NSD at the forefront digital transformation: re-defining tech companies in finance

17 October 2017
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Blockchain, crypto assets, fintech disruption, disintermediation — how Russia’s central security depository manages to mitigate issues troubling any financial market infrastructure unit? The answer is — NSD balances between daring prognosis and a very sober regard on the limits the industry faces today.

“We are not ready to become a thing of the past”, reflects Artem Duvanov, Head of Innovation at NSD. Just like in good old days NSD serves as a custodian to the custodians, but there is a feeling that our future depends on our ability to use new technologies to lever digital transformation and reach new objectives. Thus we will be able to expand — offer new services to old long-time clients and traditional combo of services to new clients.

NSD was a tech company from the start, handling only e-transactions, most of our internal processes being automatized. We don’t need to ask ourselves if we need to become a technology company.

But we have come to believe that today the very essence of “technology company” changes. It’s no longer about how much of your business is taken up by high-end technology services or automation, but how adaptive your company is and how ready to embrace new technologies and the consequent business models. The right answer to the question “How to become a tech company?” centers around fundamental changes in the organisation’s culture, and as a consequence — the way processes are performed within it. A modern tech company is founded upon deep-rooted engineering culture. We all know Google and Amazon.

At the core of NSD’s engineer innovation culture there are a few basic principles:

  • NSD tests success of any technology by client demand. We don’t do pilots just to say we have done them. Any accomplished pilot means we acknowledge existing client interest in the technology/service.
  • NSD invests in technologies development, and never takes a passive position of a technology consumer. A good example is our active role in Hyperledger consortium and adding/complementing the platform with a zero-knowledge proof
  • NSD cooperates with fintech companies and startups. Passive investment doesn’t interest us. Instead we help them develop business on the common grounds. A good example is our partnership with Waves. We have joined forces to create a decentralized platform for digital assets.
  • NSD takes part in standards development and partners with colleagues worldwide. We were one of the founders of an independent working group of CSDs on blockchain technology. The ultimate goal is to work through ways to adapt ISO 20022 to DLT.

Big blockchain transformation awaits

Blockchain can securely store accounts’ details, deliver settlement, etc. in the new and harsh reality of decentralized transparent world everyone seems to be talking about. Following this devastating logic, central depositories in general can be considered extinct species very soon. Instead of denying the danger, NSD is focusing on the bright side and trying to work its way around the possibilities blockchain grants.

Researching and experimenting with blockchain makes up for a crucial part of CSD’s strategy. “Distributed ledger technology allows us to provide another level of trust to counterparties based on cryptography used. It can also secure operations with tokenized assets and provide transparent framework to keep records about ownership and operations”, — reflects Alexander Yakovlev, Head of distributed ledger direction at NSD.

“We consider blockchain a solution when it comes to providing higher speed, lower risks and operation costs, — he continues. We would like to make all operations run smoother for our clients. Another idea we put hopes on is that crypto assets — cryptocurrencies included, although they are incredibly controversial — can change financial market significantly, and we need to be prepared”.

Blockchain allows to create a perfectly transparent environment where final beneficiaries are visible, and as our research proves, will also facilitate AML and CFT processes for all participants. This environment works better for the regulator — and basically for every party involved. Ironically, those who fear blockchain often forget that CSDs as we know them today don’t allow access to final beneficiaries, and yet no one in their right mind will ever call in non transparent.

Experiment is the key

Over the last two years we have accumulated considerable experience. Our first project was e-voting system, when we have applied blockchain to managing to annual stockholders’ meeting. The system now has its minimal functionality and is in a completely operable state. Results are calculated via smart-contracts with pre-defined rules. Vote count panel is replaced by a robot, and conflict of interest risk is thus eliminated by design. This one use case may appear relatively unimportant, but we believe that a level of risk reduction this high can have far-reaching positive consequences for the industry.

The next challenge we accepted was commercial bonds emission and initial bonds placement on blockchain. The idea was to fully emitt bonds on blockchain and code the terms of obligation with the help of smart contract. Of course, it is only a pilot project, but we believe it has potential and opens up many prospects to create digital assets infrastructure that will be cheaper to maintain and more effective than the existing traditional one. Its main function being — to help investing into digital industry companies. We operated emission of $10M worth of papers of MegaFon (Russian telecom major) in partnership with Raiffeisenbank Russia based on Hyperledger Fabric 1.0.

The emission was done in real-time, even though to give accounting data legal status, we were compelled to transfer them into our accounting system. The current Russian legislation leaves no other option.

Smart contracts bring change

We want to change the way financial products are created via smart contracts. Not only are they issued in digital form, signed by all parties concerned and kept to confirm contractual arrangements. They are also operated automatically with no intermediaries.

Smart contracts can interact and cooperate, link and form complex systems. They provide guarantee of contractual compliance. Of course, no one claims that all risks are eliminated, but commercial risk set aside, smart contracts allow to lessen manipulation risks and wilful failure to perform contract-listed services.

Crypto assets and utility tokens that continue to stir interest are also one of the types of crypto assets. We believe that they would evolve, one of the main influential factors being regulation requirements and eventually find their place in economics. And we see a big future for digital assets emitted and implemented in private blockchains, controlled by regulated financial organisations.

The importance of collaboration

Blockchain is a global technology, and we are working with multiple international partners. We have reached out to all continents, literally. Together with CSDs from South Africa, Switzerland, USA, Argentina, Chile we have launched CSD Working Group on DLT (Distributed Ledger Technology) and reached strategic cooperation with SWIFT. As a result, first working documents on corporate actions execution and specifically  — on blockchain can be implemented when it comes to voting  — are now under way.

We will continue to grow this partnership, as many share our idea that CSDs cooperation is an important tool for DLT growth and development.

In August we announced partnership with Waves.platform. Waves has created and now maintains a platform to hold ICO (Initial Coin Offerings) on. In fact, Waves acts as a post-trade infrastructure for digital assets. Our ultimate goal is to create infrastructure for digital/crypto assets in keeping with the best practices from traditional assets infrastructure while making sure that it meets all regulatory and KYC/AML requirements, as well as rights’ and security guarantees investors are accustomed to.

By way of summary, we have come to the conclusion that DLT systems won’t replace the traditional ones, but rather complement them. And do so by leaning onto financial infrastructure the innovative economy developers build.

The future of infrastructure

Explosive growth will lead to a heightened demand of new infrastructure, and we should busy ourselves with its development right away. Blockchain is one of the new technologies that have influence over the future of the infrastructure. Remote identification, open API — these are the technologies that allow to create a fiat infrastructure, and lead to development of national services for private individuals and legal entities.

Despite of the growth of distributed ledgers, the trend for centralization will continue to gain momentum. Centralization guarantees some fundamental benefits — it leads to a rise in processing effectiveness, data reliability, allows to better protect financial services users’ right and ensure data security.

Contrary to what may appear, there is no fundamental contradiction between centralization and decentralization that blockchain promises. They simply solve different problems and complement one another. We can easily call cross-fertilization. For example, private individuals identification through KYC-services providers is essential for digital products on blockchain. In the meantime, business model of a decentralized blockchain fits financial services and products that would have never appeared in the centralized organizations remarkably well.

NSD sees its role in facilitating infrastructure transformation. Our first significant step forward was e-voting system, that allows stakeholders to participate in the stockholders’ voting and to identify themselves with the help of state remote identification system.

Creation of decentralized record-keeping services for end-clients falls well in line with our business strategy — serving as an outsource provider of business and tech services we deliver to professional financial market participants — SWIFT bureau, Anti Money Laundering (AML), etc.

Decentralizing depository operations

NSD participates in what can possibly be the bright future of depository services custodians around the world are hoping for. D3 — Decentralized Digital Depository — is designed as a bridge connecting fiat and crypto assets, and the services it is set to provide will grant institutional investors access to operations with digital assets.

“Institutional investors may consider crypto assets as a part of their portfolio diversification strategy, — suggests Artem Duvanov. — What makes crypto assets attractive is their low correlation with traditional assets. And all risks aside — in an investment portfolio crypto assets may serve to reduce risks. To encourage institutional investors to further discover crypto assets, market infrastructure providers need to offer them something very familiar yet very new — depository and custodial services for crypto assets market”.

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