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Benefits and challenges of innovation in the financial sector - New trends in the financial sector
Technological innovation in payments and the financial market infrastructure – the view of a central banker
By Mersch Yves - Member of the Executive Board, European Central Bank (ECB)
Distributed ledger technology (DLT), beyond its assumed potential for supporting a virtual currency, is predicted to be the latest innovation to drastically transform payments and the financial market infrastructure, by substantially reducing reconciliation costs for market participants, limiting the number of intermediaries and optimising the financial value chain. Conceptually, technological innovation can help to resolve difficult market issues, but it can also lead to market fragmentation. From a central banker’s perspective, it is essential that technological innovation does not jeopardise the integration of the market infrastructure or create instability in the financial market.
Over the past 15 years the Eurosystem has worked towards financial market integration by reducing fragmentation. We have developed two major innovations in the field of financial market infrastructure: TARGET (now TARGET2) and TARGET2-Securities, or T2S. Both platforms have significantly improved the way payments and securities are processed in Europe. However, considering the fast pace of technological innovation, resting on our laurels is not an option. The Eurosystem is now considering the future of our financial market infrastructure more broadly, exploring whether there is room for enhancements and if innovation can help us develop even more efficient services for market participants.
In the years ahead, the Eurosystem will seek to enhance the services of TARGET2 by drawing on the state-of-the-art features of T2S. One idea is to consolidate technical and functional aspects to bring benefits and business opportunities to market participants.
Second, we are considering offering new service opportunities to the market. One possibility is to enhance the TARGET2 services with instant retail payments. The European Payments Council has been invited to develop an instant payments scheme by November 2016, ready for implementation by November 2017. The Eurosystem will then decide whether TARGET2 will settle instant payments based on this scheme. Additionally, with increased globalisation we will assess whether our markets should become more interoperable at a global scale.
Finally, we plan to review whether and where further harmonisation of Eurosystem procedures for collateralisation is needed. Here we might also consider the business case for a common Eurosystem collateral management system.
These issues will not be considered in isolation – we will work with interested market participants, via consultations and discussion forums, to ensure they are fully involved. Moreover, and as previously mentioned, we must reflect on technological innovation, in particular, but not exclusively into distributed ledger technologies.
DLT allows for financial transactions to be verified in a decentralised way, which could potentially reshape how they are carried out. Instead of settlement occurring in a centralised market infrastructure (like in T2S today), strong cryptographic and verification algorithms allow a number of participants in a DLT network to have consistent copies of the ledger (or parts of it). Multiple participants could be given authority for managing and updating the ledger, depending on the chosen setup and the regulatory adjustments needed.
Consequently, there is also a need for the Eurosystem to reflect on how DLT could impact the market infrastructure from the perspective of its role as operator and overseer of payment systems. Shying away from innovation should never be an option, but it is important to make sure that innovation does not create new fragmentation or instability in the financial market.
The financial industry comprises a complex market infrastructure with many actors and systems which need technical standards, harmonised business rules, regulations and sound governance arrangements to function optimally. Certain functions of the post-trade market are heavily regulated and this cannot be ignored when exploring DLT. Conversely, from a technological point of view, DLT could optimise the financial value chain and potentially even make some layers of the post-trade market obsolete.
Although it is still too early to judge what impact DLT could have on the market infrastructure, there is a need for reflection and collaboration to ensure that an industry-wide approach is followed. In this regard, the ECB and Eurosystem could consider acting as the catalyst to prevent new fragmentation from emerging.