Capital markets are undergoing an unprecedented digital transformation, a change which is being facilitated by non-mainstream technology providers. However, disruption will only succeed if the protagonists driving it do so in a way that is aligned with the risk tolerances of regulators and institutional market participants, according to Thomas Zeeb, Head Securities and Exchanges at SIX, speaking at the Worlds of ExChange Conference in Zurich on 29 January, an event sponsored by SIX and hosted by the Crypto Valley Association.

Risk-adjusted innovation
According to Zeeb, a commitment to asset safety and investor protection must be at the heart of digitalization. Taking digital assets as an example, Zeeb acknowledged the majority of existing crypto-exchange providers do not meet basic institutional standards, on account of their opaque business models, poor KYC/AML practices, lack of balance sheet capital, and an absence of prudential regulatory supervision. “Most crypto exchanges in the market are little more than unregulated brokers and there is no legal accountability if they fail. In other words, unless an investor holds their digital assets on a USB stick, they will have no financial recourse.”

In addition, Zeeb made his view clear that innovation needed to be conducted within the confines of a sound regulatory framework, adding that companies should have an open and regular dialog with the authorities about what they are doing, an approach which SIX and its recently established SIX Digital Exchange (SDX) is fully embracing. By side-stepping regulators, technologists may find their ability to institutionalize and scale becomes infinitely harder.

A panel – moderated by Brian Taylor, managing director at BTA Consulting –agreed further regulation of crypto-markets was inevitable and necessary, if the sector is to establish trust and meet basic investor protection requirements – especially as the industry has fallen victim to a spate of very destructive cyber-attacks. This, said one expert, would also require crypto-exchanges to vastly improve their existing governance models and practices.

Data must be protected
Equally significant is that innovators respect their consumers’ data and privacy, a shortfall which has become apparent at some of the big technology companies lately, prompting a significant consumer and regulatory backlash. “Data is one of the most powerful things in the world right now. For 15 years, people have passed on data to organizations and social media, and the consequences of that are only now being realized. The ways institutions use client data as it relates to securities is going to be firmly scrutinized by central banks and regulators so firms need to ensure they have the proper controls in place,” explained Zeeb.

Developing fast moving technology
Historically, technology infrastructure was built to last decades, enabling financial institutions to avoid having to regularly re-platform their systems at significant cost. Zeeb told the audience this way of thinking needed to change. “We need to address how we deal with constantly changing technology. We are moving away from a set-up where old technology systems are kept and maintained for 25 years. Instead, technological change needs to happen – relatively speaking – on the fly, which means organizations need to become much more agile in how they adjust to new operating models and systems,” commented Zeeb.

Our vision
SDX envisages a world whereby the digitalization of assets goes beyond just crypto-currencies, but is extended to traditional securities such as fixed income, equities and exchange-traded funds (ETFs), a development which would vastly expand the securities universe. Zeeb said SDX was working on ways to facilitate the listing of and trading in digital assets. SDX comprises the functions of a stock exchange, CCP and CSD, and will enable digital asset users to book and settle their transactions instantaneously in their digital wallets. “By converging these three functions, we will eliminate inefficiencies in securities markets,” said Zeeb.

Under SDX’s model, there will be a transition to T+0 settlement supplanting the market norm of T+2. As instant settlement will negate the need to post margin, liquidity – which has been trapped at CCPs or financial counterparties – will be freed up. “We anticipate the benefits of this transformation will be substantial. Our role at SIX is to facilitate the transition from the old world to the new world. We will run SDX in parallel to our existing infrastructure for some years but there will come a tipping point when we can reach out to our customers and agree it is time to decommission our legacy systems and become a fully end-to-end infrastructure,” he said.

Not adapting is not an option
Complacency around disruption, however, could be calamitous for financial institutions. Dr Maneesh Wadhwa, Head Innovation Financial Service Utility at SIX, told the Worlds of ExChange Conference that digital access platforms would enable investors to obtain direct exposure to the primary listings of issuers, thereby disintermediating banks and brokers. He warned big technology companies were also likely to create issuing venues, as a number of leading providers – such as Amazon and Alibaba – increasingly participate in traditional banking activities such as loan issuance. Should established infrastructures and other intermediaries choose not to innovate, they risk putting their core businesses at risk.

SIX Digital Exchange website