The Turnbull government recently announced reforms to remove the ASX’s monopoly on the clearing of cash equities and in so doing opened the door to disruption from ‘blockchain’ or ‘distributed ledger’ technology.

In an initial development phase the ASX has already invested $14.9 million in a blockchain development company named Digital Asset Holdings and expects to make a final decision on the future of Australia’s ‘post-trade’ technology by 2017.

The Turnbull government is also committed to new technologies in financial services after launching a $1.1 billion investment in its ‘Ideas Boom’ reforms, which are designed to promote transformative new financial technologies like blockchain.

How could blockchain disrupt the ASX? 

Currently the ASX has a monopoly over cash equities clearing services that are processed through its Clearing House Electronic Sub-Register System (CHESS), which acts as an intermediary between two participants exchanging legal ownership of equity holdings for cash payment.

A clearing house splits trade processing into the two distinct parts of clearing and settlement, and its other prime role is to act as a guarantor if a counterparty defaults on its obligations or goes into liquidation for example.

Blockchain’s proponents claim the technology could deliver real time clearing and trade settlements over a distributed ledger that approved market participants are privately granted permission to access.

This is important as it promises a potential revolution in eliminating settlement periods and many of the operational and counterparty risks carried by market participants under the T+2 settlement process.

However, it’s the claimed potential to deliver real time clearing services that seems harder to achieve, but could prove revolutionary in its consequences.

Real time clearing would require ordinary investors to fund their brokerage accounts prior to trading and how blockchain would achieve or circumvent this requirement has not been explained in any clarity.

Who wins if blockchain works? 

The obvious advantage for investors is that they could expect to receive cash in their settlement accounts almost instantaneously after selling a parcel of shares. Of course, you’d have to stump up the cash before you buy, too.

The potential for competition amongst post-trade processors globally could also lower brokerage fees and make overseas markets more accessible to retail investors. The trend towards international exchanges merging could also accelerate with the ASX a takeover candidate and Europe’s largest exchanges in the UK and Germany potentially merging in a blockbuster deal.

However, the real winners from blockchain would be the investment banks if they are able to slash costs by seeing their cash market settlement fees reduced as 30-year-old trade processing methods at clearing houses are consigned to the history books.

Blockchain could also simplify costly and time consuming operational errors for the trading arms of investment banks, with real time clearing even having potential to help eliminate failed trades. If blockchain really could achieve this, the banks are likely to be sitting on a huge winner.

Clearing houses also currently wear the risk of default by a clearing participant (protecting investors as well) and have supervisory rights to demand costly intraday margining, end-of-day exposure monitoring and capital adequacy requirements on market participants such as brokers. Instant settlement times could lessen some of these monitoring obligations as counterparty exposures disappear with real time settlement.

No surprise then that the investment banks are wildly enthusiastic about the cost-decimating potential of blockchain in managing their multiple compliance, counterparty, margining, and operational risks when processing trades.

Foolish takeaway 

One prime beneficiary of the potential success of blockchain technology is trading giant and investment bank Goldman Sachs, with ex-Goldman Sachs Australia Head and now Prime Minister Turnbull also enthusiastic about the bottom-line bulging potential of blockchain for the investment banks.

If it proves the real deal it could also bring big benefits for shareholders in the global financial powerhouses that continue to dominate global equity trading, although it’s worth remembering it has a long way to go yet.  

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The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.