How blockchain is going to transform CHESS

It was nearly two years ago when I first wrote about blockchain. I was particularly interested in plans announced by ASX around that time to adopt blockchain technology to replace CHESS, which has facilitated the clearing and settlement of share trades and provided an electronic subregister for shares for nearly a quarter of a century. The advent of CHESS enabled the conversion of physical share certificates into an electronic format and faster settlement, which started out at T+5 and moved to T+2 in March 2016. It also led to the development of a proprietary electronic messaging standard, which is part of the blockchain project.

When first announced, blockchain was relatively unknown, and ASX the first securities exchange globally to be considering such an application of this evolving technology. Now of course there are university degrees in blockchain, conferences devoted to the subject and no end of fintech start-ups cropping up in suburban sheds, hoping to be the next Google, or at least one day be represented in an exciting acronym like FAANG! (for the uninitiated – Facebook, Apple, Amazon, Netflix and Google).

Then of course there was bitcoin. Even those unaware of blockchain could not have failed to be aware of the meteoric rise in value of this cryptic currency – I mean of course, cryptocurrency. Alan Kohler charted its explosive trajectory on the ABC news each night for weeks and drew solemn parallels to the tulip mania of the 1600s and other famous bubbles. I suspected trouble when my mother called me and asked whether she needed to do anything about this “big coin thing” – her inbox was full of the promise of riches only bitcoin could deliver. Whatever your view on bitcoin and cryptocurrency in general, most agree blockchain is the most important player in this two-part gig.

Blockchain – a very quick overview

You can read my blockchain 101 blog here for more detail, but in summary, blockchain is a distributed – and therefore decentralised – ledger which, as the name suggests, contains blocks of data.

A distributed ledger means there are many copies of the ledger, all linked together. Each copy contains blocks, which in turn contain a pointer to the previous block, a timestamp and the relevant transaction data. Once recorded on the ledger, data is permanent and unalterable.

Decentralisation is important in this day of cybercrime. Just last month, Japanese cryptocurrency exchange Coincheck was hacked and roughly US$532.60 million in cryptocurrency stolen; a timely reminder about the importance of security in this emerging world of digital assets. The mistake made by Coincheck was to keep the currency in a ‘hot’ wallet – or in laymen speak, in a centralised register, all the information in one place, sitting on the internet. Some might say, sitting duck.

So, back to blockchain. Its distribution is important; if, somehow, a miscreant managed to get into the system and attempt fraud or theft, the piece of register affected will no longer match all the other identical copies, spread far and wide. Security measures should then stop any cybercrime from occurring – all in a matter of seconds.

Blockchain and the ASX

ASX has a website dedicated to the project; worth a visit for those who are interested. You won’t find the word blockchain appear often; the acronym DLT – distributed ledger technology – is used instead. Blockchain is distributed ledger technology.

As the core system that performs clearing, settlement and asset registration, getting the replacement for CHESS right is critical. To this end, ASX has engaged with industry stakeholders to ensure that at every step, the replacement system will do everything CHESS does, only better…and in the ASX’s words, “provide a broader range of benefits to a wider cross section of the market.”

As things stand, ASX has a monopoly in clearing and settlement services for Australian investors. As a result, we pay more for these services than fellow investors in overseas jurisdictions. It also raises the question of a level playing field for other exchanges such as Chi-X and NSX and companies listing on those exchanges.

Although the findings of the Review of Competition in Clearing Australian Cash Equities released in June 2015 found in favour of competition, the relatively small size of the market means competitors haven’t been exactly knocking down the doors. This innovation by the ASX will no doubt further cement its position as the dominant force in clearing and settling trades in cash equities for Australian investors.   

A glance through the CHESS replacement website provides a snapshot of many things taking place and a timeline for its development and deployment…although beyond the day one scope and implementation plan, the dates become a little nebulous!


Source: ASX

A few points of interest about the CHESS replacement:

  • The distributed ledger technology to be used by ASX will not be publicly accessible – like CHESS, it will be a permissioned system where ASX clients can access the network in much the same way as they currently access CHESS.
  • As indicated on the timeline, the focus now is on the ‘Day 1’ functional scope – exactly what needs to be available to users on day one. You don’t need the benefit of being part of one of many user groups to know the system has to at least be as good as, and replicate, the current functionality of CHESS on day one.
  • ASX has established an ISO20022 Technical Committee comprising industry representatives to focus on CHESS messaging and the adoption of ISO20022 messaging. I had no idea what that meant, so I did a little research. The minutes of the meetings were quite overwhelming – three or more pages of attendees were just the start! I know it’s said that many hands make light work, so too is it said that too many cooks spoil the broth!

I had to refer to the highly technical ISO20022 for Dummies to figure out what it means. You can download it from the ASX site, or you may be content with simply knowing ISO20022 is a means to create financial messaging standards.

“To conduct their business, financial institutions exchange massive amounts of information with their customers and among themselves. Such exchanges only work if the sender and receiver of a message have a common understanding of how to interpret this information. This is especially true if either party wishes to rely entirely on computers to process information.” (ISO20022 for Dummies – Chapter one)

Judging by the number and calibre of individuals involved, the messaging component of the new system is very important.

If you’re wondering what next, ASX plans to issue a public consultation paper at the end March, with details about the ‘Day 1’ scope, implementation of the new system and importantly, the migration plan for moving from CHESS to DLT. In the meantime, it’s business as usual. CHESS remains unchanged and existing equities clearing and settlement arrangements continue to operate normally until you hear otherwise.

 General Advice Warning
This information is current as at that date of the document or information is provided or presented unless otherwise specified and is provided by OpenMarkets Australia Ltd (ABN 38 090 472 012, AFSL 246705 (OpenMarkets).  The information is intended to be general information only and not advice specific to any person.  Each person should consider the appropriateness of any material presented having regard to their own circumstances and the information provided does not take into account the particular investment objectives, financial situation or investment needs of any person.  OpenMarkets does not warrant the accuracy of, nor accept any responsibility for any information provided.  Where examples, hypotheticals or case studies are used, they are used for illustrative purposes only.   If the information includes statements of opinion, forward looking statements, forecasts or predictions based on current expectations about future events and results, any such statements are subject to change and actual results may be materially different from those shown.