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Deutsche Börse and Commerz bring blockchain to secondary markets

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By Lewis McLellan
11 Mar 2019

Commerzbank and Deutsche Börse have completed of a repo transaction using blockchain technology, opening up the possibility of a secondary market environment operating on distributed ledger.

Previous blockchain operations in capital markets have been confined to the primary market, including creating and settling transactions of “blockchain native” securities — bonds created on the blockchain.

By contrast, Commerzbank and Deutsche Börse last week settled a repo transaction of a €10m KfW seven day note with an interest rate of minus 0.5%. 

Blockchain tokens were created to legally represent both the securities and cash legs of the transaction. These were then swapped using blockchain technology, allowing the transaction to be settled instantly.

Michael Spitz, CEO of Commerzbank’s research and development unit, told GlobalCapital: “We’ve used blockchain on the new issue front before, but this is a new way of applying the technology to the secondary market — tokenising existing securities and settling the cash of the transaction on the ledger. It gives an opportunity to bring the benefits of distributed ledger technology — instant settlement, removing intermediaries — into the secondary market.”

Commerzbank and KfW teamed up in 2017 when Commerzbank assisted KfW in selling an ECP on blockchain. Because there was no on-ledger cash solution, the cash leg of the transaction had to be settled using traditional settlement means. 

Many of the efficiencies of a distributed ledger system do not exist without a digital token to represent cash on a distributed ledger. If the distributed ledger system cannot access cash, it cannot provide instant settlement, nor automate payments with smart contracts.

With this recent repo transaction, that problem disappeared. Deutsche Börse has developed digital tokens collateralised by cash deposited with the central bank, creating an on-ledger means of settling cash transactions.

JP Morgan launched a similar project to much fanfare in February, called JPM Coin. This will be available for JP Morgan’s clients to settle cash transactions instantly on JP Morgan’s blockchain.

Commerzbank ran a similar project in February with Continental and Siemens, but Deutsche Börse’s innovation is that, rather than taking Commerzbank or JP Morgan risk, its coins are collateralised by cash held at the central bank.

Thomas Wissbach, project manager at Deutsche Börse, explained: “It’s a new means of payment on the blockchain backed with deposits at the central bank. So clients pay into our account at the central bank and then we create coins for them in a 1:1 relation on distributed ledger technology (DLT), which can be turned back into fiat currency at any time. With this feature, you could automate all kinds of payments on DLT via smart contracts.”

Collateralised coin, as Deutsche Börse has dubbed it, will be widely available, rather than available only to the clients of a particular bank. 

“As a market infrastructure provider, we want to ensure that as many institutions as possible are able to make use of the service. It has to be a mutualised service, available to the whole community,” said Wissbach.

A tokenised cash solution like this would allow payment streams from bonds or derivatives to be automated and settled instantly. Because the distributed ledger can verify automatically that there is enough money to cover a payment, there is no need for a delayed clearing and settlement period as is required for transactions under traditional systems.

In addition to digitising cash in a form that makes it possible to settle it via blockchain, Deutsche Börse and Commerzbank’s trade demonstrate the possibility of doing the same with the existing universe of financial assets.

Rather than simply catering to the tiny universe of securities issued on blockchain, this system allows the creation of a tokenised version of any security. 

“In enabling an existing security to be put on the ledger, it facilitates immediate settlement, de-risking capital markets, not just in new blockchain-issued securities but for the established universe of assets,” said Spitz.

Last week’s transaction took place on a blockchain developed by the partners based on R3’s Corda system. However, the participants are agnostic about which system becomes commonplace. “Within this pilot transaction with Commerzbank, we’ve done both legs — cash and securities — on the same chain,” said Wissbach. “The next step will be connecting chains.”

“We’re not married to one technological framework. We’re at the stage where the technology is not the limiting factor. We can select a framework based on which is the most relevant for the constraints of the task. The bulk of the workload is not on the technology but on ensuring that compliant legal and regulatory frameworks are developed.”

A quirk of German law requires primary issuance to take place in paper form. This meant that previous blockchain primary issuances in Germany had to be replicated in paper, rather than relying solely on blockchain. However, once the deal is created, it can be traded in purely digital form.

By Lewis McLellan
11 Mar 2019