More to ASX’s DLT extension than Covid-19 chaos

Australia Stock Exchange is not having a good Covid-19 crisis.

On Monday, March 16, in the wake of extreme market volatility in reaction to the pandemic, Australia’s securities regulator, ASIC, asked the most active equity traders to cut back activity by 25% lest they crash the systems of Australia Stock Exchange.

But ASX’s challenge is not a question of cooling market tempers. It’s more basic than that. ASX’s 25-year old post-trade infrastructure, called Chess, is struggling to cope with spikes in volume.

ASX has been aggressively pursuing a Chess-replacement program. In a bid to leapfrog its tech stack, it is building a distributed ledger, with the support of vendor Digital Asset Holdings – a vendor in which ASX also owns a stake.

ASX has pushed for a go-live target of April 2021 and has made two big drops of system specs for the industry to review, with the third and final installment planned for release this May.

Yet for many industry participants, the problem is not that the replacement is taking too long. No, they have been complaining the process feels rushed. Brokers, issuers and others are already trying to digest a big helping of unrelated regulatory changes, including those stemming from last year’s Royal Commission findings of bank abuses. The pandemic-fueled market turmoil has made it even more difficult to focus on ASX’s technical drops.

Timetable tussle

Despite this urgency, this project is not an example of fintechy agile development. On the contrary. The project dates back to 2016. That means by April 2021, it will have been rumbling on for five years – a long time even for a big institution’s old-school, waterfall-style I.T. build.

The project has gathered steam, however, and as it gets closer to testing, ASX is proceeding at pace.

“Brokers have concerns about the timetable because of the detail of what’s involved,” said Judith Fox, Sydney-based CEO of the Stockbrokers and Financial Advisers Association.

Yesterday, March 25, ASX announced it would extend some of its deadlines, including the April 2021 deployment target. It says a new go-live date will be decided in June. It’s also extended the consultation time for its second tranche of technical specs, and moved the third drop out by one month, to June.

Fox told DigFin after the announcement that the delay was welcome. But some people want a stronger commitment to deployment a full 12 months later, meaning April 2022.

Brokers have concerns…because of the detail of what’s involved

Judith Fox, Stockbrokers & Financial Advisers Association

“We think the final implementation should be extended by at least 12 months,” said Ian Matheson, CEO at Australasian Investor Relations Association, which represents issuers.

Fox added any final date should be decided in consultation with the industry, not unilaterally by the exchange.

The ASX says it will consult the industry and set a new target in June 2020, “…when we expect everyone will have more time to consider the replan and better assess the implications of Covid-19,” said ASX deputy CIO Peter Hiom in a press release.

But ASX is sticking to a July 2020 target for opening an industry test environment, which means it is forging ahead with development.

Deeper disagreements

Both the ASX and industry associations have been using Covid-19 as cover, either to ask for delays or to justify granting one. This masks deeper concerns about the project: its technical aspects, costs and pricing, and deeper questions about its impact on market structure.

The technical concern is that although the ASX is releasing a lot of information, it is coming in piecemeal, and requires deeply specialist knowledge. 

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“Our members are telling us the information is not hitting the mark,” said Megan Motto, CEO of the Governance Institute of Australia, representing company secretaries. “It’s hard to understand the impact on our business or the changes members have to make.”

She has also called for a 12-month extension of the go-live date.

Even before the Covid-19 market mayhem, Aussie brokers were struggling to understand the first two tranches of proposed technical changes released by ASX and Digital Asset.

It’s hard to understand the impact on our business

Megan Motto, Governance Institute of Australia

“Members can’t engage right now with tranches,” Fox said. “We didn’t lodge comments on the latest one. That doesn’t mean we gave our consent. Our members are just too engaged on other reforms.”

ASX disputes arguments about the clarity of its communications or the nature of the information it is releasing. Of the tranches, an exchange spokesman said, “They are necessarily comprehensive but no more than required to achieve clarity and regulatory requirements.”

According to ASX, the rules are being amended to facilitate the changes developed through the consultation process and are not making fundamental changes to market participants’ rights or obligations. “This should come as no surprise to stakeholders,” the spokesman said.

Costing conflict

The second industry concern is around project cost and how it will impact the prices ASX charges in future for post-trade services.

One reason for requests for extensions is that the ASX’s push for deploying next year comes at a time when companies must now finalize budgets for fiscal year 2021 (which starts April 1) – but they don’t know how much capital the project will require, or what kind of pricing they can expect from the exchange.

The ASX is now relaxing its timetable, so this problem may go away.

But brokers and issuers are worried about the price tag. “We’re looking at a multi-million-dollar investment in new infrastructure without any certainty of the end product,” Fox said.

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Matheson added: “It’s extraordinary that this is a process where every stakeholder is committing money and resource to benefit one party, at a time of great market stress,” he said.

Ann Bowering, CEO of issuer services for Australia and New Zealand at vendor Computershare, says the ASX has not provided the market with a clear cost-benefit analysis of its Chess replacement project.

This is a process where every stakeholder is committing money to benefit one party

Ian Matheson, AIRA

ASX is allowing brokers to connect via both a node on the Digital Asset distributed ledger, or via a communications protocol (ISO20022) that is becoming an international standard for securities messaging.

“We’re told all the goodies are in taking a node,” Bowering said. “But that benefit hasn’t been articulated, and we have concerns about the equality of these options.”

The ASX dismisses these qualms, arguing it has provided pricing estimates. “ASX has made it clear that pricing for like-for-like clearing, settlement, and issuer services will not be increased to pay for the Chess replacement project,” the spokesman said.

There will, however, be changes to clearing and settlement pricing to account for new messaging or other services (ASX is enabling messaging via a new standard, ISO20022, in addition to having users take a node on the distributed ledger). ASX says it will give the industry time to examine these before it goes live.

The ASX argues issuers, brokers and others need to help pay for the Chess replacement, noting the efficiencies the original system has delivered to the industry. “After all this time, it’s not unreasonable that the industry might now need to invest,” the spokesman told DigFin.

DLT distrust

The third bone of contention is the concept of embracing blockchain in the first place, which will enable ASX to compete in new areas of services.

Ian Matheson, at AIRA, says issuers are suspicious of a project that appears to be entrenching a number of monopolies the ASX already holds, such as clearing and settlement, and access to the market. “Replacing Chess with DLT will create opportunities for it to extend its monopolies into new areas,” he said.

The Governance Institute’s Motto calls the project exciting in theory, but says members are concerned ASX and Digital Asset will use their network to create a de facto monopoly in proxy-voting and other post-trade work.

It’s not unreasonable that the industry might now need to invest

ASX spokesperson

“From a governance perspective, we suggest the Council of Financial Regulators needs new enforcement powers to ensure ASX remains accountable,” she said. The Governance Institute is raising this with regulators such as ASIC, one of the Council’s members, but such a change would require new legislation from Parliament – assuming the regulators push for it.

Another vendor in Australia, who insisted on anonymity, said the project makes companies like his nervous. Yes, changes mean winners and losers, and while the vendor will be squeezed out of some business lines, it should be able to find new ones. “But it’s hard to identify today what those might be,” he said.

Judith Fox, representing the brokers, says her members would not want to see ASX extend its monopoly powers: “This is critical market infrastructure. Should it be owned by one party?”

ASX dismisses these concerns. “The new Chess replacement services were requested by the market through a comprehensive and transparent public consultation process,” said the spokesman.

DigFin’s take

Given ASX’s power and political connections in Canberra, it has the ability to see this project through. By granting an extension amid the Covid-19 outbreak, it can argue it is being flexible without having to directly address some of the deeper questions posed by the industry.

The ASX could have replaced Chess five years ago with existing technology on offer by vendors or other stock exchanges. Those costs would have been known, probably lower, and today the market would be able to handle this month’s spikes in volumes. The risk it faces now of an extended delay is that it could not afford to wait another two years to get Chess replaced – which would mean going back to a vendor for a stopgap. It’s hard to see ASX swallowing such an option regardless of its merits.

The ASX had laudable motives for going for a blockchain-based program. Chess was a pioneering system in the 1990s, and Australia likes to cut an outsized figure on the world stage despite its modest size. An attempt in 2010 by Singapore Stock Exchange to acquire ASX was knocked back by Aussie regulators, fating ASX to being marooned outside of Asia. Being the first venue to implement a futuristic tech like blockchain may yet restore some of its glamor and give Aussies bragging rights.

ASX is, however, a for-profit corporation with monopolistic powers. It knows how to defend those privileges. For example, it successfully kept electronic-venue upstart Chi-X Australia in a box. (Chi-X has to use Chess to clear and settle its trades, a result of some ASX-friendly Treasury rulings over obscure insurance funds for such activities.)

To some industry participants, ASX appears to be ramming through the DLT project in a drive to increase its own revenues rather than just be a neutral market operator. The fact that it owns a stake in the vendor and the lack of regulatory enforcement powers add to industry unease.

These suspicions may be unfounded – perhaps ASX is pioneering a business model that other trading venues will want to emulate – but they are real to people who grumble they are the ones paying for ASX’s glory. DigFin wonders whether the closer the ASX comes to realizing its dream, the more other parties will ask whether a distributed ledger that connects everyone should in fact be regulated as a utility.