Multilateral Transparency for Securities Markets through Dlt

By Donald, David C.; Miraz, Mahdi H. | Fordham Journal of Corporate & Financial Law, December 1, 2020 | Go to article overview

Multilateral Transparency for Securities Markets through Dlt


Donald, David C., Miraz, Mahdi H., Fordham Journal of Corporate & Financial Law


(ProQuest: ... denotes formulae omitted.)

Introduction

Shifting securities markets to a communication and registration framework of distributed ledger technology (DLT) 1 would allow markets to retain multilateral transparency despite their increasingly decentralized and fragmented nature.2 The purpose of securities markets is to bring together buyers and sellers to contract for the sale and purchase of securities,3 and then to facilitate the transfer of title and cash between those parties.4 Since about 2000, the bid/ask queue of U.S. and European markets has been increasingly fragmented among various platforms.5 And since about 1972, the indirect holding system has impeded transparent ownership of securities.6 Use of a DLT network as the market's infrastructural spine could enable distribution of identical information on pricing and holdings to market participants, restoring transparency of both the bid/ask queue and ownership.

The model sketched in this paper goes beyond what has been undertaken-or even proposed-to date, as it addresses all market functions from pricing to transfer of ownership. Despite the obvious attraction of using DLT to defragment market pricing, this has apparently not been proposed even by the team charged with defragmenting market price data under the U.S.'s multi-billion dollar Consolidated Audit Trail (CAT) project.7 In securities settlements, with the exception of Australia,8 DLT's announced use has been for marginal functions,9 leaving core settlement operations unaffected.10 During the years of blockchain's initial spike in popularity, 11 a number of institutions adopted marginal blockchain applications rationally exploiting the publicity bump that its adoption could provide.12

However, a large impediment to any significant change of market infrastructure is the ratio of cost to benefit. While there is encouragement to be drawn from the creation of the Investors' Exchange (IEX) to fight damaging high frequency trading techniques that exploited a fragmented market, major infrastructural shifts are far from the norm.13 The existing, leading model for securities settlement enjoys great respect; replacing it with a relatively untested alternative would be unusual behavior for major market participants.14 If the quantitative benefits to core system participants are viewed while ignoring negative externalities borne by others, the current arrangement and technology of securities settlement used on major markets is fast, secure, and profitable,15 which itself nearly rules out a complete overhaul of existing systems with DLT.

An analysis that casts a wider net than immediate profits accruing to core market participants reveals the major flaws of fragmentation and indirect holding in contemporary securities markets. Pre- and post-trade price information has become fragmented as data transfer enabled the creation of alternative trade matching platforms. Regulations under the U.S. National Market System (NMS)16 and the EU Market in Financial Instruments Directive (MiFID) 17 have legalized such platforms. 18 Because trades in securities listed on a major exchange in the United States or the European Union can be matched on any number of venues, pricing information for those securities has become widely fragmented.19 Although sophisticated trade routing systems enable the largest broker-dealers to navigate this archipelago of platforms, less well-armed traders cannot.20

Market fragmentation is a significant flaw of the current market structure that concerns regulators at some level. The U.S. Securities and Exchange Commission (SEC) launched the multi-billion-dollar CAT infrastructure project in 2012 to repair this fragmentation at least for end-of-day data.21 The EU rules provide for an analogous institution of a Consolidated Tape,22 although it remains more of a hoped-for volunteer post than a realized project.23

Regulators have not publicly examined distributed ledger technology as a means of distributing pricing data. …

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