Integrating HQLAX into the financial market infrastructure
01 July 2020
Raoul Bhoedjang and Mario Schlipf explain how the HQLAX platform uses DLT and discuss what is needed for frictionless integration into existing financial market infrastructure
Image: Wichy/shutterstock.com
HQLAX is one of the first securities lending platforms to use a distributed ledger technology (DLT). Connected to major industry partners, the platform enables participants to seamlessly execute capital-efficient securities lending transactions for enhanced balance sheet optimisation.
HQLAX is an innovative financial technology firm founded by financial market practitioners. Our core clients are financial institutions active in securities lending and collateral management. Our shareholders include market-leading service providers in the global financial ecosystem.
The firm formed a strategic partnership with Deutsche Boerse Group for the creation of a joint operating model. The key value proposition of this model is to mobilise collateral across a fragmented custody ecosystem; this is done without moving the collateral from one location to another.
Operating model
The HQLAX operating model consists of four layers and aims to facilitate more efficient collateral management of high-quality liquid assets (HQLAs).
Trades are executed in the marketplace layer, which is the leading Eurex Repo F7 trading system.
The digital collateral registry is a distributed ledger that records post-trade events, including all ownership changes. This registry was built on Corda, R3’s distributed ledger technology.
The trusted third party (TTP) manages segregated collateral accounts at the connected custodians on behalf of platform participants. In particular, it informs the custody entities (triparty agents or custodians) about their obligations to supply collateral for these accounts.
The custody entities (custodians or triparty agents) are responsible for safe-keeping securities and moving into and out of the segregated collateral accounts. Today, the platform is connected or connecting to leading triparty agents: Clearstream International, Euroclear and J.P. Morgan.
The HQLAX operating model allows market participants to connect to the platform via existing well-established interfaces.
In this model, securities do not move between custodians. Instead, a digital collateral registry is used to record ownership of baskets of securities, while the underlying securities remain static in the custody location of the collateral giver.
The advantages of distributed ledger technology
In today’s world, clearinghouses and other financial institutions usually use centralised ledgers as their central repository of transactions. A ledger contains the history of all past transactions and the balances per account. The provider of a centralised ledger maintains total control of this data, effectively creating a single source of truth. Verifying the integrity and correctness of such ledgers relies on reconciliation processes. Such processes involve multiple administrations and are frequently costly and time-consuming.
DLT allows multiple parties to securely create and share ledgers between them. No single party has full control over what is written to the ledger. Instead, participants of a distributed ledger are assigned roles and permissions that define their rights to append information. Each participant can cryptographically verify the information written to the ledger by other parties. Moreover, the technology allows the modelling of complex business logic and facilitates transparency and automation in existing clearing and settlement processes.
How HQLAX uses DLT
HQLAX uses Corda as the underlying DLT to build the digital collateral registry. The HQLAX platform is a Corda business network where trading financial institutions, Eurex and the TTP are represented by Corda network nodes.
To facilitate integration with existing market infrastructure, HQLAX works with existing securities that are not issued on the ledger. The distributed ledger that is maintained by the HQLAX participants’ nodes tracks ownership of those assets, but the on-ledger records are not, themselves, assets. Critically, each platform participant accepts the HQLAX digital collateral registry as the source of truth for ownership backed by a legal model that allows ownership changes while the securities remain in an account opened by the TTP.
A typical business transaction is a collateral upgrade transaction where one party lends HQLA to a party that offers lower-quality collateral in return. The digital collateral registry enables the atomic change of ownership of baskets of securities between the institutions, at a specific date and time. Corda allows businesses to manage their transactions directly while keeping strict privacy. That is to say, data is shared on a need-to-know basis with institutions having full transparency of only the data that is relevant for their business.
In a nutshell, DLT in the HQLAx model enables frictionless ownership exchange of baskets of securities at precise moments in time during the day.
The need for an evolutionary transition
With the idea of a decentralised world of market participants in mind, our goal is to make integration and onboarding to the HQLAX platform as easy as possible. To this end, HQLAX works with a widely used trading platform, Eurex Repo, and builds on existing legal constructs (the Global Master Íø±¬³Ô¹Ï Lending Agreement). Similarly, at the custody side, the platform connects to major custodians (currently Clearstream, Euroclear, and J.P. Morgan) through the TTP, using existing SWIFT messaging.
In addition, we need to consider that DLT is an emerging technology and that financial institutions and service providers are operating in a highly-regulated field. Our clients and partners are at different stages of assessing DLT and not all are ready to integrate a DLT-based system into their enterprise architecture today. To facilitate frictionless adoption, HQLAX, therefore, offers an evolutionary transition, where participants can start out with their node hosted in a secure data centre from an HQLAX partner. This allows a fast onboarding process onto the HQLAX platform to already use the benefits of the platform today. In parallel, the participant can transition into a scenario where the node is hosted in its own data-center or cloud provider. ING Bank N.V., a thought leader in DLT research and applications, is among the first to actively pursue this option and we expect more clients to join them.
Where we are going
The HQLAX platform mobilises collateral using a single well-known transaction type: a collateral (upgrade/downgrade) swap. HQLAX is a client-focused and client-driven company. We highly value our interaction with clients on additional use cases. Such potential use cases include working with other hard-to-move assets (such as gold), other transaction types (e.g., pledges), and richer information on the ledger (e.g., asset inventory). We also expect that clients, custodian and regulators will increasingly want to reap the advantages of a shared and verifiable ledger, which will in turn lead to reduced risk and cost.
HQLAX is an innovative financial technology firm founded by financial market practitioners. Our core clients are financial institutions active in securities lending and collateral management. Our shareholders include market-leading service providers in the global financial ecosystem.
The firm formed a strategic partnership with Deutsche Boerse Group for the creation of a joint operating model. The key value proposition of this model is to mobilise collateral across a fragmented custody ecosystem; this is done without moving the collateral from one location to another.
Operating model
The HQLAX operating model consists of four layers and aims to facilitate more efficient collateral management of high-quality liquid assets (HQLAs).
Trades are executed in the marketplace layer, which is the leading Eurex Repo F7 trading system.
The digital collateral registry is a distributed ledger that records post-trade events, including all ownership changes. This registry was built on Corda, R3’s distributed ledger technology.
The trusted third party (TTP) manages segregated collateral accounts at the connected custodians on behalf of platform participants. In particular, it informs the custody entities (triparty agents or custodians) about their obligations to supply collateral for these accounts.
The custody entities (custodians or triparty agents) are responsible for safe-keeping securities and moving into and out of the segregated collateral accounts. Today, the platform is connected or connecting to leading triparty agents: Clearstream International, Euroclear and J.P. Morgan.
The HQLAX operating model allows market participants to connect to the platform via existing well-established interfaces.
In this model, securities do not move between custodians. Instead, a digital collateral registry is used to record ownership of baskets of securities, while the underlying securities remain static in the custody location of the collateral giver.
The advantages of distributed ledger technology
In today’s world, clearinghouses and other financial institutions usually use centralised ledgers as their central repository of transactions. A ledger contains the history of all past transactions and the balances per account. The provider of a centralised ledger maintains total control of this data, effectively creating a single source of truth. Verifying the integrity and correctness of such ledgers relies on reconciliation processes. Such processes involve multiple administrations and are frequently costly and time-consuming.
DLT allows multiple parties to securely create and share ledgers between them. No single party has full control over what is written to the ledger. Instead, participants of a distributed ledger are assigned roles and permissions that define their rights to append information. Each participant can cryptographically verify the information written to the ledger by other parties. Moreover, the technology allows the modelling of complex business logic and facilitates transparency and automation in existing clearing and settlement processes.
How HQLAX uses DLT
HQLAX uses Corda as the underlying DLT to build the digital collateral registry. The HQLAX platform is a Corda business network where trading financial institutions, Eurex and the TTP are represented by Corda network nodes.
To facilitate integration with existing market infrastructure, HQLAX works with existing securities that are not issued on the ledger. The distributed ledger that is maintained by the HQLAX participants’ nodes tracks ownership of those assets, but the on-ledger records are not, themselves, assets. Critically, each platform participant accepts the HQLAX digital collateral registry as the source of truth for ownership backed by a legal model that allows ownership changes while the securities remain in an account opened by the TTP.
A typical business transaction is a collateral upgrade transaction where one party lends HQLA to a party that offers lower-quality collateral in return. The digital collateral registry enables the atomic change of ownership of baskets of securities between the institutions, at a specific date and time. Corda allows businesses to manage their transactions directly while keeping strict privacy. That is to say, data is shared on a need-to-know basis with institutions having full transparency of only the data that is relevant for their business.
In a nutshell, DLT in the HQLAx model enables frictionless ownership exchange of baskets of securities at precise moments in time during the day.
The need for an evolutionary transition
With the idea of a decentralised world of market participants in mind, our goal is to make integration and onboarding to the HQLAX platform as easy as possible. To this end, HQLAX works with a widely used trading platform, Eurex Repo, and builds on existing legal constructs (the Global Master Íø±¬³Ô¹Ï Lending Agreement). Similarly, at the custody side, the platform connects to major custodians (currently Clearstream, Euroclear, and J.P. Morgan) through the TTP, using existing SWIFT messaging.
In addition, we need to consider that DLT is an emerging technology and that financial institutions and service providers are operating in a highly-regulated field. Our clients and partners are at different stages of assessing DLT and not all are ready to integrate a DLT-based system into their enterprise architecture today. To facilitate frictionless adoption, HQLAX, therefore, offers an evolutionary transition, where participants can start out with their node hosted in a secure data centre from an HQLAX partner. This allows a fast onboarding process onto the HQLAX platform to already use the benefits of the platform today. In parallel, the participant can transition into a scenario where the node is hosted in its own data-center or cloud provider. ING Bank N.V., a thought leader in DLT research and applications, is among the first to actively pursue this option and we expect more clients to join them.
Where we are going
The HQLAX platform mobilises collateral using a single well-known transaction type: a collateral (upgrade/downgrade) swap. HQLAX is a client-focused and client-driven company. We highly value our interaction with clients on additional use cases. Such potential use cases include working with other hard-to-move assets (such as gold), other transaction types (e.g., pledges), and richer information on the ledger (e.g., asset inventory). We also expect that clients, custodian and regulators will increasingly want to reap the advantages of a shared and verifiable ledger, which will in turn lead to reduced risk and cost.
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