This February the Securities and Exchange Commission (SEC) confirmed that May 2024 is the deadline for shortening settlement times to T+1, with securities lending as one of the sectors most impacted. EquiLend, the securities lending provider that processes $2.8 trillion in monthly transactions, is developing a distributed ledger solution, 1Source, that addresses the heart of the challenge. It was initiated before the SEC deadline was set, so its primary objective is to remove reconciliations.
The impact of T+1 on securities lending
The difficulty with the T+1 transition is when someone sells a security that was lent out. The lending agent either has to use stock from a different client (reallocate it), or recall the security from the borrower. If the securities don’t get returned in time this could result in more trade fails.
EquiLend’s Gary Klahr noted the concern at a recent conference was “How are we going to get out the information for recall quickly enough?” He believes he has the answer: DLT. If the data is on a shared ledger, then the parties simply need to check the ledger.
“I think DLT is a necessity for T+1 and there is no obvious way to proceed to T+0 (without DLT), which is the ultimate goal,” said Klahr.
These concerns exist even though there’s less than a year to go to meet the SEC deadline. However, the 1Source DLT solution has a scheduled launch date of Q3 of 2024, which is after the T+1 transition.
One can only imagine the pressure to move the target date forward. On the other hand, it’s not uncommon for regulatory compliance dates to be pushed back.
How to eliminate securities lending reconciliations
The original goal of the DLT platform was to remove reconciliations. EquiLend already has solutions ensuring the initial securities lending contract matches between parties. The problems arise with subsequent changes which invariably are done manually by each side and hence often don’t agree.
For example, rate changes frequently mismatch. Smart contracts will enable one party to propose a rate change and the other to accept it with the result stored on the permissioned 1Source DLT.
A second key area being addressed is settlement instructions that will need to match at all times. And the third aspect is the recalls, returns and reallocations which will be based on shared data.
A working group of borrowers and lenders have allocated staff to the project and they decide on the priorities. July is the first major milestone when five firms will pilot a contract initiation pilot on 1Source. Next up will be rate changes, followed by multiple iterations with additional functionality.
The Q3 2024 launch will be a minimum viable product (MVP) focused on U.S. cash securities versus cash collateral. After that, the target is certain EMEA markets and then Asia. Over time the functionality will expand to include corporate actions and asset servicing events.
But Klahr emphasized that if the MVP is expanded then the project will “lose focus on where we’re going.”
A roadmap of interoperability
The first stage of 1Source is positioned as a DLT of data sharing, versus the more transaction oriented DLT of value. The data is foundational. “It is our goal to interoperate with other DLTs because truly that is the way the clients will get what they want out of the product,” said Klahr.
EquiLend selected Digital Asset as the technology provider after considering four other providers. One of the appeals was the recently launched Canton ledger enabling interoperability with other DAML smart contract networks involving the likes of BNP Paribas, Deutsche Börse and Goldman Sachs.
Repo and collateral DLT products already exist on the market. What EquiLend is launching next year is just the first phase with more functionality to come.
“EquiLend will not need to build distributed ledgers for other products,” said Klahr. “EquiLend will have interoperability to connect to other DLT platforms.” He has already held high level conversations with other networks.
Ultimately the 1Source project is about future proofing.
“I’ve called 1Source the art of the possible. This is a foundational project,” said Klahr. “We know that distributed ledger is the future.”
