What can HKEx’s Synapse learn from watching ASX’s game of Chess?

The Australian Securities Exchange (ASX) has recently made a name for itself for its ambitious plan to replace its Chess equities clearing and settlement system with a distributed ledger technology (DLT) platform developed by Digital Asset. But since that decision, the exchange has needed to delay its original go-live implementation timeline multiple times. After conducting a re-planning, re-sizing, and review of the project, ASX now aims to have Chess go-live in April 2023. The new timeline accounts for expanded testing, integration, and greater scale to cover the increase in peak daily volumes, among other issues. 

Although the exchange has other ongoing projects, like the buildout of its DataSphere platform, it has faced criticism over its handling of the Chess replacement project and how some amendments could lead to new risks. 

It’s not all for naught, though. Perhaps the ASX’s experience with Chess now serves as an example for how others within the financial market ecosystem should handle their own DLT project considerations. 

Take Hong Kong Exchanges and Clearing (HKEx), for example. In November 2020, the exchange introduced HKEx Synapse, a new settlement acceleration platform for its Stock Connect program. The platform, which aims to standardize and streamline the post-trade workflows of Northbound Stock Connect, will use smart contracts based on Digital Asset’s open-sourced Daml programming language. Digital Asset will also build the platform. 

HKEx has also partnered with the Depository Trust & Clearing Corporation (DTCC) to link Synapse to the DTCC’s institutional trade processing (ITP) services. The exchange has continually said the platform would remain optional for participants and expects to start testing this year with a group of pilot users. HKEx aims to have Synapse in production in Q1 2022. 

A number of sources that WatersTechnology spoke with for this story collectively believe this is a step forward for the exchange and are generally upbeat for this project. But again, the devil is in the details. 

An HKEx spokesperson would only say that, “On the technology front, we have embarked on a number of key initiatives, including plans to streamline our IPO subscription and settlement cycle, with the proposed introduction of Fini, a new web-based platform that enables all IPO market participants to interact digitally and seamlessly to complete the end-to-end IPO settlement process; and a proposal to automate and streamline post-trade workflows for [Synapse] with a planned launch in 2022.”

Same, but different

So how is HKEx’s Synapse different from ASX’s Chess project?

From the looks of it, HKEx is treading carefully with the Synapse platform. First of all, it’s meant to address existing post-trade workflow challenges for Northbound flows in the Stock Connect programs. One of these challenges is that for China A-shares, the stock settlement is done on a T+0 basis, while the cash settlement is done on T+1, while stocks on the HKEx-owned Stock Exchange of Hong Kong function on a T+2 settlement cycle. That means that post-trade participants have much less time to deal with any trade errors that could occur in the trade workflow. This workflow involves matching the security Isin, settlement value, value date, counterparty ID, commissions, and so on. 

According to a head of broker strategy at a tier-1 European investment bank, nine times out of 10, there’s no issue. But that one blip, there could be an error in the commission, or value data, or counterparty ID.

“This happens in every market around the world. It’s not unique to Stock Connect. But in other markets, and the Hong Kong market, for example, you’ve got two days to go back through your chain and work out why it didn’t get fixed. Then someone will realize, and they’ll send a replacement message, and it’ll match and go to the market. But in Stock Connect, you’ve got four hours,” says the head of broker strategy.

This is the reality of firms participating in Hong Kong’s Stock Connect. 

“We see this every day in our office,” they continue. “The way that it’s solved today is that you have quite a sizable operations team who are phoning counterparts to work out what’s going wrong with the trade. I would say you probably end up allocating two to three times as many people to Stock Connect than the Hong Kong market for the volume of activity. From a unit cost perspective, it’s probably two to three times more expensive.” 

Think ‘smart’

One area where HKEx seems to be doing well at setting its project apart is the use of smart contracts for specific use cases around addressing post-trade challenges.

Lyndon Chao, managing director and head of equities and post-trade at the Asian Securities Industry and Financial Markets Association (Asifma), believes the exchange is moving in the right direction with this project. “Conceptually, it makes total sense, and I think it’s good that HKEx is being pragmatic and targeted. They initially envisioned doing this not only with Daml, but also on a blockchain sub-ledger. But now they’ve replaced blockchain and are leveraging a more conservative approach by using the more traditional Oracle database,” he says. 

Chao adds that HKEx is being more careful than ASX, as this is a narrow business case, and HKEx is solving for a real problem given the short settlement cycle of T+0/T+1, he says. 

Under current settlement practices, brokers currently pre-fund the trade and provide financing for their clients to deal with the short settlement cycle. The securities delivered first go into the special purpose segregated account (SPSA), which is not released to the end investor until the money comes in. This has meant that the settlement process is expanded into a two-legged settlement process where one leg comprises settlement between the broker and the exchange, and the second leg comprises settlement between the broker and the client to simulate delivery-versus-payment (DVP). 

On the client’s side, they get the DVP experience—money and shares exchange hands at the same time. Participating parties, too, are better protected from a counterparty operational risk perspective. But to provide that experience for the client, the broker incurs financing charges. 

“Foreign investors currently account for about 5% of China A-shares,” Chao says. “But if foreigners continue to trade more and more actively in China, and continue to do so through Stock Connect, as volumes continue to increase, brokers will be taking on increasing financing costs for their clients. So the question is, how sustainable is that? But if Synapse works well and we’re able to improve the efficiency of the pre-settlement and confirmation matching on a near real-time basis, possibly there could be ways to still deliver a simulated DVP, but with less pre-financing done.”

Optional vs mandatory

Optionality is key, says the broker strategy head. With the ASX Chess replacement, the reality is that market participants either have to be on board or change their model. “If they don’t go through the project and go through the connections, then they won’t be able to connect to the market anymore, because it’s not an optional solution. It’s either you’re in, or you’re out,” the head says. 

In contrast, because the Synapse solution offers participants the choice of whether to connect or not, HKEx should make it as simple as possible to connect—either through API, Swift, or a GUI—to see the value it could bring to their flows, they say. 

In an optional solution like this, the scale of adoption is important because it will need both the asset manager and broker chains connected. That could potentially lead to China Connect having two different models. 

“The reality is that asset managers execute through multiple brokers. If they’ve got part of their broker panel connected and part of the broker panel not connected, then it means they’ve got to have two different models in play. Then separately, brokers are supporting execution on behalf of a multitude of asset managers. So they have that same challenge in reverse. If the asset managers buy into Synapse, they’ll perhaps be able to help more of their broker community move the solution forward,” says the source. 

This will be a challenge, and China Connect will probably end up with a fragmented process, says the CEO of an Asia-based institutional interdealer broker. However, that fragmented process will also be a driver to get everyone onto the platform as soon as possible, they say. 

Asifma’s Chao believes those who opt to be on the Synapse platform will have a competitive advantage. “My assumption is that you’re going to have a certain subset of market participants who have invested the time and energy in systems integration to be on this new Synapse platform, and you’re going to have others still doing what they do today. Those on the platform will have the advantage of being able to improve their efficiency and possibly save on pre-funding finance costs. So it’ll just be a competitive advantage for those people on that system,” he says.

However, even on that system, HKEx is provisioning for flexibility, in that those who don’t want to connect with Synapse using the smart contract technology can continue using ISO 20022. 

Chao warns that while it will allow participants to do things the “traditional way of putting in your own feedback into that loop,” the chain will only be as strong as the weakest link, or only be as fast as the slowest party to respond. 

“Whether it’s the broker, the sub custodian, the GC (global custodian), the fund manager—if anyone along that chain is slow to respond, then that will still hold up the process,” he says. 

Details, details

With a target production timeline of Q1 2022, it will all come down to the details that HKEx shares with not only its pilot users, but the entire China Connect participant chain—asset managers, brokers, sub-custodians, and global custodians. 

The interdealer broker CEO says the firm is keen to work with HKEx and get involved in the Synapse project, but there are still details lacking. 

“The information on the HKEx website is useful, but we haven’t seen anything yet in terms of technical or functional specs, and a lot of the information out there is quite generic. We haven’t really got into the weeds in terms of how it really works,” the CEO says. 

Even still, the CEO believes the work facing the interdealer broker won’t be all too complex. At the moment, all trade messages go into DTCC’s CTM platform—under its ITP solutions—for central matching. 

“It sounds like once the trades are matched, the DTCC will send all of that into Synapse, which will generate instructions to CCass (HKEx’s central clearing and settlement system for equities). So I don’t think there will be too much needed from our side. If anything, it would just be a datafeed of matched trades,” the CEO says.

Again, it seems that HKEx has yet to reveal detailed specifications of the platform to its China Connect exchange and clearing participants. 

A product manager who works within the custody and clearing services at a large, global bank says the model’s success depends on how HKEx works with the industry to bring Synapse to life. 

“It’s an interesting project, and we absolutely buy into the idea. But again, how it pans is very dependent on how HKEx runs this project. I keep going back to the fact that they have to listen to the market, because we are living this every day. We know the issues,” they say.

Sources also warn that HKEx’s timeline for launching Synapse is ambitious. This would depend on what HKEx means by “up and running” and how many parties it wants connected to the platform for Day One, says the broker strategy head.

“If they want a soft launch, then potentially, that can work. If you want mass adoption from day one, obviously that’s going to be super challenging. Look at the agents in the Hong Kong market, and look at the global agents on the global custody side—nobody’s sitting there twiddling their thumbs looking for a project to do. There are hundreds of projects that we’re all engaged on, around the world, on a regulatory basis, on an internal evolution basis, etcetera,” they say.

And, as the product manager notes, just like with Chess, even when companies have clear plans for what they want to achieve, there are often bumps in the road along the way.

“We would probably take a look again back at Chess and see some of the delays that have happened there,” they say. “We wouldn’t be surprised if there was a delay here, too. Probably not to the extent the ASX has seen, but we could imagine that a six to 12-month delay wouldn’t necessarily be a bad thing.”