Blockchain – not a silver bullet for trade reporting

Blog | 25 July 2017

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Irene Mermigidis, managing director of REGIS-TR, says the scale of demands from modern reporting standards are likely to be too great for blockchain to handle 

Blockchain technology captures the imagination with the allure of linked, distributed and indelible ledgers increasing the transparency and efficiency of the entire financial services industry. It’s a fix for practically everything, apparently. Industry commentators suggest blockchain will even mitigate some of the difficulties faced in my own area of specialty, trade and transaction reporting. In fact, the February 2017 report from the European Securities and Markets Authority provides a high level analysis of the key benefits and risks. It’s a compelling read.

But there’s a degree of hype in every new technology.

When commenting on highly technical topics like this, I’m always conscious that many of you reading this blog will have specialist insights that might challenge my viewpoint. I can’t profess to be an expert on blockchain myself, but hopefully you’ll find my thoughts on its reporting potential interesting and relevant, because I’m not convinced the theoretical potential of blockchain technology will transform the practical reality of the challenges we all face in the regulatory reporting space.

What do we mean by regulatory reporting?

In very general terms, regulatory reporting (like European Market Infrastructure Regulation (EMIR)) requires recording specific information about divergent categories of trades, along with counterparty data about the entities conducting the transaction and other information about the nature of the transaction. The data reported could be subject to change throughout the term transaction, and reporting updates need to take place when such changes occur. It is a complex, ongoing, end-to-end reporting process, and is not like taking a snapshot of a precise, specific moment in time.

It’s also worth pointing out that there’s no complete overlap of reporting requirements between regulations, or a prescribed process for multi-regulatory reporting. There’s divergence in reporting requirements in Europe between regulations such as EMIR, Markets in Financial Instruments Directive (MiFID) II, Markets in Financial Investments Regulation (MiFIR), Securities Financing Transactions Regulation (SFTR) and so on, including differences in:

·         what needs to be reported

·         how quickly it needs to be reported

·         who needs to report

·         who regulates the reporting

·         what the reporting is for.

On that last point, we can recognise a distinct difference in purpose between EMIR (which seeks to promote transparency in the derivatives market and to promote overall market stability) and MiFID (which is primarily designed to increase investor protection and minimise fraud).

To give you an idea of the scale of reporting taking place, REGIS-TR is comfortably the second largest EMIR trade repository by number of participants and transaction volume. Since Feb 2014, we have processed more than 14 billion trade reports at a rate of more than 50 million trade reports per week.

These factors become highly relevant when considering a transformative new technology like blockchain in the context of regulatory reporting.

Can blockchain be applied to reporting?

Considering the challenges of reporting, in terms of requirements and scale, a few principles come into clear definition concerning the design of a blockchain reporting process.

First, the membership. This would have to be broad, including both financial institutions and non-financial institutions who would be required to report, regulators or trade repositories for those entities (and only those entities) that they regulate, and potentially even encompassing the general public (to access aggregated statistics on such reporting).

Reporting may also be delegated to specific participants, and this ability to report on behalf of others would also have to be included in the solution. Different permissions and access rights would be required between these varying categories of participants. That’s a complex systems challenge to scope out.

Second, the data collected. This would need to vary in terms of specific regulatory requirements. The blockchain would need to cope with the sheer variety of different reporting requirements and their respective workflows and timeframes. So there’s no one-size-fits-all solution that appears obvious, which means managing multiple memberships and multiple processes.

Third, updates to data. The blockchain would also have to cope with edits and modifications to the data over the course of the transaction. In a blockchain context, this would likely be done not by modifying existing records on the blockchain, but instead by adding these new records in a manner connected to the previous entries – this is primarily because the advantages in transparency concerning blockchain lie in the write-only nature of record entry – which implies multiplying the data that describes each report significantly. Again, that’s a big systems challenge.

Challenges this model faces

Perhaps the most obvious problem here is one that distributed ledger technology applications in other fields also grapple with – scalability. The quantity of information reported under the diverse (and growing) number of regulations worldwide is colossal, and the blockchains that store this data would grow to become huge, rapidly and cumulatively. Its capacity to handle that kind of volume remains completely untested at this scale.

The second most obvious problem is also related to scale. The benefits blockchain potentially brings in the field of transparency only come when it is used by, at worst, a majority of the reporting participants and at best, all of them. If the blockchain coexists with other reporting systems, even other blockchains, its benefits may be limited by the need to reconcile the records of the blockchain with the records of the other reporting systems. It requires a mature and expansive ‘network’ with fully functioning interoperability and standardisation, capable of handling ever-increasing amounts of complex data.

Additionally, blockchain implies a sharing of responsibility between market participants, regulators and market infrastructure. This raises legal and compliance issues and, potentially, decentralised supervision of the different nodes that could ultimately be less effective than the supervision of central market infrastructures. Would the ‘ownership’ of the DLT be truly distributed, i.e. single-participant or multiple-participant owned utilities?

The final challenge to note here is how that kind of DLT will manage privacy issues. Most blockchain implementations are ‘write-only’ – the data stays on the blockchain. This may cause issues with global data protection regulation and ‘the right to be forgotten’ if any of the data relates to natural persons.

It’s the input that needs work, not the system

The practical considerations of reporting have led me to think that blockchain may not be able to deal with the real-world issues affecting trade reporting. There are just too many unanswered questions over the issue of data quality and standards. I have written extensively on some elements of this, including the use of UTIs and the need for ISO20022 standards in reporting.

Blockchain doesn’t solve these issues. They are likely to be major challenges for a blockchain solution, just as they are for current non-blockchain trade repository operations. Solving data quality issues actually has more to do with regulatory standards and harmonisation activity, than it does with the technology that actually acts as a repository for the reported data.

To put it simply, despite the potential of blockchain in post-trade more generally, it’s ultimately just a ledger system. The issues in regulatory reporting are not connected to the quality of the ledger, but rather the quality of the inputs and the operational complexity of recording them. That’s a human problem, not a technology challenge. Blockchain will no doubt play a part in the solution, but that’s not the same thing as actually being the solution, is it?

Irene Mermigidis is managing director of REGIS-TR, a European trade repository. Follow REGIS-TR on LinkedIn for further insights on the European regulatory landscape

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