Distributed Ledger Technology-Based Digital Regional Settlement Intermediary Platform in ASEAN+3 Region
Country: Southeast Asia countries, Japan People’s Republic of China (PRC), Republic of Korea (ROK) (ASEAN+3)
Year of implementation: 2021-2022
Technology: Distributed ledger technology
ITD Partner ADB Department: Economic Research and Development Impact Department
ADB Partners:
· Consensys (technology service provider)
· R3 (technology service provider)
· Soramitsu (technology service provider)
· Fujitsu (technology service provider)
In line with ADB’s Operational Priorities:
· Fostering regional cooperation and integration
o Greater and higher quality connectivity between economies
o Global and regional trade and investment opportunities expanded
· Strengthening governance and institutional capacity
o Strengthened public management and financial stability
The Asian Bond Markets Initiative (ABMI) was launched in 2003 by the finance ministers of ASEAN+3 countries to boost the development of local currency bond markets, with ADB acting as ABMI secretariat since its inception. The Cross-Border Settlement Infrastructure Forum (CSIF), whose members are central securities depositories (CSDs) and central banks in the ASEAN+3 region, was created to enhance dialogues among policymakers and bond operators. Ways to improve cross-border bond and cash settlement infrastructure in the region, are covered in these discussions.
One of the topics of these discussions was on establishing regional settlement intermediary options (RSIs) to address regional market impediments to link key market settlement infrastructures of the ASEAN+3 more effectively and efficiently. This would also support the efficient utilization of local currency bonds as collateral, which, in turn, would increase local currency liquidity in times of market stress in the region. However, Asian economies require at least one trade day plus two working days for these cross-border transactions to be processed under the current market practices through correspondent banking networks, although they are located in the same or similar time zone. The time lag between a trade agreement and the settlement of securitiesand money cannot eliminate settlement risks.2 In addition, developing a centralized regional infrastructure consisting of national financial market infrastructures was deemed costly and could not escape from the issue of geopolitical hegemony.
The idea of CSD-RTGS linkages proposed by CSIF can avoid the issue of hegemony and ensure sovereignty; thus, the Bank of Japan and Hong Kong Monetary Authority established the link in 2021, along with the CSIF discussion. However, a host-to-host linkage is too costly to implement in developing markets.
Against this backdrop, ADB explored whether innovative decentralized technologies with blockchain could be used to make processing transactions more efficient for developing markets even with the current legal and regulatory systems in place.
As early as 2014, many ASEAN+3 members saw the CSD-Real-Time Gross Settlement (RTGS) Linkage model as the model that best addresses their requirements for a regional settlement intermediary.3 It uses a flexible implementation approach that enables cross-border/cross-currency bond settlement in delivery-versus payment (DVP) using central bank money to mitigate settlement risks and encourage cross-border transactions and investments. This model assumes that only CSDs and central banks interact in cases of cross-border settlements, and this premise was carried over in this initiative, dubbed Project Tridecagon.
Project Tridecagon was borne from this: the proof of concept (POC) tested whether key market infrastructures across the ASEAN+3 region—central banks’ RTGS and central securities depositories’ book-entry systems—could be connected using innovative technology. It sought to connect three economic models to reflect the financial environment in the ASEAN+3 region, which is composed of countries with different frameworks, systems, and policies.
The POC sought to show if it was possible to connect three different distributed ledger technology (DLT)-based blockchain platforms to perform an atomic swap of three tokens (foreign currency, local currency, and security tokens) to simulate the real-world environment wherein heterogeneity of DLT/blockchain-based platforms and economic models are expected across countries.5 The intent was not to show that DLT/blockchain could replace the existing legacy systems but rather to show that it could co-exist with these, as the technology was seen to have a huge potential to streamline the process of cross-border financial transactions.
DLT/blockchain can create an opportunity to reduce costs associated with a cross-border environment. In addition, it enables decentralized data management with equal status of participating members.
ADB screened and invited technology service providers that had experience in and exposure to similar initiatives. The selected firms were assigned to develop DLT/blockchain-based platforms based on the following economic models:
· Model Economy A. The RTGS and book-entry systems are separate ledgers of different tokens, with the central bank running the former and the CSD responsible for securities. This is based on the system followed by the PRC, the ROK, Malaysia, the Philippines, and Thailand. R3 was tasked with developing the Economy A model using Corda as its DLT solution.
· Model Economy B. The RTGS and the government bond book-entry system are under one ledger of the central bank. This is the model that is used by Hong Kong, China; Indonesia; Japan; and Singapore. Soramitsu used Hyperledger Iroha 2.0 to develop a DLT-based platform for this model.
· Model Economy C. In contrast to the two models, this is a hypothetical model based on the premise that an economy can run full-scale DLT payment and securities settlement systems. Consensys, using Ethereum, was tapped to develop this model.
Fujitsu was tasked with connecting the DLTs of the three model markets with its ConnectionChain, which uses the Cacti Ledger Plugin to enable interoperability across the different ledgers.[2] Its extended smart contract function enables it to connect multiple DLT-based platforms. ConnectionChain also records all transaction processes across the different chains, ensuring transparency.
Given that there were different parties involved in the implementation, the teams conducted regular meetings to align expectations, as well as thresh out issues and identify solutions to these.
Cross-border DVP was executed by dividing the transaction into cross-border and cross-currency payment-versus-payment (PVP), where cash tokens were exchanged, and domestic DVP, where cash and securities tokens were exchanged. This setup was intended to comply with the current regulatory framework wherein currency exchange and fund transfers between two economies are done through a banking system, while securities and cash are exchanged in a domestic payment and settlement system. The simultaneous exchanges of three different tokens was a novel attempt under this initiative; previous POCs only tested two token exchanges. The transaction flow was designed to follow the path of a typical securities settlement in regional markets so that the process could be realistically compared with the existing environment.
ADB specified the entities of each simulated transaction and provided the same instructions in the form of input files to the service providers acting as DVP and PVP facilitators. Some of these instructions deliberately contained non-matching or missing data to test whether these transaction attempts would be successfully stopped, and the failure was reported. The input files contained either one or multiple instructions depending on the service provider’s preference. The service providers extracted the data from the input files and checked the consistency of information. They then exported the data to their respective DLT/blockchain and created ledger entries or transaction records in preparation for the cross-borderDVP. Meanwhile, Fujitsu acted as a bridge in the market where the buyer (or seller) was located and made the local currency amount available to a simulated nostro account in the RTGS system of the domestic DVP environment. The service providers acting as the DVP facilitator simulated the minting of an equivalent amount of local currency cash tokens into the account of the buyer’s custodian based on the local currency amount funded by Fujitsu. The domestic DVP was carried out once the expected amount of local currency cash tokens and security tokens were recorded in the DVP solution and detected and assessed using smart contracts. Fujitsu, once provided with the status update, released the foreign currency. All transactions, including those that failed, were documented through console logs or transaction history files, which were aggregated by Fujitsu in a common journal.
The POC showed that DLT/blockchain was workable and fit for purpose for cross-border cross-currency DVP even with the current regulatory environment. DLT/blockchain was seen to be more resilient and tamper-resistant compared to existing payment and settlement systems. The decentralized nature of these platforms reduces the likelihood of data manipulation if properly managed. Thus, a well-designed system that uses DLT/blockchain has strong potential to increase efficiency and security. Project Tridecagon showed strong potential for using DLT/blockchain for the cross-border cross-currency DVP.
The three different types of DLT-based platforms—Corda, Ethereum, and Hyperledger Iroha—were successfully connected. The POC proved to execute the simultaneous exchange of three different kinds of tokens, which was the technical highlight of the POC. The processing of cross-border cross-currency DVP transactions (including the blocking of the balance in one economy during cross-border PVP and transferring the money after the transfer was completed in the other economy) was carried out immediately. The “failure” cases (missing/incomplete data) were also successfully handled by the systems.
The result of the POC showed the potential benefit of DLT/blockchain, especially for the case of programmability and expandability, while cost-efficiency would depend on the preference and choice of the consortium for the data and network governance, which remains a challenge to develop the regional system.
Taxation and the Know-Your-Customer process were not considered in the POC to make the design simple; however, these must be considered in actual cross-border transactions.