Six of the world’s largest banks — Barclays, Credit Suisse, KBC, SIX, Thomson Reuters and UBS — are collaborating to automate Markets in Financial Instruments Directive (MiFID) and Markets in Financial Instruments Regulation (MiFIR) regulatory requirements using Ethereum-based smart contracts.
The project was initiated by UBS in the innovation lab at Level39 in London, in preparation for the upcoming implementation of a revised MiFID and MiFIR regulation, a new legislative framework that aims to strengthen investor protection and make financial markets more efficient, resilient and transparent.
MiFID has been applicable in the EU since 2007 as part of the union’s regulation of financial markets. In 2011, the European Commission adopted a proposal for the revision of MiFID (MiFID II) and MiFIR. MiFID II and MiFIR will be applicable in the EU starting on January 3, 2018.
The European Securities and Markets Authority (ESMA) noted that MiFID II and MiFIR will ensure fairer, safer and more efficient markets and facilitate greater transparency for all participants.
“New reporting requirements and tests will increase the amount of information available, and reduce the use of dark pools and OTC [over-the-counter] trading,” reads the ESMA document. “The rules governing high-frequency-trading will impose a strict set of organisational requirements on investment firms and trading venues, and the provisions regulating the non-discriminatory access to central counterparties (CCPs), trading venues and benchmarks are designed to increase competition.
“The protection of investors is strengthened through the introduction of new requirements on product governance and independent investment advice, the extension of existing rules to structured deposits, and the improvement of requirements in several areas, including on the responsibility of management bodies, inducements, information and reporting to clients, cross-selling, remuneration of staff, and best execution.”
ESMA maintains a Q&A document on topics of investor protection under MiFID II/MiFIR. Within the regulation framework is the expectation for each institution to have an individual Legal Entity Identifier (LEI). The LEI is a 20-digit, alphanumeric code that enables clear and unique identification of legal entities participating in financial transactions. Once a legal entity obtains an LEI code, the code is assigned to that legal entity for its entire life. LEIs are needed by firms to fulfill their reporting obligations under financial regulations and directives, and permit matching and aggregating market data, both for transparency and regulatory purposes.
The initiative of UBS and partner banks is focused on the reconciliation of LEI data for each entity, such as industry classification, identifiers and ESMA data. The project, currently in a pilot phase, is scheduled to complete by the end of January 2018, with further, staged rollout dependent on the findings.
Running on a permissioned blockchain on the Microsoft Azure cloud platform, the project is aimed at improving the way in which participants can baseline their LEI reference data against the industry consensus.
“Traditionally, a firm such as ours quality checks data against multiple sources but we do not have a quality baseline against peers,” said Christophe Tummers, head of data at UBS, in the media release on the project. “Through using blockchain-inspired smart contracts, the reconciliation of data can happen in almost real-time for all participants, anonymously.”
In the project’s framework, LEI source data are held within participating institutions, and cryptographically hashed LEI data are submitted, anonymously, to an Ethereum private blockchain powered by Microsoft Azure. Then, Ethereum smart contracts reconcile the data against the consensus and warn each participant, in real time, of any anomalies in their own specific data, which permits timely corrective actions.
“We hope that in future, with the help of further automation, this project can move beyond simply anomaly detection to that of resolution,” said Tummers.
“This is an important project as it establishes blockchain benefits in a broader context than clearing and settlement,” said Emmanuel Aidoo, head of blockchain strategy at Credit Suisse, per the release. “The use of blockchain [technology] to solve real-world regulatory requirements in a cost effective way is very appealing.”
Ultimately, this application of blockchain technology is another indicator of its growing popularity among mainstream financial institutions as they look to comply with increasingly burdensome regulations.
“MiFID II creates complex data management challenges for businesses, and this initiative presents a unique opportunity for firms to benchmark content alongside their peers before it is used in regulatory reporting,” said Mark Davies, global head of RMS data services at Thomson Reuters. “This is an exciting and collaborative project that uses the latest blockchain technology to solve a real-world business challenge by improving the quality of counterparty reference data.”
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