Australia | Dec 08 2017
ASX has decided to replace its CHESS system with a distributed ledger technology. While this has potential to create new revenue opportunities, broker suggests it will be some time before these become evident.
-Costs should come down with less need for reconciliations
-Near-term value seen reflected in the share price
-Initial focus for DLT introduction will be on market stability and integrity
By Eva Brocklehurst
Australia's Securities Exchange, ASX ((ASX)), has leaped into the forefront of the digital revolution, deciding to replace its ageing systems for clearing and settlement of transactions with a new platform. The company will replace its CHESS equity clearing and settlement system with a distributed ledger technology (DLT).
At this stage, Citi considers this little more than a decision to replace one technology with another but suspects, in time, it could lead to significant changes in revenue streams. Some revenues will likely diminish but this should be substantial scope for new services.
Costs should come down, as there is less need for reconciliations when participants connect to a fully functioning DLT. In turn, this should make it cheaper to transact and potentially increase volumes.
ASX will give customers choice in accessing post-trade services, allowing them to continue to connect in a similar way using the current front-end, if preferred. Customers will also be able to connect directly with a distributed ledger.
Regulators, at this stage at least, are not expected to object to the implementation of DLT. Regulators will be a party to the architecture by being a node in the network.
Citi expects the introduction of DLT to clearing will have implications for a number of players such as share registrars, including Link Administration ((LNK)) and Computershare ((CPU)) as well as investment banks.
The broker believes the ASX is a perfect case for testing the technology given it is a private network and has only one small competitor. Further advantages include the fact that transactions committed to DLT can never be undone and represent a single source of fact.
Deutsche Bank agrees the impact will be limited in the near term, as the focus is expected to be on market stability and integrity, but DLT opens up significant opportunities for growth in the longer term.
The broker envisages the main risk depends on whether trading levels vary significantly from trend, while unexpected regulatory changes could also provide risk over the medium term. Deutsche Bank likes the company's strong market position and balance sheet, but as cost growth is currently running at double the revenue growth believes the stock is fairly valued.
UBS believes the boost evident in the share price in the lead up to the decision is likely to fade. Moreover, with buoyant equity markets over the first half that have not translated into stronger revenues the valuation metrics appear increasingly stretched. Alongside the the bullish sentiment regarding technology the shares also appear to have outperformed on rising equity markets.
Yet equity revenue drivers have failed to follow suit, as turnover is down -2% in the year-to-date and higher margin on-market turnover is down -4%. Furthermore, dominant settlement messages, which are a key revenue driver, are down -7.5%. Within derivatives, SFE futures volumes have been robust, UBS acknowledges, although equity options are flat. All up, the broker opts to downgrade its rating to Sell from Neutral.
A blockchain is a distributed database, a decentralised list of transactions shared between computers instead of being stored on a central computer. The ASX DLT system, being built by US-based Digital Asset Holdings, will require permission be granted for access i.e. it is a “permissioned blockchain” as opposed to a public blockchain.
The DLT system means ASX will continue to control settlement and ownership data but will make it available without access barriers to market operators and other clearing facilities.
Ord Minnett considers the benefits provide a medium-term tailwind for ASX and expects the the legislated monopoly in CHESS will be replaced by a natural monopoly in providing IT and back-office infrastructure and data. Costs are likely to increase from FY19 but the company has suggested a lot of this could be covered under its existing capital expenditure plans.
Morgans guesses DLT will be relatively neutral to earnings, although new functionality may provide some earnings upside. The company has maintained FY18 capital expenditure guidance at $50m and the broker expects similar levels over the next few years, given the DLT development costs will likely offset some reductions in expenditure from completed projects.
The company has stated that DLT was selected as the technology because, in part, it can deliver additional revenue opportunities. Day one requirements of participants will ultimately affect the timing of capital expenditure, Morgans suspects.
Transition To DLT
The proposed timing for the transition will be provided by March 2018 but details and capital expenditure are unlikely to be available until August. Full roll-out is likely to take around 24 months. The clearing function is unlikely to completely disappear but over time there may be less need for it.
This should then reduce the capital ASX needs to support its clearing house. Nevertheless, Citi suggests it may be a while before the Reserve Bank of Australia allows significant capital to be released.
The main transition involves replacing the old clearing house electronic settlement system, which has not reached the response time that pre-trade order-queuing and electronic trading of financial assets has reached. This results in a settlement latency. Latency is expected to be maintained in the transition to DLT.
A testing phase will be started in March 2018 and settlement times will remain at T+2, despite the technology allowing faster settlement. A longer settlement period allows market participants to open and close positions in the same trading day without posting capital, and benefits ASX volumes. In particular, high-frequency traders use this feature.
FNArena's database shows three Hold and five Sell ratings. The consensus target is $52.24, signalling -6.8% downside to the last share price. Targets range from $49.09 (Morgans) to $54.90 (Citi).
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