It argues that the current model makes transactions safe by next to eliminating counter-party risk. This is done at the price of exposing the holding of securities to custody risk. Investors nowadays hold securities through chains of custodians and are exposed to risk of any of these failing. Custody chains also prevent them from exercising and enforcing rights against issuers.

The paper explains why somewhat counter intuitively the introduction of electronic settlement has led to an intermediated holding system which has significantly increased custody risk particularly in the UK.

The paper then argues that blockchain technology would make it possible to create a system that has the same level of transactional safety as the current system and that at the same time eliminates custody risk.

Existing custodians however are unlikely to bring about change that creates a system that is overall efficient. They are limited by their current business model. They are unable to fund the elimination of inefficiencies of the system as a whole when the elements that cause system-inefficiencies are factors that underpin their business model from their individual perspective.

The paper recommends empowering asset owners by requiring custodians to disclose that they have outsourced custody. Custodians should also make available to their customers details about the sub-custodians they have delegated custody to enabling investors to evaluate the chain that operates between them and the issuer. This will enable asset owners to evaluate the risk associated with the custody arrangements that are on offer.

The paper also encourages asset owners with market power to ask questions about the way in which the assets they look after are held. In addition to engaging with custodians, regulators should actively involve asset owners in their work on blockchain technology.

More: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2786972

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