ESMA identifies challenge in linking blockchain technology into existing financial market IT infrastructure

ESMA has opened a consultation (34-page / 588KB PDF) with industry and other stakeholders seeking views on how blockchain or the broader category of distributed ledger technology (DLT), could be applied to securities markets and what the potential benefits, risks and challenges would be in its use. The consultation closes on 2 September.

Whilst ESMA said blockchain technology could help speed up the clearing and settlement of financial transactions, record ownership of assets and support regulatory reporting, among delivering other benefits, it warned "technological issues" would need to be addressed for the potential of blockchain in the market to be realised.

The interoperability of blockchain technology with other systems was highlighted as potential barrier to its use.

"It seems unlikely that the DLT would be deployed across all market segments and activities simultaneously," ESMA said in its consultation paper. "In a step-wise scenario, the DLT would need to interoperate with existing market infrastructures and the attendant systems, at least in the short to medium term. In addition, separate ledgers might be used for different asset types and these ledgers will need to interact with one another. This raises a number of technical challenges."

"Not all market participants may choose to build interfaces to the new technology and existing market infrastructures might have no immediate benefit in starting interoperating with different ledgers. Also, many of the benefits of the DLT could be reduced, unless it is widely adopted by market participants and market infrastructures," it said.

There are also questions over whether blockchain could be implemented on a large scale, ESMA said.

It said: "It seems that the technology is developing rapidly and that some firms have begun using DLT for targeted financial activities. However, ESMA is not presently aware of a securities market DLT system operable on a large scale. What has been achieved for targeted activities might be difficult to replicate on a wider scale, with a broad range of instruments and participants. Some of the benefits attached to the technology, e.g., low latency, may also become less relevant if the technology is deployed extensively."

ESMA also said the deployment of DLT could raise "fair competition issues".

"As an example, the supporters of a DLT network could prevent new participants to join or impose such conditions that it becomes economically unviable for new members to join the network," ESMA said. "A monopoly-like situation could emerge, with possible negative consequences on the cost and the quality of the services. It might be difficult to establish competitive ledgers or ensure the interoperability between ledgers, thus negatively impacting the competitive nature of securities markets."

"Unless adequate controls are in place, some participants to the network could also unduly exploit the information recorded on the network, e.g., recent trades made by competitors or the level of their inventories, to front-run them or manipulate the market. The lower the privacy level of the network or the lower the safeguards attached to it, the higher the risks would be," it said.

The widespread use of blockchain in the securities market could also be restricted by "differences in securities and company laws across the EU", ESMA said.