In capital markets, the nirvana of a golden record, representing the single source of truth for trade data, ensuring that all parties in a transaction have access to the same, consistent information, has been as elusive as the quest for the “Holy Grail”.
The use of a golden record is fundamental for accurately tracking and referencing trades across various systems and stakeholders, facilitating error-free processing, regulatory compliance, and efficient risk management, providing a complete and immutable record of a financial transaction.
This is essential for:
1. Transparency and Traceability:
- Unified Data Source: A golden record ensures all parties use the same data, eliminating discrepancies and reducing errors.
- Standardisation: it standardises trade references, improving data quality and consistency across the trade lifecycle and markets in general.
2. Operational Efficiency:
- Simplified Reconciliation: With a single source of truth, reconciliation processes are more efficient and less resource-intensive. Reconciliation activities are estimated to account for about 30-40% of firms’ total back-office labour costs, and the vast majority of this cost cannot be passed through to customers. It is further estimated that increasing the efficiency of these processes could cut these costs by 50%.
- Streamlining back-office processes and reducing errors: Facilitates automated workflows and processes, reducing manual intervention and associated costs. Moreover, reducing trade breaks would translate into considerable annual cost savings for all market participants.
3. Risk Management:
- Real-time Monitoring: Accurate and up-to-date trade data enables better risk assessment and management.
- Dispute Resolution: A clear, authoritative record of trades simplifies, reduces and speeds up dispute resolution.
4. Market Integrity:
- Transparency: Enhances transparency by ensuring all market participants have access to the same trade data, providing a consolidated tape where necessary/requested.
- Trust: Builds trust among market participants by maintaining the integrity and reliability of trade data.
5. Regulatory Compliance:
- Traceability: the golden record provides a clear audit trail, making it easier to meet regulatory requirements and conduct audits.
- Reporting Efficiency: Streamlined and accurate reporting to regulatory bodies enables compliance with requirements and can be a pre-cursor for Digital Regulatory Reporting (DRR). Fines associated with non-compliance of trade reporting have ranged from tens of thousands of dollars to tens of millions!
Synergies of integrating a UTXO-based Blockchain with Finos CDM, and FpML
Tokenovate discovered the “grail” through a combination of the “trinity” of UTXO (Unspent Transaction Output), Finos CDM (Common Domain Model), and FpML (Financial products Markup Language), creating a powerful ecosystem for capital markets:
- Trade Initiation: A trade is executed, and an FpML message is generated.
- Golden Record Creation: A comprehensive golden record is created, incorporating trade details in accordance with the CDM and including relevant elements of the FpML.
- Blockchain Recording: The golden record is recorded on a UTXO-based blockchain.
- Data Enrichment and Validation: Additional data points are added to the golden record, and data quality checks are performed using CDM rules.
- Real-time Access: All stakeholders can access and verify the golden record through the blockchain, including, where necessary, permissioned access via a private ledger.
- Smart Contract Integration: Smart contracts can be embedded within the golden record to automate certain aspects of the trade lifecycle, as required.
The Importance of UTXO-Based Infrastructure
A UTXO-based infrastructure, compared with account-based systems (e.g., Ethereum, Solana), offers several advantages for implementing the golden record:
- Security: UTXO-based systems maintain distinct and traceable notional units of account (satoshis) for each transaction, enhancing privacy by making it difficult to link transactions to specific users. This structure also provides better security against certain types of attacks, as each UTXO is a unique entity that can be tracked independently.
- Traceability: The distinct nature of UTXOs allows for more granular tracking of each unit’s provenance, facilitating the application of traditional legal doctrines like tracing. This is crucial for reclaiming misappropriated assets and establishing ownership, offering greater legal robustness compared to account-based systems where asset identity is often lost due to the mixing of funds.
- Scalability: UTXO systems handle high transaction volumes more efficiently by processing multiple transactions in parallel, unlike account-based systems that update balances sequentially. This scalability is essential for large-scale financial operations, ensuring low latency and high throughput for tokenisation and other financial transactions.
Tokenovate creates UTXO-20 tokens by acquiring “clean” satoshis from the coinbase output, which are derived from the mining reward. Therefore, they have not previously been spent or circulated and have no previous transaction history. A token is attached to one satoshi and has the notional value inscribed on it as metadata. When a transaction occurs, old UTXOs are marked as spent and new UTXOs generated.
This contrasts with account-based tokens, which are necessarily mixed when transferred to a single public address (where that address already holds a quantity of the same tokens). This approach further mitigates uncertainty as to deficiencies in the prior chain of title, which facilitates the golden record. Tokenovate then embeds metadata within the token to identify any relevant off-chain information.
The Significance of Finos Common Domain Model (CDM)
The Finos CDM is a standardised, machine-readable, and machine-executable data and process model for how financial products are traded and managed across the transaction lifecycle. The CDM is based on cross-industry collaboration between ICMA, ISDA, and ISLA and facilitates trade processing of repo, securities lending, bond, and derivatives transactions.
The CDM provides a standardised framework for capturing trade data. Its integration into the golden record offers:
- Data Standardisation: Ensures consistency in data representation across different systems.
- Data Enrichment: Enables the inclusion of additional relevant data points.
- Data Validation: Facilitates data quality checks and error prevention.
The Power of FpML® (Financial products Markup Language)
FpML® is the open source XML standard for electronic dealing and processing of OTC derivatives. It provides a standardised format for electronic communication, ensuring consistent and accurate trade data exchange between parties.
Incorporating FpML into the golden record provides:
- Precise Contractual Terms: Ensures accurate representation of complex financial instruments.
- Interoperability: Facilitates seamless data exchange between different systems and institutions.
- Automation: Supports automated processing of trade data for various purposes.
Implementation Steps
- Data Capture and Standardisation:
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- Trade Data Collection: Capture trade data in the Finos CDM format, ensuring standardisation and consistency.
- FpML Output/Templates: Convert the standardised trade data into FpML templates for electronic communication and sharing.
- Blockchain Integration:
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- UTXO Model Implementation: Use a public blockchain that supports the model to record trade data, now in FpML format, on the blockchain as UTXOs
- Golden Record Creation: Each UTXO represents a unique trade record, forming the golden record on the blockchain.
- Token generation is optimised by certain “proof of work” chains, rather than “proof of stake/account based” chains, as parallelised processing enables the scalability and reduction of cost required for a Capital Markets network.
- Contrary to misconception this can be achieved without excessive energy consumption and maintains confidentiality through the use of a private ledger capability, with permissioned access, on a public blockchain.
- Smart Contracts and Automation:
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- Smart Contract Development: Implement smart contracts to automate trade validation, execution, and settlement processes.
- Compliance Automation: Incorporate regulatory requirements into smart contracts to ensure compliance.
- System Integration:
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- APIs and Interfaces: Develop APIs to integrate blockchain-based golden record data with existing trading, clearing, and settlement systems.
- Data Synchronisation: Ensure that blockchain data is synchronised with internal systems, maintaining consistency and reliability.
- Security and Regulatory Considerations:
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- Security Protocols: Implement robust security measures to protect trade data and prevent unauthorised access.
- Regulatory Approval: Work with regulators to ensure that the blockchain-based system meets legal and regulatory standards.
Conclusion
The integration of golden records through the “trinity” of UTXO, Finos CDM, and FpML presents a transformative vision for the capital markets. This framework has the potential to revolutionise the industry by significantly enhancing the efficiency, accuracy, and transparency of trade processing in the capital markets. While challenges exist, the potential benefits are substantial and warrant further exploration and development. This integrated approach ensures a reliable golden record with unique trade identifiers, streamlines regulatory compliance, and fosters greater trust and productivity in the market. Tokenovate have unearthed the Holy Grail!
