Can Blockchain Change the Reconciliation Game?

In the animated series The Jetsons, we see a family of the future going about their daily lives. The daughter holds up a remote-control-like device and her clothes magically change, they have a robot maid, and the dad sits in front of a computer and pushes one button to do his job. Nearly every bit of the Jetsons’ lives is automated, and, as the cartoon would have us believe, it was Utopia.

Automation is so common in science fiction that consumers today expect those futuristic tools to bleed into real life. Examples exist everywhere, from asking Siri to call someone to letting a car do the parking and driving without input from the driver. Not only does this kind of technology serve to make our lives easier, but it is also supposed to reduce human error. The possibility of a tired person behind the wheel hitting someone on the road can be greatly reduced by technology that can immediately assume control of the vehicle.

Technology firms are seeking to further automate our lives, possibly even removing the need for human supervision altogether and bringing us ever closer to the future of The Jetsons. Just look at the potential that blockchain offers the financial services industry if you want to see an area that some believe is ripe for automation.  

Distributed-ledger technologies—and specifically blockchain—are set to take the financial technology world by storm. This revolution is purported to make post-trade activities more efficient and less prone to human error. One of those post-trade activities is the reconciliation process, which, in theory, stands to greatly benefit from the new technologies currently being trialed. Industry experts say blockchain has the potential to eliminate the need for reconciliations entirely. But is this a future we can expect in the next few years, or is it still the stuff of fiction?

Blockchain, however exciting, is still too far off to be a viable technology that will do away with reconciliations, and some in the industry are still not comfortable with the idea of having to invest that much in post-trade activities. Many believe that it will take years before back-office reconciliation teams will be driven by distributed-ledger technologies, says Jeffrey Billingham, vice president of processing at Markit.

“Nobody translates all the blockchain white papers for the back office. We don’t really know what it means for us and how it can be fully relevant to the back office.” Nancy Grady, Northern Trust

“Blockchain presents interesting things for reconciliations and can potentially eliminate costs,” he says. “A single, shared ledger eliminates the need to reconcile with a central data source.  If we can use blockchain to further automate operational functions such as reconciliations, we can then focus on using the technology to optimize balance sheets and securitize complex financial products in order to reduce risk.” 

Single Version of the Truth

The reconciliation process is one such function that banks have to manage, and they’re having to oversee it more diligently than ever as regulators demand more frequency and transparency around reporting. Every bank must ensure that line items in transactions, contracts and balance sheets match before submitting reports to regulators. 

This also helps in setting accounts straight for internal purposes. Research firm Aite Group states in a paper, Regulation Trends in 2016: Regulation and Nervous Recs, that 40 percent of the 82 firms surveyed point to compliance requirements as the biggest pressure on reconciliations. 

As a result, vendors have been looking to enhance their technology and ancillary services, whether through the use of machine learning or more simply to help banks move toward enterprise solutions and away from spreadsheets. And blockchain could be the next innovation for the back office, according to Neil Vernon, CTO of Gresham Computing.

“If you think about it, reconciliations seek to establish one version of the truth,” he says. “And with blockchain, there is just one version of the truth.”

Since the reconciliation process seeks to determine if all line items on a balance sheet match up, it makes sense to argue that it is all about figuring out the correct version of the truth for all parties. It is the ability of blockchain to put everyone on the same page that is attractive to players in the reconciliations space, including regulators. 

Blockchain would allow all parties—not just the two or three banks involved in a transaction and various regulatory bodies—to have real-time access to transactions. And when they are part of a chain, they can see first-hand all the numbers involved without having to wait for a report to come through, only to find out some line items do not match. In a blockchain, each party to a transaction or smart contract can see all related information at the same time.

“Blockchain is both scary and attractive,” says Leda Glyptis, a director at Sapient Global Markets. “It reduces some operations costs, interventions and touch points. At the same time, manual intervention can be a value-added service.” 

The idea that only one set of numbers and unique legal entity identifiers exist is also interesting and appealing. This means that each firm involved in a transaction will not have a different code that might need to be decoded or figures that need to be matched. 

Distributed-ledger technology is already being tested for many applications in the financial industry, though not necessarily for reconciliations purposes only, according to Markit’s Billingham. “Large-scale implementation is on the horizon; people are getting more comfortable with the technology and we’ll see many more initiatives before the end of the year,” he says. 

Markit undertook a proof-of-concept with distributed ledger infrastructure firm Axoni, the Depository Trust & Clearing Corp., and four different banks using blockchain to manage post-trade lifecycle events for North American credit default swaps (CDS) in April this year. The test was declared a success, and a pilot project is on the horizon before it moves on to live testing with real-time data. 

Think of the Expense

At this stage, however, distributed-ledger technologies are going to be expensive to implement and will likely require a complete overhaul of systems already in place. Changes include not only software used to manage reconciliations and other post-trade activities, but they also involve a top-down change to the way most banks trade or create contracts, essentially dismantling traditional trading practices.

Aite Group research director Virginie O’Shea says that organizations are hesitant to spend large amounts of money in non-profit-making areas, even though reconciliations is a large expense due to the sheer number of people employed to check the same information over and over. Even with the personnel necessary, there’s no evidence yet to suggest that it would be cheaper to implement a blockchain solution and remove humans altogether. 

“AIs or robotics—even blockchain applied to reconciliations—are far-fetched since it’s still cheaper for companies to hire people to do reconciliations,” O’Shea says. 

Aite and other reconciliations experts indicate that organizations are always looking to cut expenses across the back office, although they might not be comfortable implementing a blockchain-based solution. Some are even hesitant to move away from spreadsheets and into enterprise-based reconciliation services. So, drastic changes aren’t likely to happen overnight, if at all. 

Despite this hesitation to commit capital to technology supporting reconciliations, Aite’s survey notes that spending around technology for post-trade activities is picking up. According to Aite, around two-thirds of firms it surveyed anticipate technology spending on reconciliations to increase over the next two years, “which reflects the function’s increased importance at an enterprise level.” 

While this might appear good for blockchain’s ultimate goal of eliminating the need for reconciliations, it has taken many years for banks to get to the point where enterprise technology is being considered ahead of spreadsheets. Capital markets firms also feel more comfortable having groups of humans double or triple checking the veracity and accuracy of data—even though it has already passed through machines—as a way of providing a value-added service to their clients. While a number of industry players say an environment where blockchain will be prevalent is “Nirvana,” those interviewed for this article say that it will not come in the next five years. 

Limited proofs-of-concept—like the project Markit undertook with Axoni—are still about a year away from real-time testing. Operations people, those in the back office who actually do the reconciliations, are wary of blockchain and what it might mean for the jobs. Nancy Grady, senior vice president and North American regional head of fund services at Northern Trust, says that she’s still not totally sure how blockchain will play into the reconciliations space. “Nobody translates all the blockchain white papers for the back office,” she says. “We don’t really know what it means for us and how it can be fully relevant to the back office.” 

Glyptis of Sapient notes that one reason why the conversation surrounding blockchain is not yet at the forefront has much to do with the fact that most investment projections are still made quarter-on-quarter rather than years ahead, a requirement for systems like blockchain because it will need a long lead time to replace current technologies and platforms. 

Where Will Reconciliations Go?

So, if the future of reconciliations and blockchain is still too far in the future, where is the industry likely to be in the near- and medium-terms? Since reconciliations are on the rise, there might be an expansion of the software and data repository activities currently managed by various organizations. 

Data repositories—where multiple organizations drop in information on contracts and transactions—provide a means to reconcile and store larger amounts of data for a fee. Gresham’s Vernon thinks an increase in the use of data warehouses is more likely to happen rather than firms running toward distributed-ledger technologies because of the expense and complications involved in needing to rewrite systems to use the new technologies. 

“Blockchain is exciting but the real-world uses are not as many as people think. Most likely we’re going to see more data warehouses,” Vernon says, although he cautions banks to ensure that any data sent to data repositories must “have the right controls in place and integrity ahead of any move to blockchain,” and that organizations should ensure that they are marking the accuracy of the data correctly in data lakes. 

Many reconciliations vendors and experts acknowledge that there are inefficiencies in the reconciliations process, particularly because of the large number of firms still using spreadsheets. “I applaud any move that means we can remove inefficiencies in the organization and retire spreadsheets and move to enterprise solutions and ultimately blockchain,” Vernon says. 

However, it is likely to take a number of years for any new technologies to make their presence felt. So, for the foreseeable future, it’s unlikely that we’ll see back-office operations being underpinned by distributed-ledger technology and workers lounging in chairs, tapping screens, superseded by the chain. 

While the future that SciFi promises is still far off, organizations burdened by large quantities of data that need to be reported to regulators could usher it in by harnessing tools available now to increase efficiency. The value of less human intervention in reconciliations is debatable, but the value of robust, accurate data is important, and that is where the strength of reconciliations lie. 

Salient Points

• According to consultancy Aite Group, reconciliations are on the rise and spending is increasing in the space.
• Blockchain can eliminate the need for reconciliations, but it’s expensive and requires a complete overhaul of current systems.
• The technology is still too far off to eliminate reconciliations in the near future.
• Data warehouses and a move toward more enterprise solutions for reconciliations—and away from spreadsheets—is the most plausible future for the space.