Algorithmic trading has been in place for a long time now. Artificial intelligence has powered the ability to evolve and tune these algorithms similar to what a human being would do by evaluating results and reworking models, albeit at a much faster pace and with much more accuracy and less bias.
AI has the potential to replace and improve upon the thinking of analysts (by screening large volumes of data like market data, brokerage reports, company annual reports and results etc.) and framing answers to questions to make good investment decisions. Blockchain can also help in some parts of the lifecycle, such as making data securely available to everyone in a secure fashion, enabling functions such as efficient proxy voting and reducing systematic risks like insider trading.
Blockchain as driving force of future stock markets
In the world of blockchain, the regulators are perceived as the biggest barrier or enablers for its adoption. However, research suggests that a major section of organisations do not believe regulatory issues will be a barrier for increasing blockchain investments. This is also because many market regulators and global exchanges across geographies, including the NYSE and Deutsche Borse, have already showed their intent to evaluate the feasibility and advantages of blockchain.
Japan’s Financial Services Agency has allowed the Japan Exchange Group, which operates the Tokyo Stock Exchange, to use blockchain as its core trading infrastructure. In 2015, Nasdaq unveiled the use of its Nasdaq Linq blockchain ledger technology to successfully complete and record private securities transactions.
Still, there are many national and regional regulators adopting a wait-and-watch approach, preferring to explore and understand blockchain’s regulatory and policy implications before moving forward. Overall, there is certainly slow progress on the development of the necessary regulatory frameworks, legislation and industry standards that are required to move from pilots to production.
Major advantages of blockchain implementation in stock market
Blockchain can be the answer to interoperability, trust, and transparency issues in fragmented stock market systems. Stock market participants such as traders, brokers, regulators and stock exchange are required to go through a cumbersome process (which takes 3+ days to complete transactions mainly due to role of intermediaries, operational trade clearance and regulatory processes).
Blockchain can make stock exchanges much more optimal through automation and decentralisation. It can help reduce costs levied on customers in terms of commission while speeding up the process, resulting in fast transaction settlements. The technology can have a viable use in clearing and settlement, while securely automating the post-trade process, easing paperwork of trade and legal ownership transfer of the security. At the end, the faster and efficient trade cycle will lead to higher liquidity and investments.
Blockchain use in Indian markets
India’s financial sector has shown the promise, which blockchain can bring in and is largely invested in the exercise to reap the benefits it can provide. Sebi is taking early steps to understand how the technology is being used in markets globally and possibly derive the benefits gradually. Recently, Sebi appointed an advisory committee called as Committee on Financial and Regulatory Technologies (CFRT) for conducting research on the blockchain platform and other technologies making waves in the sphere of fundraising, asset management and post-trade settlement. Blockchain offers huge potential for tracing securities lending, repo and margin financing and monitoring systemic risk.
What are the key risks or challenges?
Potentially attractive to regulators due to increased transaction security and reduced risk of manipulation, this new technology gives rise to difficult legal and regulatory challenges that regulators are grappling to understand.
The financial market ecosystem is currently uncertain about the extent to which blockchain, particularly as applied to capital markets, will live up to its promise. The implementation of blockchain also brings along the risks of maintaining security standards across a decentralized database, besides the concerns around scalability and regulations. Blockchain looks to combine elements of trading, clearing and settlement but current legal frameworks and regulations ascribe them separately.
What is the way forward?
While the market monitors potential regulatory developments, effective governance is the key to the successful implementation of blockchain to protect participants, investors and stakeholders whilst ensuring that the system is resilient in the face of systemic risk, privacy concerns and cybersecurity threats.
Blockchain has the potential to disrupt the financial services, particularly in automating market surveillance events processing and in automating post-trade events processing. The technology promises to address problems such as loss of data, data fragmentation, insider trading, review of margin system, reconciliation and ticket matching.
However, the full potential value from restricted mutual distributed ledgers and smart contracts will require widespread changes in business processes and investments from firms, virtually from buy-side and sell-side of the industry. Regulators will also have to play an active role by adopting shared data arrangement for regulatory reporting.
(Som Shekhar Singh is the Director of Technology at Sapient Consulting. Views are his own)