EquiLend, the industry’s leading proprietary securities financing platform, plans to launch a blockchain-based platform, 1Source, to hold the gold record for securities lending transactions. Initially, the goal is to eliminate reconciliation of securities lending transactions. But as we will see, it can be a fundamental step to reduce securities settlement times.

The EquiLend platform currently processes $2.8 trillion in monthly transactions and is backed by Bank of America, BlackRock, Credit Suisse, Goldman Sachs, JP Morgan, Morgan Stanley, State Street, and others.

The Business Case for DLT in Securities Lending

Although the EquiLend platform is used to arrange securities lending transactions digitally, there is a surprising amount of manual processing afterwards when changes are made. Those lifecycle events, such as price changes, rate changes, or a partial return of borrowed securities, sometimes don’t coincide.

This is because changes are recorded separately in each counterparty’s internal records, which means that the two systems must be reconciled. Meanwhile, there are frequent breaches of contract.

While reconciliation may sound like a boring accounting problem, it’s not just an accounting department problem. Since it is the merchants who make the deal, they are the ones who have to verify what happened. “There are merchants spending time reconciling items when, in reality, they could be chasing alpha. They could be putting on new trades. They could be (providing) added value,” said Gary Klahr of EquiLend, Director of Strategic Initiatives, who leads the distributed ledger (DLT) project.

During the time the data is inaccurate it can lead to poor business decisions, for example if the cost of the loan is wrong. Sometimes it results in settlement failures, for example if there has been a change of details about where the transaction should be settled.

The potential savings are not just about reducing the time spent on reconciliation, but also reducing the internal technology footprint at each institution. DLT capitalizes on both benefits by ensuring that changes are validated before being posted to a shared ledger.

The current state of the game

So far, the 1Source project is still in the design phase. Initially, in 2021, a ten-member working group of EquiLend stakeholders and clients drew up a list of potential projects. The goal was to establish what “would make the desktop more efficient. (What) process can we come up with that would really transform the industry digitally,” Klahr said.

Numerous ideas came up, but the group unanimously decided to delete reconciliation.

Today many changes can happen with a phone call or a message from Bloomberg. Klahr gave the example of a rate change. “Today, we both enter our own individual information that goes into the individual systems. We accumulate overnight at the wrong rate. We’ll fix it tomorrow,” he said.

“In the world of 1Source that couldn’t happen. One of us would put through the fee. The other side affirms it.”

block chain technology

Meanwhile, a yet-to-be-announced partner is working on a smart contract technology proof-of-concept, and there is another workstream exploring business requirements.

Unsurprisingly, the distributed ledger is a permissioned system where only the two counterparties to a contract can see the details of the contract. Currently the plan is for EquiLend to host the main node. It can also host nodes for customers who don’t want to manage their own.

One of the key requirements is to ensure interoperability with all processes before and after a securities lending transaction. That sets the stage for future opportunities.

A Potential Roadmap for T1 Settlement

In the US, the SEC has begun work to reduce settlement times from two days (T+2) to one (T+1). Securities lending plays a role in slowing down liquidation. Let’s say a broker has lent some stock, but his client sells it. To enable settlement of the client’s trade, the broker may need to borrow shares. That takes time, mainly because it has to filter through all the systems. Having all the data on chain is a key step in the future automation of the process.

Other potential future features include the transmission of beneficial ownership information, asset servicing and interoperability with collateral management systems. When asked if security tokens were on the roadmap, Klahr said the topic had been discussed, but it would ultimately depend on customer interest.

Before the group starts thinking about this type of topic, they should start with their first use case, removing reconciliations.

After all, “if you were creating a securities lending workflow today, you would never allow both parties to have the ability to put details on their own side and not have a reconciliation until a later date,” Klahr said.