IBM and CLS bank, the global clearing bank for foreign exchange that handles about $5 trillion a day in 18 currencies, have been working together on blockchain initiatives, cautiously.
IBM built and maintains the technology powering CLS, which is based in London but has the U.S. Federal Reserve Bank as its primary regulator. In a joint paper on blockchain, they described the way they took a conservative approach, but one that could go into practice, not merely result in a proof of concept.
At IBM, the target was dispute resolution in its IBM Global Financial Unit which extends credit to partners who purchase from IBM suppliers. The finance division’s 2.9 million transactions lead to about 25,000 disputes annually. Resolution has historically been labor intensive and slow, often taking more than 40 days to reach a resolution while tying up $100 million. Using blockchain is expected to drop the resolution time to fewer than 10 days while improving capital efficiently by 40 percent.
IBM described its process as augmenting and extending an existing process, which is far less risky that creating a new process on a new technology.
“At the IBM Global Financing (IGF) Unit, [we found] that adding new functionality to an existing process is a good place to start.”
It kept its existing dispute resolution system so it had a fallback position in the event of problems with blockchain. Running them in parallel “eases the challenge of integrating blockchains with existing processes and accelerates the time to move to production.” It also adds some costs during the early stages until the older process can be shut down.
“Blockchain technology has a lot of potential to deliver.” said Keith Bear, vice president, financial markets, IBM. You need to replace the underlying network architecture, design and business development." But in the future, IBM could make it available to other participants and for other purposes.
CLS decided to use blockchain for its CLS Net to allow netting of foreign exchange trades for buy-side and sell-side institutions. It worked closely with regulators from the outset to introduce the new method which would “simplify the architecture and enable scalability of the underlying solution, as well as provide a strategic network across which additional blockchain services could be delivered.”
CLS wants to provide other value-added services, said Ram Komarraju, head of innovation and technology. CLS Net is the first of those. While its initial function is netting for buy-side and sell-side firms’ FX trades, the rails, once proven could be used to deliver other services. That’s one reason CLS decided to use blockchain where they could have used traditional tools.
The bank’s goal was to add liquidity and reduce risk. They wanted a project with distributed ledger technology that wouldn’t wind up as a proof of concept. That’s why they started small.
“We aren’t dealing [here] with the settlement of billions,” said Komarraju. “Instead we are solving a problem but not one that is so critical we can’t get approval from regulators.
The company announced CLS Net last year and is in late stages of testing now.
“The journey has been accelerating. We were building something for the very first time, and we started selling to larger buy-side firms. Some of them are attracted to bleeding edge technology while others would rather stick with existing systems and wait and see. As we talked to banks we found they are investing in blockchain but they aren’t taking the risk to actually use it. They are investing in multiple blockchain vendors." CLS provides access directly to CLS Net or users can access it through their existing SWIFT interfaces.
In their paper, CLS and IBM encourage banks to do more with blockchain.
"Based on the CLS-IBM collaboration, it seems most banks will need to readjust their approach to risk in terms of go/no-go decisions, especially in the early phases of a project. As we’ve learned, organizations can design their first blockchain initiative to avoid significant risks. At CLS, our first decision was not to build a bridge too far or wide. In other words, our first initiative could not be one where failure put our existing business at risk," the paper said.
They suggest banks use design thinking workshops, sandboxes, join consortia or work in blockchain garages which house banks and fintechs.
“The best way to see the future is by experiencing it. And the only way to get to that new future is to build a bridge,” they conclude.
