How did SDX get started?
The SDX project has been going on for about four years. Back in 2018 SIX Group decided that DLT blockchain technology was going to be revolutionary in the financial markets space and bring significant benefits to the financial market infrastructure (FMI) space in particular. So we decided to set up a digital securities exchange, leveraging that technology to add value to existing asset classes that were already being traded on the traditional infrastructure, with the hypothesis that in a few years’ time, this would be the infrastructure upon which all activities would eventually be conducted.
We have built an organisation, discrete with SIX Group, connected in terms of control environment, legal etc, given independence in terms of our own technology, market and sales, and we have built out a CSD and exchange built on a permission-based private ledger technology from R3 called Corda. Then in September 2021, we got our license to operate as a CSD and exchange from Swiss regulator FINMA and went live with our first bond issuance on the platform. Since then, we have been doing a lot of work on interoperability to build that migration path for the markets to adopt the new technology, and we have also set up a separate Web3 focussed business line to provide services for institution’s activity on public blockchains and have recently gone live with an institutional grade crypto custody platform and a non-custodial staking service.
What was the journey towards the recent digital bond issuance?
On the FMI side, the big changes and enhancements have led up to the recent issuance of the UBS bond. Back in November last year, to issue or trade any bond on SDX you had to be a member of SDX, so to invest in a bond issued on SDX you had to have one of the SDX members as your intermediary. We have made significant strides since then to expand that investor community and increase that liquidity that a bond issuer could reach when carrying out a digital issuance on SDX. That has been achieved by the onboarding of traditional infrastructure onto SDX. That’s what triggered the ability by UBS to do the latest bond issuance. Now you can issue a digitally native bond on SDX, and it can be traded and settled on SDX, or it can be traded and settled on the traditional SIX infrastructure as well as over the counter (OTC).
The big difference is that on SDX, you’re trading and settling a token, based on DLT technology, and trading and settlement is atomic – they are a single indivisible step. On the traditional exchange there is a T+2 settlement cycle. That offers a huge benefit – as a member of SDX, UBS can trade and settle atomically, but as an issuer, they can reach the entire community that exists on the traditional exchange as well – so there is no downside, only upside, to doing the issuances on SDX. That’s the first major step in building these vital bridges between the two worlds.
What’s the importance of interconnectivity between traditional and digital infrastructure?
Next year, aiming at the end of Q2, we will have onboarded SDX onto the traditional SIX infrastructure – so the other way round. At that point, we will be able to mobilise assets listed on the traditional exchange and enable them to be traded and settled atomically on SDX. At that point we will have eliminated the other downside– of there not being the whole universe of assets available on SDX that exist on the traditional infrastructure, and squared that circle, bringing that benefit to members of SDX as well. That migration path between traditional and digital is then smoothed completely.
As well as providing this innovation around existing securities, we’re also building new markets on the platform. We did the first digital bond issuance on a regulated FMI, but in June of this year we also did the first digital equity issuance as well, as part of the private market ecosystem that we are building out. The next equity issuance will probably come in Q1 of next year.
Was the development of SDX driven by investor demand?
SIX Group is owned by approximately 120 banks in Switzerland, so they determine what we do. We are very much driven by the appetite amongst our member banks for creating this infrastructure, and there is tremendous excitement around adopting the benefits of atomic settlement across that community. If you think about what that means for them, it means the elimination of central clearing – because you don’t have to put up capital for clearing. You don’t have to collateralise your trade for the T+2 cycle, because that settlement happens instantaneously. And in a rising interest rate environment, both of those T+2 requirements become less and less attractive, because it just means you’re paying more and more to trade the same amount. In addition, with atomic settlement there is a huge reduction in the need for reconciliation, because the trades are happening immediately, so there is less requirement for middle- and back-office reconciliation.
There’s a significant reduction in capital allocation and overall costs associated with today’s trading, within this DLT infrastructure. That’s incredibly attractive as a benefit already, and then on top of that, you’ve eliminated risk associated with the settlement cycle, because it happens instantaneously. The cost of settlement failures is extremely high, it runs into the billions of dollars every year. The overall settlement cost of securities transactions globally is something in the region of $30 billion, not even including the cost of doing other activities associated with that, like cross-border payments, which is now over $100 billion per annum. There are efficiencies, risk reductions, and cost savings associated with leveraging DLT infrastructure. But there has to be this migration path. UBS couldn’t have done an issuance on the platform without being able to reach all the liquidity that they could on the traditional infrastructure. Thus, the bridge that we’re putting into place – so you can do a digital issuance but reach investors on both sides.
What are your plans for the future?
This is a long-term play. SIX Group sees this as being the infrastructure of the future, and it’s taken us decades to get to where we are today, with the current electronification of the capital markets. It will not take us decades to get to DLT-based infrastructure in the future, but it is a multi-year process that requires very substantial and robust foundations. This isn’t a get-rich quick scheme. It’s about building something robust, regulated, and transparent.
We’re onboarding more members, including Berner Kantonalbank (BEKB) off the back of the recent private equity issuance, and three other banks are also in the pipeline going through the initial AML/KYC process.
Onboarding onto an FMI is a rather longer process. Compared to an unregulated platform, which you can do in an afternoon, these take multiple months to complete, both in terms of legal and compliance, integration and conformance testing. So we will onboard members at a relatively steady pace. If we get to double digits in a year, that would be great. That’s why the bridge is helpful as an intermediary step – to help those are already on board to issue instruments, which then encourage others to join. It’s now a question of getting the 100+ members of the traditional exchange and CSD to become members on SDX.
What impact has the FTX chaos had on your operations?
Could we have predicted that FTX would be the next shoe to drop? No. But I don’t think anyone was in any doubt that there was more to come, in terms of the shake-out of that crypto native space. The problems we are seeing there today are very much CeFi problems, but they are CeFi problems on steroids, because of the lack of regulation. Whether it’s a lack of transparency, or due diligence between counterparties, or clarity of service offerings such as custody – they aren’t related to the underlying technology, they’re totally unrelated to blockchain and DLT. In fact, decentralised exchanges are being used as examples where in fact there haven’t been any issues, because when using the technology “naked” (as it were), it works very effectively. These issues are associated with a repeat of the same sort of challenges we had back in 2000 with the dot com collapse, or 2008 – where people behaved badly because they could hide what they were doing because of a lack of transparency, accountability and regulation in the marketplace.
If there is anything good that comes out of the FTX downfall, it will be to highlight the importance of trusted counterparties, transparency, clarity, and well-thought-out regulation.
It’s key that not all regulation is the same across jurisdictions. SIX Group has got to where it is today with SDX because the regulation in Switzerland is very clear and quite advanced – the regulatory environment lends itself very well to the use of DLT. What’s missing globally, however, is clarity around custody. Globally, there needs to be regulatory clarity about what it means to provide custody and – crucially – a separation of duties between exchange and custody.
What we’ve seen in a lot of instances is the segregation of funds issue – that’s reappearing as a challenge, and we don’t yet have the investor protection that you see in other asset classes, which is holding back trust and therefore, inevitably, adoption.