FIA EXPO 2022: Baton Systems President on building post trade rails for capital markets

Stuffed into two jam-packed days, visitors were given the opportunity to discuss and exchange ideas with industry experts on the latest trends and developments in futures and options trading.

FinanceFeeds had the chance to set up interviews with an incredible lineup of industry leaders who pass through here this time of year. As part of our coverage, we caught up with Jerome Kemp, President at Baton Systems.

Asked about his impressions of the event, Kemp said that he was delighted to have spoken with companies regarding  partnership offers, questions, and requests for meetings and demonstrations at this year’s show. Moreover, he apparently found time to give a couple of interviews.

Turning to the macroeconomic side of things, Kemp said that for so many years, we did not have to deal with the rising interest rate environment. But, with more interest rate hikes on the rise, it’s worth reviewing workflow practices and it’s becoming even more important for industry players to optimize their non-cash collateral usage.

Moving on to the business side, we spoke a little bit about Baton Systems’ turnkey solutions with a quick rundown on what kind of services they provide and what kinds of customers they cater to.

Jerome explained that Baton Systems basically addresses the most critical settlement risk, funding and liquidity issues impacting clearing, settlement, and post-trade today using distributed ledger technology (DLT).

Baton Systems has big ambitions for its network as a decentralized financial market infrastructure, he said, and it’s already making considerable progress.

The company’s tech stack includes three flagship products, including Core- Collateral, which is used to manage margins for exchange-traded and cleared derivatives; Core-FX, which uses DLT to power bilateral interbank settlement of FX trades on a riskless or Payment vs Payment – PvP – basis, extending access beyond the constrained group of CLS participants and the currencies eligible for settlement on the platform.

Baton currently settles close to 20 eligible and ineligible CLS currencies and most recently added CNH or off-shore Renminbi to its settlement platform; and Core-Payments, which uses business-defined rules to enable banks to gain complete control and sequencing of their payments and settlements, together with a clear view of current and forecast funding requirements at the currency level.

According to Baton Systems’ President, the network of CCPs now connected to their Core-Collateral solution comprises more than 93% of cleared margin posted by U.S. registered FCMs. And work is already underway to on-board additional CCPs in 2023. The solution enables clearing members to automate their collateral management processes by providing intraday visibility of current margin obligations and collateral holdings at the CCPs.

“We are focused on the clearing and settlement for a wide array of asset classes. We actually  move assets  faster, cheaper, and with absolute transparency, which means that we reduce the risk across multiple verticals. And all of this is built on top of our distributed ledger technologies. What is distinct about Baton is that when we build our technologies, they interoperate with the bank’s existing systems to move real assets in the real world.”

Mr. Kemp was keen to highlight that at this stage in its journey Baton is not creating or minting any crypto assets or tokenized instruments. He also drew a line between public blockchains’ focus on transactions, and what Baton has in common with capital market providers, which is a focus on workflow.

What also makes Baton really unique in terms of competition with crypto-native players is that Baton’s solutions interoperate with real-world entities, such as the exchanges, nostro accounts, custody banks, and CSDs, where a broad spectrum of assets are held. On the other hand, they outperform peers in mainstream finance through selling powerful market infrastructure rails and distributed workflows on top of it.

The Baton President also believes that the power of their technology will be truly seen with the continued rise in interest rates as it ensures money isn’t being left on the table. Practically speaking, Baton enables clearing members, who basically clear at various exchanges on behalf of a bank or their clients, to automate and optimize their collateral management processes by providing intraday visibility of current margin obligations and collateral holdings at the CCPs. That is a particularly important aspect for future commission merchants (FCMs) to improve both the financial and operational efficiency of their collateral movements for centrally cleared derivatives.

In our conversation, we also shed light on how volatility over the past three years has raised settlement and counterparty risks. Then we asked if the distributed ledger technology is better than legacy systems in facilitating settlement and managing liquidity.

Kemp thinks that extreme volatility and operational glitches can lead to an increase of counterparty risks in stressed market conditions. This might contribute to amplifying the importance of DLT to the existing financial market infrastructure. He explained how it can improve settlement processes substantially, as it enables counterparties to collaborate and settle on a Payment-versus-Payment (PVP) basis, on-demand, multiple times intraday with legal settlement finality and complete the settlement process within a matter of minutes thereby reducing costs and risks for various business processes.

Speaking of the recent BIS triennial survey, we asked Jerome if London’s position as the global hub for FX and derivatives trading has eroded due to the Brexit effect. And how does that impact their business in post trade processing?

Kemp acknowledged that while the UK remains the world’s top trading hub, its market share has fallen. Obviously, the decline comes as London continues to grapple with the financial fallout after Brexit, while clearing euro derivatives has become a battle as Brussels seeks to build up the bloc’s own capital market and end reliance on the City.

Jerome also believes this makes a particularly beneficial use case for Baton Systems’ technology in terms of the transparency for the trade counterparties, and ultimately how to mobilize and move those assets to their ultimate destination.

He explained how DLT provides the required upgrades for faster trade settlement, which could help the system keep up when things get hectic. He noted how shorter settlement cycles reduce the time traders are exposed to the risk that their counterparty might default, or that markets undergo some disruptions.

Mr. Kemp added that Baton is already shortening the trade cycle from a proposed T+1 settlement to T+0 for FX transactions with a solution that is live and being used to settle billions everyday and which would reduce the amount of margin that counterparties need to post with clearing houses.

“In harnessing the distributed ledger technology that we bring to the market, whether it’s for FX settlement or moving margin collateral from a custodial location, let’s say, to a CCP location, we can essentially achieve that in T+0. The big challenge is getting the broader user community up to speed in terms of having the systems in place to accommodate the compression of settlement to close to real time. I think it’s a bit more of a challenge in cleared markets because CCPs do tend to operate on 24 hours, but if you imagine an ecosystem where CCPs themselves are nodes alongside FCMs and their clients on a permissioned distributed ledger network, then real time or near real time settlement is clearly within reach.”

Crypto regulation in the US

FIA Expo 2022 kicked off with a fireside chat featuring U.S. Commodity Futures Trading Commission Chairman Rostin Behnam, discussing commodity markets, climate risk, and other trends in cleared derivatives markets. But with FTX fresh in everyone’s mind, Behnam took some time to discuss his perspectives and offer his views on how the regulatory landscape around cryptocurrency might change.

We asked Jerome, who participated in the panel featuring the CFTC’s head, about the debates in and around crypto. He said the major question at hand was not whether the CFTC can regulate this wild west. They certainly have the tools and flexible legal authority to do so. But how they may approach this area because CFTC is going to play a key role in how these markets develop further.

Baton’s President was also keen to highlight that people sometimes use the terms ‘Blockchain’ and ‘Distributed Ledger’ interchangeably. He clarifies that blockchains are one form of distributed ledger technology. In essence, distributed ledger technologies drastically reduce the cost of trust.

Finally, Jerome Kemp also noted that cryptocurrency regulation has been a controversial topic, and that regulators will need to navigate a fine line between ensuring that markets, and most importantly market participants, are protected while allowing for innovation and market structure to evolve.