SIFMA president and CEO Kenneth E. Bentsen, Jr., recently sat down with Michael Bodson, President and Chief Executive Officer of DTCC, for a one-on-one conversation on a look at how post-trade is being reimagined in an era of change. This is an excerpt from their conversation, one in a series of Executive Viewpoints at SIFMA’s 2021 Annual Meeting.

About Executive Viewpoints

Filmed for SIFMA’s 2021 Annual Meeting, Executive Viewpoints is a series of insightful conversations about trends and innovations shaping the future of our capital markets. The capital markets are in the midst of major transformation, arguably one of their most fundamental shifts yet. In this special series, SIFMA president and CEO Kenneth E. Bentsen, Jr. and chief operating officer Joseph Seidel interview a cross-section of experts to understand just some of the dynamics at play in the market’s next evolution.

To view more from the 2021 SIFMA Annual Meeting, please visit www.sifma.org/annual.

A Conversation with Michael Bodson

Ken Bentsen: SIFMA, DTCC, and the Investment Company Institute are finalizing a roadmap to accelerate the settlement cycle in the U.S. from T+2 to T+1. What are the benefits of shortening the settlement cycle as well as the challenges that the industry will need to overcome?

Michael Bodson: We started working on T2 to T1 right after T3 to T2 occurred (the same troika that led the industry to that successful completion). We started looking at it internally in the 2017-’18-’19 period, changing some of our internal processing. But in ’19, we started having conversations with the industry, and there was obviously a lot of interest in moving to T1. But there were also a lot of questions.

With the early ’20-’21 buying surges – the famous meme stock episodes – there was a lot of focus put on going to T1 and what did it really mean. So again, we put our troika together. The teams coalesced. We started talking to all the stakeholders.

The benefits are pretty self-evident. By reducing the outstanding period of trades, we’re able to lower our margin. The value of risk component, which is the biggest component of the margin, should go down by about 40 percent and even more in some of the highly volatile market times. There should be a lot of operational efficiencies. People can lose sight of the fact that you’re chopping settlement time in half and really a third of what it was just a few years ago. So it’s a significant acceleration. There will be a lot of operational efficiencies that’ll come out of it, like settlement risk and failures. The industry benefits from all of that in terms of capital savings and cost savings.

The challenges are going to be legacy technology. A lot of the technologies are batch processing still; how are they going to be adapted to a different time cycle? We’re looking at some of the operational issues around FX, prime broker, allocation process, recalls. There are workstreams looking at significant challenges but, so far, no hurdle cannot be overcome.

It’s a lot of work, but we’re still looking forward to late ’23, early ’24 as a timeline to get this done.

Ken Bentsen: As you said, instead of taking a third out we’re now taking a half out. It does compound some issues.

DTCC is also looking further out when it comes to settlement. Can you explain the details of Project Ion and the alternative settlement service that you all are currently developing?

Michael Bodson: In parallel with accelerating the settlement cycle, we like have been looking at DLT and what benefits could accrue to the industry if we used it as a base technology. Project Ion is an eye towards having ultimate optionality in the settlement cycle. You could go from T0 to T1-2, or any other timeframe if the industry wanted it. But we also wanted to make sure that we leverage the benefits we have of central counterparties (CCPs) and Central Securities Depository (CSD).

What is going to be unique about Ion is that while it’s a DLT-based layer between participants, it will connect to legacy technology. The legacy technology will remain the golden record. So, you really are balancing the two. You have the ability to go back and forth between legacy and DLT; or, if you want to go pure DLT, you’ll still be connected to the rest of the industry. It’s that optionality.

It’s the start of a journey with DLT. There’s so much hype and there are so many benefits that can be accrued. It’s still early days and, by working with the industry, we can make sure that we design the optimal solution for the industry, rather than just saying “oh, this is a great technology, let’s throw it out there.” It will be an iterative development so that we get the benefits to the industry as soon as possible.

Ken Bentsen: What about Project Whitney?

Michael Bodson: Whitney is an exciting one. When we look at technology, there are times when it can be disruptive and times when it’s about whitespace. Whitney definitely is about whitespace.

Whitespace is the private security marketplace, which is not something that we historically have been heavily involved with. But as everyone in the industry knows, it is a growing part of the industry. We see that by its size and how companies are waiting longer to go public. Most private companies now are doing three rounds of private financing rather than one, which was the norm a few years ago. The average size of the raise went from about $43 million to $200-something million. The stat I really love is that, in 2014, there were 14 unicorns, or billion-dollar entities. In 2021 so far, there’ve been 342 unicorns created. It’s just absolutely amazing. There is a lot of wealth creation, a lot of benefit for issuers, a lot of benefit for investors – but, a very, very fragmented space.

Working with stakeholders – everybody from issuers to private equity firms to Wall Street firms – we decided we could bring standardization, processing efficiencies and regulatory and governance structures. This will benefit the entirety of the private market ecosystem, from issuer through the intermediaries all the way through to end investors and secondary trading.

We’re using DLT and API. We’ll be using the cloud. We’re excited that it allows us to use new technology but, more importantly, we’re going to bring a lot of benefits to the industry in an important and growing space.

Ken Bentsen: What made private markets ideal for this innovation?

Michael Bodson: It was talking to stakeholders. This was obviously whitespace. There are some players performing certain functions within it but it is generally a white space where we felt the capabilities that DTCC has in terms of processing, governance, regulatory capabilities, etc would benefit the entirety of the ecosystem.

People want modular, service-based architecture. They want to use DLT, they want to use APIs. So, it fit the mold. It was a high-value proposition for not just a niche group of players but rather the entirety of the financial ecosystem. It allowed us to use new technologies in a very effective way.

It ticked all the boxes of why would you want to do it. There was a need, there was a value-add that we could bring, and there was a means of doing so. And that’s exactly what we decided to do.

Ken Bentsen: DTCC is clearly at the front end of using new technology. How do you balance digital innovation with your risk management and resilience responsibilities?

Michael Bodson: I never thought anybody would say that we’re at the forefront of new technologies. If you’d said that five years ago, people may have been aghast. But we are definitely involved in all these new technologies.

Our going-in premises are really based on two facts:

1. The technology must provide a benefit you can’t accrue otherwise. That’s a baseline of why to use a new technology. Beyond the shiny new toy, it has to provide value.
2. Do no harm. We still have to do our daily processing and responsibilities while integrating new technologies into it.

Saying all that, there obviously are benefits, be it the reconciliation benefits of a DLT, operational efficiencies of smart contract, or the move to tokenize securities that you’re seeing everywhere in the world. It’s important for us to understand that and then ask how we bridge from today to tomorrow. That’s exactly what we’re doing.

The upside is significant. But building it is in some ways easier. It’s the transition that I think will take the longest time.

We have the largest financial firms in the industry down to small agency shops. We have to bring them all along together to be fair and equitable. That is in some ways the most difficult part of the process.

Ken Bentsen: Are you able to identify which new technologies will have the most significant impact on the financial markets in the coming years? Which may be the most transformational?

Michael Bodson: These are hard questions because it changes and it evolves. One of the interesting parts is how the new technologies interface and work together. If you have to start, obviously it’s tokenization – the digitalization of the industry. Five years ago, we both would have been shaking our heads asking what’s a cryptocurrency. Now, we talk about it as if it is an everyday part of our lives in the move to tokenize securities. That’s going to be a gamechanger in terms of just evolving the way post-trade transactions are working and even during the trading process.

Second, I would say artificial intelligence (AI) because the applications are so varied. You’re seeing it in everything from robo-advisors to trading desks to risk management – be it financial, credit, operational risk, cyber risk, etc.

DLT as the means of connectivity is going to change tremendously.

It’s at the asset on one level, then the communications network and the protocols underneath, and AI on top. You’re talking about a completely new world. I think the last factor that the whole industry and SIFMA need to grapple with is what DeFi (decentralized finance) is going to do to the industry. Some out there say DeFi is just going to basically bring the end to banks and brokers. I don’t believe that. I’m a dinosaur possibly. But, I do believe the concepts underneath it in terms of open access and ease of use are powerful forces that are going to change the industry. We either embrace them and work with them, or they’re going to be out there someplace causing mayhem.

Ken Bentsen: Let’s talk about DLT. That was introduced with great fanfare five or so years ago. But reality soon set in that it was easier to conceive ways to use it than actually integrate it into existing processes or create new ones. What are the main barriers to broad-based adoption, and what will be needed to address them? And perhaps this applies to other areas of so-called fintech. How do we avoid a free-for-all mentality and instead tailor this to where it actually has the most impact?

Michael Bodson: It is amazing looking back and seeing all the hype. I remember being in Davos one year where every session was about how DLT was going to change the world in the next six months. It’s a great technology, but those were early days. We didn’t have the expertise and I think we all underestimated the time and effort it takes to replace legacy processes and technologies.

In some ways, as you said, identifying the base case was simple. Identifying how to get it done was not so simple without expertise, but it could be done. But transitioning, that would have been a massive undertaking. I think what it really comes down to in some ways is governance. We did a paper with Accenture a couple of years ago that talked about the varying roles that have to be put into place for DLT to work. Who’s going to engineer it? Who’s going to build it? Who’s going to allow people onto it? Is it permission or non-permission? Who’s going to ensure the quality of smart contracts? All of these things have to be taken into consideration.

We viewed it more as a technology rather than a new ecosystem and underestimated how difficult it would be and what it would take to get there. It obviously has had fantastic impacts on the payment systems of the world. You can see the power of it there. The securities world is much more complex in a lot of ways. We have to take our time to learn about it and use it the right way, but also make sure we have the right structures around it, or else — I like the term you said — it’s a free-for-all.

We don’t want to go back 40 years and have fragmented liquidity pools and non-interoperable platforms. That would be a massive step backwards. The good news is you have high tech; the bad news is your ecosystem’s an absolute mess. The industry has got to work together and say, what is the vision, how are you going to get there, and what are the roles that everybody has to play?

Ken Bentsen: You’re the major market infrastructure player. What are the top priorities you think about when creating this foundational layer of a digital infrastructure?

Michael Bodson: What comes to mind are basically three things, and I’m going to be a little repetitious.

1. What is the business case? What is the value proposition that you’re trying to achieve with what you’re trying to do? It’s a combination of what and why. Why is it a white space? Are you replacing technology to get operating efficiencies? Are you lowering operational risk or any other type of risk? You need to have that base case and really understand the cost-benefit.
2. What are the governance structures? You need to understand who’s playing what role in this new ecosystem and make sure that everybody agrees on how that’s going to play. Financial intermediaries have in the past played this role – basically, being Switzerland and creating efficiencies and doing the right risk management.
3. What are the non-functional requirements? Do you have the capacity? Do you have the scalability? Do you have the intra-operability? Do you have the resilience? All these things that we spend days after days and years after years building into our current ecosystems. You have to make sure that the new technology meets the existing standard if not far surpasses it. When we were first looking at DLT, we worked with Accenture and we did a test – could the platforms that were out there handle the volume of a normal day? And that was about 125 million buys and sells. We tested four platforms. Two were able to do it, and two were not. The two that could, it was really adding more and more cloud power behind them to get there. During January of last year, we did 470 million of the same buys and sells. Would the platforms be able to handle that, or would the cost of adding more engines behind it be prohibitive? Going into something without really understanding what the limits are that you’re going to have to hit could end up being a very costly experiment.

Ken Bentsen: How do you see the transition unfolding as the industry moves from legacy systems?

Michael Bodson: If you look around globally, there are a bunch of different approaches going on. The Australia Stock Exchange has been working on replacement processes. They’re doing a big-bang type process. In Switzerland, SIX has parallel exchanges and processing going on where they’re working side by side but not interconnected.

As a contrast, we have Ion which has legacy technology but we’re going to have new technology interfacing with it and leveraging each other. There’s no one right way, but when we’re looking at our marketplaces – as I was saying before about nonfunctional requirements – we have to ask, what are you trying to solve for and how do you do that transition?

The irony of where we are today or where we will be in a few years is that we’ll have paper security, which hopefully we can get rid of. We’ll have current legacy technology representations. We’ll have tokenization of those existing securities. And then you’ll have natively issued securities. So one foot in the past, one foot in the future, and two steps in between. You really have to pick the approach that’s appropriate for the segment of the market.

For Whitney, starting de novo works perfectly because you’re not connecting to any existing technology. Given the size of the U.S. market and the volumes of the U.S. equity market, I think what you’ll see is more of the Ion approach of living in a parallel world, transitioning, giving people time to shift, but that you don’t live forever with the high cost of duplicate structure out there.

Ken Bentsen: It begs the question, why do we still have physical securities?

Michael Bodson: Darned if I know. I’ve got to tell you, we have a lot of them, and we’d rather not. This was an issue post-Sandy, when we had the flood, but also now with COVID. People are finally realizing that there’s a risk of paper securities and that there’s no need. So we have started with electronic — with CDs and putting them where there was typically physical paper. We’re doing more and more. We’re up to about 30 percent electronic issuance.

We just have to go asset class by asset class. We have to work with the issuers, transfer agents, and the entire industry to stop issuance because it’s very costly and it’s very risky. It’s just an anachronism for a market this big to still have paper. So, I don’t really see a need, but it’s just the will and the force to get it done.

Ken Bentsen: All that we’ve talked about – making this transition, adopting new technologies that are not just a shiny new object, even moving to T+1 – how should the industry be thinking about their investment in IT and other business processes?

Michael Bodson: This is probably one of the hardest questions on Wall Street and probably in all parts of the industry. If we’re like other firms, 50 percent of my budget is tied up in technology. We are all big tech firms underneath when you look up the hood. But the whole question of prioritization is one of the hardest things the industry has to face, both collectively as well as individually.

We look at our budget. You have to keep the lights on in the enterprise operations piece. You have to support your business applications where you’re just doing tweaks. But then you come down to the most important part, which is delivering new capabilities or changing bank capabilities and how you parcel that out. Unfortunately, we all face limited pools or we don’t face unlimited budgets to do whatever we wish.

You really look at the two pieces. You look at what you do to modernize. We have a large modernization project called Stride on the Way. That will take years to get done because you are replacing legacy technology; there are complete rewrites and they’re complex. But then you want to add capabilities. You want to add new products to your legacy technology. You want to do that to keep your clients happy and keep the industry happy. But all you’re doing is adding to your technical debt at the same time by piling more onto legacy. So we basically take an approach of trying to get to a 50-50 kind of balance. We think that makes sense, and we try to push more into modernization over time – things like T1. Regulatory change comes to the top.

The other consideration is cybersecurity and how much you’re now spending on technology risk and cybersecurity expenses, etc.

We ask, what are we doing with those dollars? And again, we classify it into four areas:

1. You can be enhancing your existing processes. It could be that you’re making them more efficient, you’re changing the technology platform, or you’re just fixing things.
2. You can be going into adjacent areas where you are providing a service, but you could extend that service further down the pike and provide more value to your clients.
3. You could be doing what we’re doing with Ion – saying, look, we do settlement, but let’s do settlement in a completely new way using brand new technology.
4. Or you go into the whitespace, which is Whitney.

I have not seen a magic formula for how much you want to do in those spaces. But obviously, through time you want to see yourself spending more into the disruptive whitespace and getting into modernized architecture. My whole life on Wall Street, this has been one of the toughest points to take on.

Ken Bentsen: How do you see the role of trusted intermediaries evolving in the world of digital markets and tokenizations?

Michael Bodson: I always tell my team that if you don’t change and evolve, you will become irrelevant pretty quickly. I think what we do – with the stability we bring, the risk management we bring, the connectivity we bring, the efficiencies we bring – there will always be the need for those qualities in the financial marketplace. But, it’s going to look completely different 10 years from now than what we’re doing now, just like it looks different now from 10 years ago.

We have to focus on what the value-add is that financial intermediaries bring. We also have to evolve it to face the future. People were saying we were going to disappear five years ago. And, obviously, we’re still here. There’s a lot of pride in how we handled things like January of last year. We just have to redefine how we’re doing the roles we play, be it standard setters, gatekeepers, risk managers, connectivity, all these roles that are somewhat taken for granted but we do very, very effectively.

We have to transition that to the new world. The governance structure we did with Accenture, as I pointed out earlier, talks about those roles and how somebody has to play them. It’s got to be somebody that everybody can trust and is also going to be impartial. That’s where the FIs are going to get to over the longer run.

Ken Bentsen: Do you see a bridge between trusted intermediaries in the future DeFi world?

Michael Bodson: Yes, I believe so. If you think about DeFi, again, if it goes wrong, it’s a very fragmented world and very inefficient world. By the nature of who we are, our focus is to bring the parts of the ecosystem together. There is going to be this evolution.

Looking at DTCC, we’re cash for securities settlement processing. We’re going to migrate into much more of an asset versus asset, tokenized versus physical security – possibly in the next few years. There’s going to be a bridging process.

I also think there’s another aspect where regulations are developing. Regulators have to understand what exactly these products are. They don’t want to stifle innovation. The DeFi world wants massive innovation.

But as a recent The Wall Street Journal article talked about, there are two reasons why Wall Street exists in the way it does and they are the two risks that exist in DeFi. They are fraud risk and operational risk. Somebody’s going to have to play that overseer role. Again, you can call me a dinosaur, but I just don’t see the world just trusting the app, trusting the technology. There’s nobody there. I don’t see it happening. I don’t see the regulators allowing it to happen.

In the worst of all possible worlds, you have chaos on one side and regulation stifling innovation. If you get it right, then I think you have a well-protected, safeguarded market that works efficiently. That’s what we all want, and that’s where I see DTCC and other FMIs playing a very crucial role. So it’s an exciting future, but we can’t lose sight of all the lessons we’ve learned in the past either.

Watch the Full Conversation

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Michael C. Bodson is President and Chief Executive Officer of DTCC. He is also President and Chief Executive Officer of DTCC’s principal operating subsidiaries, DTC, FICC and NSCC and a member of DTCC’s Board of Directors.

Kenneth E. Bentsen, Jr. is President and CEO of SIFMA. Mr. Bentsen is also the CEO of the Global Financial Markets Association (GFMA), SIFMA’s global affiliate.

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