New technology has the potential to increase the efficiency of systems settling securities trades

Published 04-07-2023

The Danish Financial Supervisory Authority (DFSA) has investigated, together with Deon Digital Denmark A/S and their partners Agreena ApS (Agreena), BEC Financial Technologies a.m.b.a (BEC), Capital Market Partners A/S (CMP) and the University of Copenhagen (UCPH), whether and under what conditions Deon Digital’s Smart Financial Instruments system (SFI system) can be covered by the new EU DLT Pilot Regulation. The result from the test run in the DFSA’s regulatory sandbox, FT Lab, shows that Deon Digital’s DLT trading and settlement system may in the future be able to make use of the exemptions from current rules that the Regulation allows.

DLT can produce gains of efficiency 

Deon Digital’s SFI system can be used, under certain conditions, to provide both a multilateral trading facility (an MTF) and a central securities depository (a CSD). The SFI system can also support this provision in a different way from what is currently the practice, partly because it is based on DLT: 

The SFI system automates the entire securities lifecycle, and provides direct trading access to investors and their advisors, banks and fund managers.  It can complete securities trades within seconds, and eliminates counterparty, settlement and liquidity risks for investors without the need for third parties. The SFI system also enables full transparency and unambiguous real-time status of the securities traded in the system and the underlying projects they finance. This means that the system has built-in functionality, which among other things is valuable in financing green transition projects,’ says Fritz Henglein, Research Director at Deon Digital, responsible for the company's participation in the FT Lab programme.

Among other things, the FT Lab programme has shown that DLT can be used for a number of the post-trade activities that currently support investors' confidence in the execution of their securities trades: 

The test has shown that DLT has the potential to make securities trading processes more efficient. We have also discussed various issues that require special attention from both a supervisory and a business perspective, including the challenges that may be associated with a time-limited regulation’, says Anders Balling, who, as Assistant Director General of Capital Market Analysis, Bank Resolution and Financial Reporting at the FSA, is responsible for the supervision of the capital market infrastructure in Denmark and the DLT Pilot Regulation. 

Although the FT Lab test has illustrated various potential benefits of using DLT in capital market infrastructure, it is still too early to say whether the regulatory opening for the use of DLT will change the way we think about capital market infrastructure: 

‘The dialogue with Deon Digital and their partners has given the DFSA new insights into DLT and its scope of application. The DLT Pilot Regulation is a good tool for FSAs to gain experience with DLT in practice, and thereby gain a better understanding of the risks involved,’ Anders Balling continues. 

FT Lab has once again proved its worth

A key issue in relation to the use of DLT in the capital market infrastructure is the method of settling the cash leg of securities trades:

Discussions in the test have included the possibilities of DLT-based settlement systems to settle the cash leg in a securities trade. In particular, this has raised questions about the integration possibilities to existing payment systems,’ says Tobias Thygesen, who, as Director of Fintech, Payment Services and Governance at the FSA, is responsible for FT Lab, and continues: 

‘An obvious question is therefore whether the settlement options offered by the DLT Pilot Regulation can be considered sufficiently secure in the long term, or whether a broader implementation of the technology requires a rethinking of the integration options with existing payment systems.’

While questions like these require further understanding of the pros and cons of the technology, the Deon Digital test has once again highlighted the value of an initiative like FT Lab: 

‘FT Lab’s specialists subjected the SFI system to an in-depth technical analysis with a regulator's focus on risks. They have been remarkably active and investigative, constructively critical and encouraging, rather than reactive.  It's still a huge challenge for a relative newcomer like Deon Digital to break into the established world of regulated CSDs and exchanges, despite our heavy technology and financial market expertise. Without FT Lab, this would have been impossible,’ says Fritz Henglein. 

When companies and regulators can create space for informal dialogue through a confidential and formalised framework, it creates a fertile ground for good synergies, where both parties can learn from each other. In this case, on the interplay between DLT, capital market infrastructure and regulation,’ concludes Tobias Thygesen.

The DFSA wants the learning points from the test to benefit the market at large, and is therefore also publishing a briefing on the DFSA's view on the DLT Pilot Regulation and the issues raised by the use of DLT in the capital market infrastructure. 

Read more here.

Last updated 04-07-2023

Distributed Ledger Technology (DLT)

DLT is basically a database shared between networks of data centres. Each data centre stores, maintains and continuously works to include new data. Blockchain is probably the most publicly known variation of the technology today.


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