Blockchain technology has been recognized as one of the potential technologies to be utilized in capital markets. The goal of this paper is to evaluate the applicability of using the blockchain technology in securities settlement process. First, current financial market infrastructure is examined. Then Central Securities Depositories Regulation is studied. Blockchain applicability framework is applied to assess the blockchain technology's applicability to securities settlement. A blockchain architecture model and potential node structure for securities settlement are developed. The proposed blockchain architecture model and node structure is then evaluated against scholar expected benefits and drawbacks of using blockchain for securities settlement and cross-border settlement efficiency.
Blockchain technology has a potential to be the technological driving force of the next
advancement leap in the financial market industry. Current financial market
participants, while focusing on serving their local markets, are standardizing processes, and
accommodating cross-border relationships. Many industry professionals have
recognized the potential of the blockchain technology that could significantly improve the
currently existing processes and solve many of the existing inefficiencies [
One of the identified processes that could significantly benefit from the blockchain
technology is securities settlement process. Also as referred as securities post-trade
(since it happens after securities are traded), the process involves a lot of intermediaries,
especially when there are long chains of custody and cross-border settlements. The
nature of the financial market ecosystem, where there are centralized entities that execute
securities settlement processes and contain large number of intermediaries that share
information between each other, indicates potential to use blockchain technology.
Scholars support it and claim that this kind of environment with multiple intermediaries
can benefit from blockchain technology, for example, from data reconciliation process
efficiencies, reduced risks, increased transparency, and other benefits [
Because the securities settlement practices and legislative requirements vary from country to country, it is hard to generalize blockchain’s potential in securities settlement on a global scale. Since financial markets in the European Union (EU) are operating under the same or similar legislations, they have harmonized the financial market practices and structures in the EU countries. Therefore, the scope of this paper is to examine the applicability and usability of blockchain technology within the EU, considering the current EU-level rules and regulations.
Considering the nature of the current securities settlement process and the financial market ecosystem, the aim of this study is to assess applicability of using blockchain technology in securities settlement process in the current regulatory environment in the EU. Namely, the authors of this paper evaluate if blockchain technology can be used to ensure securities settlement, and, if it can, then what would be the possible blockchain architecture and node structure. To make this assessment, the following research question is asked: Can blockchain technology be used to process securities settlement in the EU?
To answer the research question, the following tasks are defined: • Examine the applicable regulations for securities settlement in the EU, • Evaluate blockchain technology’s applicability for securities settlement, • Develop a blockchain architecture model and node structure that describes potential blockchain usage for securities settlement, • Assess the benefits and drawbacks of the proposed blockchain architecture model and node structure. 2
The current financial market infrastructure in the EU consists of multiple components
that are interconnected with each other and allow securities (also called financial
instruments) transactions between the parties. Financial market infrastructure is the core
of safe, efficient, and robust financial markets [
Central securities depositories (CSDs) have a crucial role in the financial market
infrastructure. By some authors, the CSDs themselves are defined as financial market
infrastructures because of their position in the securities settlement chain [
Legend
Mandatory relationship Optional relationship
CSDs are entities that operate securities settlement systems (SSS), provide notary service (initial recoding of securities in a book-entry form), and provide central maintenance service (registration of securities accounts at the top tier level) for CSD participants – banks or brokerage companies. CSDR defines these functions as core CSD services. Different CSDs operating in different countries may have varied service scope that they provide, but they usually provide the same set of core services.
SSS ensure technically and legally safe securities transfer between the involved parties at CSD participant level. Securities settlement can be either free of payment (FOP) or delivery versus payment (DVP). FOP transfers involve only securities transfer, and DVP involve simultaneous exchange of securities and money. Depending on the regulation and market practices, the securities settlement can happen in real-time, or it can be aggregated and netted at pre-defined times. 3
Legal requirements towards how financial markets, in particular securities settlement, must operate are dependent on the locally adopted laws and regulations. Since the scope of this paper covers securities settlement in the EU, the relevant legal acts are inspected to identify the legal requirements that any current or future solution must comply with, including one built on blockchain. European Commission has published many EU regulations that describe how financial markets should operate and define requirements for the financial market components. According to European Commission, various legal acts have been published to ensure that settlement systems operate as expected, especially after the financial crisis in 2008.
Central securities depositories Regulation (CSDR) is the main regulation that defines
how various aspects of securities settlement must operate. The date of entry into force
of this regulation was 17 September 2014, and since then multiple CSDs in the EU have
licensed their operations under the regulation. The aim of this regulation is to
synchronize how CSDs function and how securities settlement is organized within the EU.
According to the regulation’s subject and scope, it “lays down uniform requirements for
the settlement of financial instruments in the Union and rules on the organization and
conduct of CSDs to promote safe, efficient and smooth settlement.” Similar operational
and legal requirements set by the CSDR also improve the environment for more
streamlined cross-border settlement across the EU [
CSDR stresses the systematic importance of CSDs and the SSSs they operate for the securities markets. It recognizes the multi-level relationships between the parties involved in the financial markets, and the importance of CSDs to ensure that the information and assets shared in the financial markets are secure, processes are trustworthy, and there is no unjustified creation or deletion of securities. CSDR provides common definitions to all the relevant items – physical, legal, and theoretical – related with financial markets, CSDs, and their operations. It defines the requirements on securities settlement, CSD supervision mechanisms, requirements for CSDs, and other items. The CSDs are required to record all securities traded on the stock exchanges in book-entry form so they can be properly settled in an SSS. In other words, all the securities should be issued digitally and recorded in an SSS in a way that the ownership of the securities can be traceable. An important aspect is settlement finality – the moment when the change of ownership can be considered final and irrevocable. The CSDs must comply with the Settlement Finality Directive (Directive 98/26/EC) and define exact moments of entry and irrevocability when the settlement instructions are accepted, matched, and executed. Besides, CSDR states that for all cash settlement originating from securities settlement (for example, for simultaneous securities exchange for cash) the CSD should settle cash using the CSD participant cash accounts opened in the relevant central banks (cash settlement in central bank money), where it is practical and possible.
In addition to the CSDR, the European Commission has published Level 2 measures that complement CSDR with more detailed descriptions and requirements towards CSDs. These Level 2 measures include regulatory and implementation technical standards on CSD requirements, regulatory technical standards on settlement discipline, and others. For CSDs to be compliant with the CSDR and be allowed to operate in the EU, they must comply with the CSDR and the Level 2 measures and certify with the local competent authorities that they have completed all the requirements defined by the CSDR and Level 2 measures.
For this paper it is important to understand the legal requirements and implications towards securities settlement. The current laws and regulations are technology-agnostic and do not specifically define what technological solutions are allowed or not allowed to be used for the securities settlement. Therefore, any solutions that are used should still be compliant with the legal and regulatory environment. Since blockchain technology as such is considered as disruptive and could potentially replace or drastically change the operations of some financial market infrastructure components, it is important that the imposed changes are still compliant with the relevant legal and practical requirements defined by the law. When modeling the potential blockchain architecture that could be used for securities settlement, the general principles and operational requirements defined by CSDR must be respected. In particular, the following general aspects must be considered: • Requirements on securities records in a book-entry form, • CSD participant and account structure, • CSD link requirements, • Settlement finality aspects, • Cash settlement in central bank money.
Other requirements defined by the CSDR that are not directly related to the operational aspects are disregarded in this paper, as they do not impact the underlying system ensuring the securities settlement. These requirements include cooperation between the competent authorities, CSD authorization, CSD’s capital and organizational requirements, and other non-operational requirements. 4
While some scholars recognize the potential usage of blockchain technology in the
financial markets, others argue that for some applications it is hard to pinpoint whether
blockchain based solution would be suitable, or the centralized technology is more
appropriate [
The blockchain applicability framework asks 92 control questions to determine the
blockchain technology’s applicability. The authors of the framework claim that the
control questions have been designed by evaluating numerous operating blockchain
solutions, their core concepts, similarities, and differences, as well as by analysis of
consensus mechanisms, and other aspects [
Each domain is further divided in smaller sub-domains that contain a group of
controls in question formats. The framework states that answering the control questions
gives a mathematical result for applicability of blockchain solution for securities
settlement. In particular, the framework allows to answer the following decisions:
1. Does the application need a blockchain?
2. If the application needs a blockchain, does it need a private blockchain or
permissionless/public blockchain?
3. What consensus is most suitable for the application? Proof-of-work (PoW),
proof-of-stake (PoS), proof-of-burn (PoB), and proof-of-authority (PoA)?
We applied the framework to securities settlement context. The results of the
application are available in full scope in [
Domain 1: Data and participation. This domain summarizes the control questions
on data attributes, authority nodes, readers and writers and their characteristics. The
assessment of the answers was made based on the previous literature on blockchain’s
applicability in securities settlement, where it was indicated that CSDs could retain the
role of governing who could access the network, and what would be the participant
rights [
Domain 2: Technical attributes. This domain includes sections of codebase and
networks, smart contracts, transaction constraints, transaction processes, and miners
and consensus sub-domains. The answers to these control questions were based on the
current financial market infrastructure and the specifics of the securities settlement
process defined by the CSDR, and the evaluation of the blockchain applicability by other
scholars. As previously identified by Mori, if blockchain is used in securities
settlement, the blockchain network should ensure close to real-time settlement, it should be
cryptographically safe and accurate, as well as the transactions and securities ownership
should be traceable [
Domain 3: Security. This domain includes governance, security activities, and access control sub-domains. Answers to these control questions were based on the technical requirements originating from CSDR. CSDR is clear on the responsibilities of the CSDs and what are the necessary security measures that the CSDs and their SSSs must ensure. Should a blockchain solution either partially or fully replace the CSDs and their SSSs, it would still be required to be compliant with the applicable regulations, including the ones regarding security and proper governance of the securities settlement. It means that the CSD participants would need to be vetted, counterparties should be able to access only the data that is relevant to them, and the integrity of securities issuances, transactions and balances would need to be compliant with the applicable standards and regulatory requirements.
Domain 4: Trust parameters. This domain includes visibility, integrity, and
validation sub-domains. The answers to these control questions were based on both CSDR
requirements and Mayer’s view on the future tasks of the CSDs. The involved parties
in the securities transactions should be known, but the data scope they access should be
limited to themselves. For example, a CSD participant should be aware of the
transactions and balances of its own clients, and not the clients of another CSD participant.
There should be a party that governs the access rights and defines the rules on what
information can be accessed by what party [
Domain 5: Performance and Efficiency. This domain includes system performance, expandability, and market design sub-domains. According to CSDR, the system that operates securities settlement should be capable to ensure the volumes of the peak amounts of securities transactions. Therefore, the answers to the control questions considered no compromises on the latency, throughput, and performance of the system. Additionally, the blockchain solution should be capable to scale up to ensure crossborder securities settlement and function as the current CSD links.
The answers were grouped according to the decision they impact, and their weights were summed up and compared per each decision. The results of the comparisons are summarized in Fig. 2.
The blockchain applicability framework indicates that blockchain is indeed suitable
to be used for securities settlement (61% vs 39%). This is consistent with the previously
reviewed literature that indicates blockchain’s potential usage in the financial markets
[
By a large margin (90% vs 10%) the framework suggests that for securities
settlement the most appropriate type of the technology is private permissioned blockchain.
Again, this finding is consistent with the reviewed literature and can be explained by
the regulatory and practical need to have a governed control over the blockchain
network [
Regarding the most suitable consensus mechanism, there are two distinct consensus
mechanisms that are considered more suitable than two others. In particular, PoS and
PoA consensus mechanisms are considered as the most suitable ones for securities
settlement (36% and 35% vs 12% and 17%). Not considering PoW consensus mechanism
as applicable is in line with the need to have fast and high-volume based transaction
and information exchange between the blockchain participants. PoW consensus
mechanism is computationally expensive and can result in limed performance capabilities of
the network [
This section analyzed the results originating from the blockchain applicability framework. The results show that it is worth to further develop the model of the blockchain architecture and the model for node structure for securities settlement. 5
To define and represent the overlay of the blockchain architecture, a modeling approach
used by Zhuang, Chen, Shae and Shyu [
The blockchain architecture model proposed by Zhuang, Chen, Shae and Shyu [
Transaction layer. At the core of the transaction layer is the blockchain network
itself and the used smart contracts for automated processes. At this layer, the nodes
would maintain the distributed databases at their premises and ensure operation of the
underlying blockchain solution. Transaction layer also ensures data encryption and safe
transfer between the blockchain network’s participants. In the context of securities
settlement, the information being transmitted on the transaction layer would be close to
the currently exchanged information between the CSD and CSD participants in ISO
20022 messaging standards. The data scope would be close to the ISO 20022 messaging
standard because it contains the mandatory information fields required by CSDR. In
their model Zhuang, Chen, Shae and Shyu [
Interfacing layer. This layer allows any blockchain adapters and graphical user
interfaces to interact with the blockchain network. The proposed model by Zhuang, Chen,
Shae and Shyu [
For securities settlement process defined by CSDR, settlement should be initiated by submitting settlement instructions – a set of mandatory information of the transaction. This requirement can be fulfilled by Post method. The CSD participants or other entities, such as supervisory authorities, may need to reconcile their systems with the blockchain network. Therefore, Get method could be used for such purpose. The same method can be used by the CSD participants to receive updated on the settlement instructions they have submitted, as well as perform internal data reconciliation. When securities are registered and issued, their information must be stored and shared on the blockchain network. For this purpose, Store method could be used. The CSD can use Send method to deliver settlement related information to the network participants, such as information about securities issuance, corporate actions, and other. Therefore, all four methods – Send, Get, Store, Post, can potentially fulfill all the necessary actions for the securities settlement on blockchain.
Application layer. The application layer allows for blockchain participants to build
and integrate applications with the blockchain network, such as ERP systems,
businessspecific systems, analytics tools, and others. It uses interface layer to collect the data or
instruct data to be transmitted to the blockchain. The applications themselves do not
have direct interaction with the blockchain network, and they cannot change or impact
the settings of the network [
The proposed layered blockchain architecture model would allow securities settlement to occur as follow (see Fig. 3): 1. CSD participant A initiates securities transfer in its banking or accounting system, 2. The securities transfer is communicated to the blockchain network using Post method (equivalent to settlement instruction), 3. The counterparty CSD participant receives the relevant information about the initiated securities transfer using Get method, 4. Depending on the underlying blockchain solution, the counterparty CSD participant either approves (signs) the proposed transaction, or also communicates transfer information to the blockchain network (equivalent to settlement instruction), 5. Depending on the underlying blockchain solution, the securities are settled either by the smart contract configuration or other pre-defined process, 6. The CSD validates the securities settlement and the state of the network, 7. The CSD participants update their banking or accounting systems according to the information received from the blockchain network using Get method. 6
When the blockchain architecture is defined at each node’s level, it is important to also
define the node structure itself to describe the financial market infrastructure if
blockchain is used for securities settlement. According to the proposed blockchain
architecture model, each of the network participants that hold and exchange information on
blockchain should be a node – holder of the copy or part of the copy of the shared
database. This approach is also consistent with the literature on blockchain
fundamentals where nodes are the individual parties that interact with the distributed system, can
send and receive information to the network, and work in an organized manner
according to the network’s rules [
Currently, to ensure cross-border securities settlement, the CSDs have to establish technical and legal links with each other to allow securities issued in one CSD to be settled in another CSD. It is being done either in T2S (if both CSDs are members in T2S) or outside T2S (if at least 1 CSD is not a member in T2S). If a blockchain solution is used for securities settlement, the usage of CSD links is dependent on the geographical and legal participation of the linked CSD’s participants in the blockchain network. If they are capable technically and legally to be a part of the blockchain network, then there is no need for having links between the CSDs, and the linked CSD’s participants can become nodes or participants of the blockchain network themselves. However, if they are not capable or willing to become members of the blockchain network, only the linked CSD can become a node of the network and ensure cross-border interoperability between the CSD participants on the blockchain network and off the blockchain network. Taking into account that there can be multiple scenarios with various kinds of combinations of how links between blockchain network and off-blockchain CSDs are created, controlled, and practically operated, this paper does not consider all the possibilities and details of such relationships as they are not in the main focus of this research. Only generalized possibility of a potential links with an off-blockchain CSD, and consequently with its participants, is recognized. Similarly, T2S as the central hub between the CSDs within the EU is considered as a potential, but not necessary part of the blockchain network.
Central banks are also components that are part of the securities settlement process. They can have a dual role – the central banks are involved in cash transfer part of securities settlement, and they can be CSD participants themselves. Since they must directly interact with the network (settle cash leg of the securities transfers), they should be part of the blockchain network as nodes as well.
According to other scholars, CSDs can be part of the blockchain network and
provide supervisory, validator, or gate-keeper functions of the network [
Additionally, there can be other interested parties that could become members of the blockchain network. For example, supervisory authorities or regulators could access the network to directly receive information that is traditionally delivered to them by the CSDs.
Fig. 4 summarizes the components of the current financial market ecosystem members that would become nodes of the blockchain network for the securities settlement.
The proposed blockchain architecture model and node structure for securities
settlement on blockchain was evaluated against the potential benefits and drawbacks
identified by Benos, Garratt and Gurrola-Perez [
The proposed blockchain architecture model and node structure was also evaluated
in context of cross-border settlement efficiencies. The blockchain architecture model
and node structure was assessed against the criteria defined by Schaper [
The performed evaluation of the proposed blockchain architecture model and node structure indicated the model’s and node structure’s usefulness for the application. It also highlighted the benefits and drawbacks that the proposed blockchain architecture model and node structure would have in comparison with the traditional settlement systems. 8
The evaluation of blockchain technology’s applicability for securities settlement was
done by applying a blockchain applicability framework developed by Gourisetti,
Mylrea and Patangia [
For further evaluation, the blockchain architecture model for securities settlement
was created. To define the possible blockchain architecture a blockchain architecture
modeling approach used by Zhuang, Chen, Shae and Shyu [
The proposed blockchain architecture model and node structure were evaluated
using Benos, Garratt and Gurrola-Perez’s [
The findings of the paper as well as the developed artefacts can be considered as the contribution to the scientific body of knowledge and can be used by anyone who is interested in further elaboration of more specific applications of blockchain technology in securities settlement or in expanding blockchain’s usage to other financial market processes than securities settlement. The results of this research also can be used by the current financial market infrastructure components to design and implement blockchain-based securities settlement systems. Additionally, the graphical representation of financial market components and relations (Fig. 1) that was produced during the current financial market infrastructure examination can be considered as an additional artefact that can be used by other scholars to navigate the financial market ecosystem and understand the relationships between the components.
Even though it has been indicated that blockchain technology can be used for
securities settlement in the EU, it was also noted that a practical application of a blockchain
solution for securities settlement would be a complex implementation project that
would require commitment from many financial market participants [