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“Distributed ledger technology redefines markets”

26 Feb 2019

“Distributed ledger technology redefines markets”The Head of DLT, Crypto Assets and New Market Structures on his projects

Mr. Hachmeister, what is the significance of the crypto division of Deutsche Börse created in 2018, comprising around 20 employees and which you are in charge of?

Jens Hachmeister, Head of DLT, Crypto Assets and New Market Structures

Let me briefly outline the context. Deutsche Börse has defined three growth areas as part of its “Roadmap 2020”: Nine business areas in the core business that follow different growth ambitions. In addition, acquisitions where they support the growth of these nine business segments. And third, new technologies. In this last area, there are four clusters: one encompasses everything that has to do with cloud technology. At its core is how Deutsche Börse can use the cloud and how the existing application landscape must be adapted to make it cloud-ready.

And what are the other three clusters?

A second area is Big Data and Data Analytics - where our core data business is being further developed. However, it goes beyond pure price data marketing or index business. This is where marketable solutions and services are to be developed, for example,to support customers in their investment decisions in the market, such as predictive analytics. The third cluster deals with automation and robotics, and how application programming interfaces (API) are used. In a central competence center for the various units of Deutsche Börse Group, for example, the focus is to explore what can be automated where and how. The aim is to make processes more transparent, secure and stable, while at the same time opening up new data pools.

Your area does only comprise the fourth cluster?

My area comprises decentralised database technologies - distributed ledger technology - and the associated digital assets as well as new market structures. Blockchain is an example of such distributed ledger technology. We have moved from a phase of research and ideation to a phase of driving and implementing initiatives that claim to be productive. With distributed ledger technology this is not always easy, because the use cases always appear to be the most suitable in complex market situations that could be brought to a simpler and more transparent level by the new technology. This happens above all where markets are rethought and redefined. This is our task as a stock exchange operator: to identify and develop new markets.

There are bad tongues that do believe that many blockchain projects have only been initiated by company boards in order to demonstrate that they are active in this area, although the chances of realisation are very low right from the start. How do you prevent this from happening at Deutsche Börse?

Our business model is to build, load and operate markets based on technologies within a regulated framework. Distributed ledger technology redefines markets. These are more distributed and less layered, i.e. on a single level. Similar to an internet of values, the movement of digitized assets will be possible in the future. More precisely, the movement of assets which were digitized in a new way. These assets can be transferred back and forth in different constellations, be it business-to-business, business-to-consumer or business-to-business-to-consumer. All these possibilities are included in the new technology at the same time.

What do you mean by that?

I am not talking about native crypto currencies here. I am talking about digitized assets that will expand the world of existing asset classes and the infrastructure that goes with it. We must not only understand these technologies, but also be able to apply them. Another question will be how such technology can add value to our existing business model. The technology cannot be an end in itself, but must be applied in a specific business case and create value for market participants. The collateral management solution that we developed together with HQLAx is a perfect example.

The aim is to make it easier to move securities that serve as collateral.

Yes, the HQLAx Target Operating Model uses distributed ledger technology for this purpose. From a technical point of view, the first step is the tokenization of securities. There is one level that is based on DLT, but which has various links into the established value chain. At trading level, this is the Eurex Repo System, which is an electronic trading platform for off-exchange financing transactions. Deutsche Börse acts as a so-called Trusted Third Party, to which custodians are connected.

Is the project primarily focused on Europe?

The initial group of participants of the HQLAx model has its focus in Europe, but it can be applied beyond Europe. This depends on the origin of the participants, who are willing to accept the legal construction of this solution. HQLAx does not have to be limited to the lending of high quality assets. There is no payment processing, we are talking about Delivery versus Delivery - DVD. In fact, only credit relations and securities are exchanged. If one day there will be cash on a decentralized network - i.e. cash on ledger - and this will be possible via a coin or a token that has the quality of central bank money, then this model will also open up for different delivery versus payment (DVP) deliveries and thus for today's usual securities settlement standard.

What is the economic advantage of the solution for users of the HQLAx model?

With HQLAx, the attraction lies in the fact that our customers hold securities in various places and basically hold too much collateral - because they cannot use it efficiently and have to bear significant basis points in costs. In addition, many market participants do not always have the right quality of collateral available at the right time and in the right place. It is often not possible to move the desired collateral from A to B within one day. Our solution allows them to be mobilised without having to move them across custodians. The DLT allows security baskets - so-called collateral baskets - to be represented by a token and ownership to be transferred in real time.

The solution is based on R3 Corda, what is it all about?

R3 is one of DLT's enterprise solutions. With the HQLAx model, we are not only developing a solution for special collaterals, but are also building a network of participants who are connected to a DLT solution for which they have usage rights - a so-called Permissioned DLT. When this network is in place, and when the major market players have their nodes on this network, it acts as the base for a communication channel, regardless of which assets are moved on it. The construction via HQLAx is basically not limited to any particular type of collateral. If a trusted payment processing solution can also be built on it, then step-by-step processing is also possible for each asset that is tokenized, if it is legally secure. These tokens are able to represent ownership or ownership shares. With a payment token of appropriate quality, be it a so-called stable coin or a secured token, new markets can also be opened up.

This is the vision - what does R3 Coda have to offer?

R3 is a technological network solution that will contain various components in the future, such as legally secure tokenization, risk management, a collateral solution, a matching solution and reporting. Others who provide such network solutions are also working on these options. Such a kit could then be used for any market. Talking to providers of such DLT enterprise solutions, you can see that different networks may be linked together, not just financial networks. This is exciting because process chains come into play that are not efficient and transparent today and do not have the level of automation that is common in parts of the financial services world. Here, DLT can bring about a significant increase in efficiency and transparency. DLT's only problem is that this new technology must compete against a technology that has been built up over forty years and is recognised by regulations and customers. This is good and bad at the same time: we have a good, trustworthy infrastructure in which all levels are always synchronized with each other. The regulated framework is consistent with the functionality and business model and with the technical implementation. The result is a decentralized technology that is much more peer-to-peer oriented and requires fewer intermediaries. In Asia, for example, the financial infrastructure is not as old and established as it used to be.

Can this be the nucleus for a new type of stock exchange?

It can be a nucleus for multiple possible platforms. The exciting question is how we position ourselves as a market infrastructure provider to build an ecosystem for digital assets. In principle, issuing a security, as it is happening today, is nothing more than a regulated, legally compliant tokenisation. At some point, every token must also be listed and made tradable. Listing requires a trading opportunity on a regulated marketplace. Every token needs a home, i.e. secure and, I suppose, regulated safekeeping.

Would it help if tokens were defined as securities?

That is probably not enough, because there are infinitely many types of tokens, those that represent parts of a company, or that aim to replicate things that have securities as financing instruments or investment instruments. It depends on the quality and property of these tokens and how they are classified. If a token corresponds one-to-one to a security, the regulator would have to recognize a token as a security, agnostic to technology, and it could be listed on a stock exchange. Then the token follows the path of all securities in a regulated world. I believe though, there are other possibilities, depending on whether a financial instrument is tokenised or any other type of asset, such as real estate or industrial goods. These would then of course not be affected by financial market regulation or potentially regulated differently.

To come back to HQLAx: A stock exchange operator can also act as a standard-setter in the construction of secure trading places?

What is needed is a secure trading platform and a custody solution that is acceptable to institutional customers. We are also taking a close look at this and are examining it intensively. For us, the question is what is the right environment to enter such a market. Also against the background that we need a regulatory environment where we can try out such things. And where we can also tread a learning curve. However, the markets based on tokenization are developing very quickly. If you look at the crypto hype, or the attention around initial coin offerings that has now subsided, the pace of development is rapid. Basically, stock exchanges should and will continue to play a decisive role in the future when it comes to setting standards and providing a transparent, secure market infrastructure. However, in order to do this on the basis of DLT for digitized assets, we need a regulatory stable and an environment which is agnostic to any particular technology.

Can this be in Eschborn?

Anyone who deals with regulation will see that there are some legal areas in Europe that are further advanced than the German one. Regulation is quite fragmented worldwide. In Asia regulated jurisdictions certainly tackle the issue. There is a very vital movement in Switzerland, and there are initiatives in Malta, Gibraltar and Luxembourg too. In general, the further development of the technology is currently progressing much faster than the regulatory frameworks which are required. As long as this gap exists, especially at the German and European level, we will not be able to fully exploit the potential of the new technologies.

The interview was conducted by Dietegen Müller.

The original German version of this article was first published in Börsen-Zeitung on 26 February 2019.

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