Why Instant Settlement Won’t Revolutionize Capital Markets

However, a recent discussion between Jorgen Ouaknine of Euroclear, a prominent international central securities depository, and Ethan Buchman, CEO of Cycles, suggests a more nuanced perspective. They contend that while instant settlement might seem appealing on the surface, it doesn't necessarily equate to a more efficient or safer capital market. Their core argument centres on the distinction between settlement and clearing, positing that clearing, rather than instantaneous settlement, is the true lynchpin of market integrity and efficiency.

Clearing involves the process of reconciling all buy and sell orders, calculating net obligations, and ensuring that both parties have the assets and funds to complete a trade. It's a critical step that mitigates risk by guaranteeing trades before settlement occurs. Ouaknine and Buchman highlight that simply accelerating the final transfer (settlement) without a robust clearing mechanism could introduce new forms of risk and complexity, potentially making markets less, not more, efficient. This challenges the popular narrative often espoused by those advocating for a wholesale shift to DLT-based, instant settlement systems in traditional finance.

Why it matters for Australian investors

For Australian investors, understanding this distinction is crucial, particularly as the local financial ecosystem explores integrating DLT. While platforms like CoinSpot, Independent Reserve, Swyftx, and BTC Markets offer relatively quick cryptocurrency settlements, these are often within a more limited or self-contained environment compared to the vast, interconnected traditional capital markets. The debate around instant settlement versus robust clearing has implications for the future design of financial infrastructure, which could indirectly affect how quickly and securely investors can move assets, not just in crypto but also in traditional shares or other financial instruments.

Australia's regulatory bodies, such as ASIC (Australian Securities and Investments Commission) and AUSTRAC (Australian Transaction Reports and Analysis Centre), are keenly observing global trends in DLT and settlement. Any moves towards instant settlement in mainstream Australian finance would need to ensure compliance with existing regulations designed to prevent market manipulation and facilitate tax reporting. The Australian Taxation Office (ATO) already treats cryptocurrencies as property for tax purposes, meaning capital gains tax applies upon disposition. A shift to instant settlement in traditional markets could simplify some transaction flows but also necessitate careful consideration of how reporting and compliance would be managed in a high-velocity environment.

Furthermore, the robustness of clearing is paramount for investor protection. If the Australian financial system were to embrace DLT for capital markets, a focus on effective clearing mechanisms would be essential to maintain market stability and investor confidence. Without proper clearing, the speed of instant settlement could amplify errors or fraudulent activities rather than prevent them, posing risks to individual portfolios and systemic stability.

Impact on the AUD market

The Australian Dollar (AUD) market, particularly in its capacity within foreign exchange and other capital flows, relies heavily on established global clearing and settlement frameworks. While the prospect of instant settlement in these large-scale markets might seem attractive for reducing counterparty risk and freeing up capital, the arguments from Euroclear and Cycles suggest caution. A poorly implemented 'instant settlement' system that bypasses or diminishes the role of clearing could, in fact, introduce inefficiencies and increase systemic risk in AUD-denominated transactions.

For Australian financial institutions and corporate treasuries managing AUD liquidity, the underlying mechanisms of global settlement are critical. They depend on the certainty and finality that robust clearing processes provide. If DLT is adopted for AUD-denominated assets in capital markets, Australian stakeholders would need assurance that these new systems incorporate equivalent, if not superior, clearing capabilities to the existing infrastructure. Simply moving to an instant transfer without full pre-transaction risk mitigation could disrupt market confidence and potentially increase the cost of capital due to elevated risk perceptions.

Moreover, the interoperability of any new DLT-based settlement system with existing AUD clearing houses and international financial market infrastructures would be a significant challenge. A piecemeal approach to instant settlement without comprehensive clearing integration could create fragmented liquidity pools and introduce friction, counteracting the intended benefits of speed. The broader impact on the AUD's stability and its role in global finance is contingent on a thoughtful, risk-managed evolution of clearing and settlement, rather than a mere acceleration of the final transfer process.

What to watch next

Australian investors and market participants should continue to monitor how global financial institutions and regulators approach DLT integration into capital markets. The focus should be on the development of DLT-based solutions that enhance both settlement and clearing capabilities, rather than prioritising speed above all else. Initiatives by major central banks and financial market infrastructures exploring wholesale central bank digital currencies (CBDCs) or tokenised assets often include discussions on how to embed robust clearing within DLT frameworks.

Closer to home, attention should be paid to any pilot programmes or regulatory sandboxes established by ASIC or the Reserve Bank of Australia (RBA) that explore DLT for traditional financial assets. These initiatives will be crucial in defining the practical application and regulatory treatment of new settlement technologies within the Australian context. The ongoing debate between 'instant settlement' and 'robust clearing' highlights the need for a balanced approach to innovation, ensuring that new technologies genuinely improve efficiency and reduce risk without inadvertently creating new vulnerabilities.

Finally, observing the evolution of major international DLT projects in capital markets will provide insights into best practices and potential pitfalls. The global financial system is interconnected, and the lessons learned from implementations in Europe or other major economies will be highly relevant for Australian market participants contemplating similar transformations. The path forward for DLT in capital markets will likely involve a careful, incremental approach that prioritises security and stability alongside innovation.