Analysis: DTCC Adopts Cautious Deployment Model for Ambitious Distributed Ledger Credit Derivatives Pilot

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The recent news that the Depository Trust & Clearing Corporation (DTCC) is planning to rebuild a key element of its trade processing infrastructure using distributed ledger technology supports the notion that proof-of-concept (PoC) projects are now transforming into real-life pilots. It also could act as a blueprint for managing the implementation of distributed ledgers for mission-critical financial applications.

Distributed spoke with Chris Childs, CEO of DTCC Deriv/SERV (the DTCC’s OTC derivatives processing unit), and Jennifer Peve, executive director of strategy and business development at the DTCC, in order to get more background on the project and to find out how they expect the pilot to roll out. The key takeaway is that, despite the transformational nature of distributed ledger technology, the DTCC has adopted cautious and traditional software selection and implementation disciplines, including a phased approach to rollout that won’t take full advantage of a decentralized architecture on day one.

Founded in 1999 and owned by many of the market participants to which it provides services, the DTCC is responsible for post-trade processing across a wide range of securities, including global exchange traded equities, corporate bonds, mortgage backed securities, over-the-counter (OTC) derivatives, money market instruments and mutual funds. In 2015, it processed securities worth about $1.5 quadrillion.

Its Deriv/SERV unit focuses on OTC derivatives and operates its Trade Information Warehouse (TIW) to support processing of credit default swaps (CDS) transactions. It is the TIW system — which is used by around 1,000 customers and supports CDS with a notional outstanding value of approximately $11 trillion — that the DTCC is looking to “re-platform.” Thus, while the rebuild project is certainly an ambitious and credible pilot for distributed ledger technology, it represents a fraction of DTCC’s overall business.

The TIW acts as a data store and performs certain calculations on a range of transactions related to CDS, including new trades, terminations of trades, calculating cash payments, credit events and compressions (combinations of trades). Transaction inputs are provided by electronic execution and confirmation platforms (operated by major banks as well as vendors, such as Bloomberg, MarketAxess and IHS Markit’s MarkitSERV unit) while payments are processed by CLS, a global foreign exchange settlement provider whose technology is run by IBM.

According to Peve, the impetus to replace the TIW was driven by the cost of operating an aging mainframe technology, which went live in 2006. Last year, the DTCC and a number of its members — including Barclays, Citi, Credit Suisse, Deutsche Bank, JPMorgan Chase, UBS and Wells Fargo, as well as market infrastructure providers IHS Markit and Intercontinental Exchange — conducted a joint review of technology approaches for a new system. Its members, encouraged by a PoC that was run in March 2016, lobbied for a distributed ledger approach to be chosen.

It was the PoC that introduced DTCC and the PoC participants to Axoni, a New York City-based sister business to TradeBlock, which provides information and transactional services for institutional digital currency traders. Axoni, which emerged at the end of 2015, has since participated in a number of PoCs across the foreign exchange and derivatives markets. In December 2016, it raised $18 million in investment from a number of financial markets participants, infrastructure providers and venture capitalists.

According to Childs, the DTCC subsequently issued a request for proposal (RFP) for the TIW replacement, which resulted in a winning bid from IBM, which chose to work with Axoni and R3 as partners to deliver the system.

The choice of IBM as the prime contractor is hardly surprising, since it is a global IT leader with a strong services operation which has invested heavily in becoming a key distributed ledger player. Childs says that IBM will take a leadership role in the project, and will provide ongoing support once the system goes live. Surprisingly, though, IBM will not provide cloud delivery services, says Peve, who suggests that the DTCC will run the system, leveraging another, to be named, cloud provider. That direction might be considered a blow to IBM, since its business model includes earning cloud revenues for distributed ledger deployments.

While the DTCC is not saying how many bids were considered during the “extensive” RFP process, or who submitted them, Peve says that distributed ledger technology from eight different vendors was considered during the RFP evaluation. Meanwhile, Childs notes that R3’s involvement in the project is in a “pure advisory role” and that the fintech company (which leads a consortium of nearly 80 financial services players) was brought in because it was felt that it would “add value to the solution.”

Interestingly, one stipulation of the DTCC — which is a leading member of the Linux Foundation’s Hyperledger Project — is that the distributed ledger technology should be open source, a requirement that led to Axoni agreeing to open source its AxCore platform once it has been further developed to support the TIW.

Says Childs: “The DTCC set the requirement [for open source]. It is important to the DTCC that base code is made open source to allow firms to develop it further.”

One drawback that is sometimes associated with open source software is a lack of performance (since it is often designed to be general purpose). By going with a proprietary platform that has been designed for financial markets applications, the DTCC gets the benefits of a specialized proprietary product, but ends up with an open source one that fits its software ideology.

When the first phase of the new TIW goes live in 2018, it will be as a direct functional replacement to the current system, with no new additional features. While the TIW will run on distributed ledger technology, it will be implemented to support a single, centralized node operated by the DTCC itself (essentially, as centralized as the legacy TIW that it is replacing).

Further phases, however, will see distributed ledger peer nodes being deployed at the larger market participants, allowing them direct access to the shared data ledger, which can be used more readily for their own calculations and processing.

With the deployment of peer nodes, access controls will need to be implemented to ensure that access to the datastore is controlled. Meanwhile, data inputs to the TIW will remain as trade execution and confirmation platforms, with data undergoing validity checks as it does currently. Thus, the distributed ledger architecture for the TIW can be considered as very different from an open, peer-to-peer one that many in the decentralized application world view as the real promise of the technology.

As well as providing its distributed ledger, Axoni will also build application functionality using smart contract approaches. Peve says these have yet to be fully defined, but suggests functions including calculations, life cycle actions and basic credit events could be implemented as smart contracts.

While the TIW project will be a high profile project for the DTCC, it is not the only distributed ledger project that it is in engaged in. Last year, the DTCC ran a PoC with Digital Asset and several members related to the settlement of repo transactions. Peve says that the second phase of that project will begin soon, with the goals of refining business requirements and proving the business case, which focuses on cost reduction, for the approach.