framework. No artist will make their music available if the copyright or royalty situation is unclear. The same applies to the financial markets: Market participants need clear rules that suit the purpose. Strong regulation underpins credibility and trust in the capital markets as it aims to create a level playing field for all participants. European regulators have been working to create regulatory frameworks that work for different domestic markets as well as at the EU level (see Germany’s Electronic Securities Act (eWpG) or Luxembourg’s Digital Issuance Act or the EU’s Digital Finance Package (Blockchain Act II), just to name a few some).

Stairway to market adoption

Despite these positive signals from regulators providing guidelines for the market to move more freely towards digitalisation, we have seen a relatively slow take-up of the opportunities and potential among market players so far. Market readiness is the key to the development of digitization, but although most financial institutions have expressed their intention to adopt digital securities, only 10-15% have started actively investing in the segment so far.

Investment in technology is expensive, especially in new technology, especially while the old infrastructure cannot be fully retired and thus still needs a certain level of investment over time. And even worse: there is no guarantee of success and no immediate return on investment. But in the end, what good is a streaming platform if no one has a smartphone to play the various tunes on? It takes courage to stand up for the long journey of digitization if the investment committee does not immediately thank you for it. It requires courageous pioneers who share the vision of future-ready digital markets and who do not shy away from the responsibilities that come with it. The challenge does not lie in digitizing our old processes, but in digitizing the product itself – the financial instrument. We at Clearstream have driven this development with our digital post-trade platform D7.

As always, technology must be tailored to the needs it appears to meet, or obstacles it appears to overcome. DLT and blockchain have been the talk of the town for a few years now, but it’s no holy grail for all the industry’s problems. DLT-based systems offer a great deal of transparency, consistency and standardization that we urgently need. But more importantly, market propositions must recognize customer needs, whether these can be addressed via a centralized or decentralized system to form a digital financial ecosystem that works for all participants. Neutral market institutions, such as central securities depositories, play a crucial role in safeguarding this confidence in the financial markets in conjunction with appropriate regulations.

More than a technology

Technology must be a means to an end, not technology for technology’s sake. In the context of financial markets, the ultimate question about digitization must be: How can it improve the functioning of financial markets today and tomorrow and make room for new products and services for the industry?

The most obvious benefit that digitization brings to the market is improved operational efficiency, which is critical to overall profitability and market efficiency. However, it would be short-sighted to stop there. Digital solutions also provide an improved user experience and room for new approaches, which in turn open up opportunities for future growth and product creativity. From a business perspective, digitization allows access to, liquidity in and mobilization of assets across the financial market ecosystem. Such efficiency gains and flexibility support the development of completely new business models as well as product and service offerings. A music streaming platform becomes increasingly attractive the more styles there are and the greater variety of artists who add songs and tunes to the platform.