Why the ASX is saying checkmate to CHESS

Summary: Dominic Stevens, the head of the ASX, explains why our main stock exchange is adopting blockchain technology.

Key take-out: Investors can look forward to easier and more efficient share transactions in real time.

Australian Securities Exchange CEO Dominic Stevens says the stock exchange’s switch from the Clearing House Electronic Subregister System (CHESS) to a blockchain-based system will make equity transactions faster and more efficient for all investors.

In an exclusive interview with Eureka Report, the head of Australia’s stock exchange says the new system will make it easier for investors and other stakeholders to access information regarding their holdings.

In partnership with fintech company Digital Asset Holdings – of which it owns a stake – the ASX began developing the technology in early 2016. After close to two years of development and consultation, it was announced in December 2017 that the ASX will become one of the first major stock exchanges in the world to use blockchain technology to assist in clearing and processing transactions.  

Although no specific figure was mentioned, Stevens says the ASX is making a significant financial investment in the new technology, but only slightly more than would have been necessary to maintain and update CHESS.

Blockchain technology – also referred to as distributed ledger technology – is commonly known as the technology driving cryptocurrencies such as bitcoin. However, Stevens says that only certain elements of the technology will be employed by the ASX.

When the new system comes into effect – currently slated for March or April 2021 – it will mark the culmination of an almost five-and-a-half-year process from development to adoption.

You can listen to the podcast, or read the full interview transcript below.

Michael Pepicelli: Back in December 2017, the ASX officially announced that it would adopt blockchain technology in favour of the CHESS system for the processing and clearance of transactions – almost two years after development commenced. Although we're still two-and-a-half years away from the scheduled starting date, there is plenty of intrigue surrounding the decision and ASX CEO Dominic Stevens has joined Eureka Report for an exclusive chat about the switch. Dominic, welcome.

Dominic Stevens: Thank you Michael.

Michael Pepicelli: So first up, the ASX is going to become one of the first stock exchanges in the world to adopt such a system. What is the reason for the change and why is now the right time to make this change?

Dominic Stevens: Well, I think the interesting thing is, is that obviously we have a number of systems and technology at ASX and what you have at ASX, in the clearing and settlement space is the CHESS system. The CHESS system was a ground-breaking system when it came in in sort of the mid-90s. It's now sort of getting towards the end of its career in clearing and settlements. And the interesting thing is that the board, back in 2015, when we were looking at how we were going to replace this system, said, “Let's look at all of the options out there and ... We're hearing a bit about this new technology called blockchain that actually is an interesting way of running databases and running registries”, and so that started a long process as you mentioned in your intro around actually finding out about this technology and whether it was applicable for running a clearing and settlement system such as what we have in Australia.

That process went for a couple of years. A lot of work finding the right partner to work with us in the technology. A lot of work basically proving up the actual technology itself, and a lot of work talking to all the participants and stakeholders in the market and regulators about what they were looking for and whether this was appropriate for them and that gets us to where we got to in December last year as you mentioned, and now we're sort of moving forward on a path of looking at this as a technology or actually implementing this as a technology to replace the CHESS system.

Michael Pepicelli: So probably the question that most investors will be asking is what are the main differences between the CHESS system and the blockchain system?

Dominic Stevens: I think that's a really good question, Michael. I’d say there's quite a bit of confusion on this because I think most people when they think of blockchain and distributed ledger, they go down a path of, “I've heard about this thing called bitcoin and there’s ICOs and there’s cryptocurrencies and there’s ... Doesn't this thing use the electricity supply of a small European country”? And there's a consensus and it's all anonymous and all these things. And so, the interesting thing from our point of view is there is all of those things with the bitcoin implementation but what we've done is actually say that, “This is a highly regulated market that trades billions of dollars in a day and so what we need is a very transparent system and one that actually solved the problem of real-time source of truth”.

And so what I mean by that is, is that instead of having, us all having a whole bunch of different systems and disparate technologies that actually spend all their time reconciling with each other, can we actually take this bit of IP out of the blockchain concept and apply it to the clearing and settlement system such that when ASX – which is the source of truth for transactions in the equity market – has a database that everyone can actually have distributed to them, that same source of truth in real-time, such that actually will make their processes more easy, more efficient, and actually enable those participants to our market to provide better services to their customers and their customers' customers.

Michael Pepicelli: So you’ve briefly touched on this, but what do you think the benefits will be of the switch for investors?

Dominic Stevens: Well, I think for investors, there's a number of things that come from this. The first thing is, is actually putting the information out, getting information out on a real-time source of truth basis should mean that every ... The efficiency of the way that the whole, what we call post-trade world – in other words, once a trade happens, how it clears; how it settles; how it is registered; how do people get updates of what their positions are; how do people get confirmations of what happened should all happen in a more efficient and real-time sense. So for end-user investors, there's that. What that will probably then allow our participants to do is … offer customers more choices. So, I see in a future world that participants might be able to – instead of settling over two days – they may have the option to settle earlier.

They may have the option to see the real-time source of truth online ... They could opt out of getting sent envelopes with records that are paper-based. Because that information is out there, it will mean that the brokers and the banks that they use to actually supply them with their portfolios and their information will be able to do that in a more efficient and better way. So, I think all of this comes from actually ... ASX, as you would know, is not dealing directly with retail investors and end-users so much out there, but what we're doing is providing the infrastructure for banks, custodians, brokers, financial advisers or whatever to enable them to provide better services to their customers.

Michael Pepicelli: So how will investors be affected when the switch is coming into effect? Will they notice the difference?

Dominic Stevens: I think initially what will happen is, so we’re talking as you said earlier on about sort of like early 2021, and I think that for end-user investors like retail investors, they won't notice the difference sort of day one because where the work really is is actually ASX developing and putting in a new system and all the participants that connect to that system, actually basically connecting all their systems together to join with the ASX system. What investors will see after that is all of those benefits that I've talked about: whether in the future it means that they'll be able to get their dividends earlier, whether it means that a rights issue becomes more efficient, whether it means that they can get electronic source of truth information rather than it getting sent out via paper. All of those things will follow from there. But the real sort of grunt and hard yards will be done by the ASX and our participants, our customers.

Michael Pepicelli: So you probably touched on this a little bit in your last answer there, but will there be any changes to the roles of share registries as a result of the change?

Dominic Stevens: Well, I think what it will mean is again, it’ll probably make share registries’ lives easier in the fact that they will actually now be able to get that information easier. I think – there's still details to be worked out here – but I think also it will allow investors to be able to put together shares that they may hold on a HIN and shares that they may hold on an issue of register and consolidate them better. It will probably allow brokers and custodians to actually enable those processes to happen easier. We're also in tandem with this working on what we call sort of STP, or Straight Through Processing too. Dividends now are straight through processed from an issuer, basically putting in an electronic form that actually processes that dividend through the system; rights issues; bonus issues; stock splits; various other straight through processing will happen automatically by the time we get to the rollout of the new CHESS system. So, a whole bunch of efficiencies that are happening in the back will just make dealing with the system a whole lot easier.

Michael Pepicelli: I'm sure there'll be plenty of people out there who probably when they hear all this talk of technology and blockchain and whatnot, they probably might get a little bit intimidated and I guess a little bit scared of what they don't know potentially. Will the ASX be doing anything in particular to educate investors about the new system?

Dominic Stevens: I think we will. I think, if you look at what we've done with the sort of our inner ring of people who we talked to – the participants – we've done sort of two years of consultations. We've had, I think Matt [Gibbs, ASX general manager of media and communications] something like 500, 600 maybe presentations. We've got a room here, where we take everyone through it. So I think as we look into 2020 and 21, when this is sort of going more out into sort of a retail world, we'll think about how actually we can explain this better to people. And I think you bring up a good, good, good point there which I sort of touched on a little bit earlier on, which is I think people get a little bit scared that … blockchain and bitcoin and “is this all voodoo? What does it really mean”? But what you really find when you look at it is, is that there are still going to be relational databases as they are.

These things are still going to sit behind firewalls. These … things, these systems will still have the same communications that sit over permissioned networks and all of those things. And what they'll have is more cryptographic security around them. So, what people should feel is, is that these are ... We are moving to something similar, but what it's got in the fact that it's got this append-only blockchain or distributed ledger that's attached to it, it allows actually the process of reconciliation to drop out of the system and allows this information. We see at the ASX is what we're doing is actually exposing information to permissioned people who want access to that and that information they can rely on without having to ring us up every day to say, "My ledger says this, can I just check that that's correct”? They'll be able to look at that and say, "I know, because I can prove mathematically that if I've got this information and I'm sitting on the distributed ledger, I know that that's exactly what ASX has got”, and so that's going to make it easier for everyone.

Michael Pepicelli: So it sounds like there's-

Dominic Stevens: They shouldn't feel sort of worried about it.

Michael Pepicelli: Okay. So it sounds like there's plenty going on and I'm sure it's not cheap. So I guess what are the expected costs of the switch?

Dominic Stevens: Well, there's a whole lot of things there because the interesting thing is – is that as I began this conversation – it was about the replacement of CHESS and the interesting thing is, is the way the equity market works in Australia is not the same as the way the equity market works in any other country. And so, when we're replacing CHESS, it's not as if we can go and buy a equity clearing and settlement system off the shelf. We'll have to build a new one and so building a new equity clearing and settlement system, which was in sort of I guess you could call it traditional technology, or sort of just replacing what we had, or doing it with the piece of IP attached to it, be the blockchain that allows us to synchronize all this in real-time.

The differences between those two things is actually not too much different. Obviously, we're spending a significant amount of money in replacing this system, but we were going to have to do that anyway and so this is part of the ... If you look at ASX's accounts, you'll see that we spend sort of like 50 to 70 million dollars a year on capital expenditure and that is expenditure of basically keeping our systems serviced; up to date; keeping hardware up to date and all those things. So this is part and parcel of what we do. It's probably going to cost us a little bit more to put in the blockchain piece, but we feel that the upside for the industry from that, I personally believe could be quite significant over the coming years.

Michael Pepicelli: As I'm sure you're well aware, we've seen teething issues with new technologies in the past. How confident are you that this technology will be able to handle the volume of transactions on the ASX?

Dominic Stevens: I think we're totally confident in that and I think it's a really good question and it goes to this sort of concept of, "Oh, this is all new and a bit scary”. Effectively, the speed of being able to process transactions is all … in the world of blockchain and bitcoin is all about the consensus mechanisms, which is, you might've heard of mining for bitcoins.

Michael Pepicelli: Yes.

Dominic Stevens: That's what uses the power. That slows the system down so that you can only do five to seven trades a second or whatever. The system that we're implementing doesn't have any of that in it. And so what that means is, where the system stands now, we can see that we'll already process transactions faster than what we're currently processing today, and in fact significantly faster. So, that's actually a sort of a bitcoin related red herring. There will be no problem with transaction speeds.

Michael Pepicelli: The start date has already been postponed, with the recent announcement that it would be pushed back to probably March or April 2021. How confident are you that everything will be ready to go by that day?

Dominic Stevens: Firstly just to clarify that, the original timeline was somewhere, it was either fourth quarter 2020, first quarter 2021. So it's been moved to the end of the window, and what I would say is that was at the request of the market. And I think the market actually wants a lot of new functionality and actually wants the system in as fast as possible. We delivered something like 40 new pieces of functionality to the market on top of replacing CHESS. And I think the market said sort of, "That's quite a lot. Maybe can we thin a few of these down and actually move the window of ... Move to the back end of the window”, and I think to put myself in their shoes, what you've got to understand is a lot of these players are global custodians. They're global investment banks and they're watching what's going to happen with Brexit over the next couple of years.

There may be some technology initiatives having to come out of that. I'm not sure if you're aware of the MiFID rules, which a lot of the changes to the way the whole equity market works over in Europe. And so, I think this next couple of years, people are very busy with their technology programs. So, I think people were just being conservative in saying maybe a little less functionality on day one and let's move sort of like to the back end of that window just to make sure we've all got time to get there.

Michael Pepicelli: Okay. So there you have it. Dominic Stevens, thank you very much for joining us.

Dominic Stevens: Thank you, Michael.