The following transcript is taken from season one, episode one of The Scoop, The Block’s new podcast. Listen below and subscribe to The Scoop on Apple, Spotify, Google Play, Stitcher, or wherever you listen to podcasts. Email feedback to [email protected]. This transcript has been edited for clarity and length.
In this episode of The Scoop, Frank Chaparro and Ryan Todd interview Mike Bodson, CEO of DTCC. The Depository Trust & Clearing Corporation is a 5,000 person operation that touches every corner of Wall Street, handling 1.8 quadrillion dollars of trades every year, flipping the GDP every three days. DTCC also operates a custodial service, securing 54 trillion dollars worth of securities, mostly in electronic form. Mike discusses Wall Street’s adoption of distributed ledger technology, cryptocurrency valuations, and how Superstorm Sandy almost wiped out 35 trillion dollars.
Frank Chaparro Howdy folks this is Frank Chaparro senior correspondent at The Block. And welcome to The Scoop. Blockchain technology has long been touted as a force that would be able to disintermediate Wall Street banks and since its genesis however power players across the street have dismissed it. “Bitcoin’s a fraud. Blockchain is overhyped.” But Mike Bodson is one CEO who recognizes the power of crypto and has even said blockchain will make his firm disappear. That firm is DTCC, a 5,000 person operation that touches just about every corner of Wall Street, providing custody and clearing services. My colleague Ryan Todd and I visited bots in DTCC Jersey City headquarters. We explored what the firm, which processes over a quadrillion trades a year, does exactly, how it’s embracing blockchain technology, and for good measure we dove into some old war stories. I hope you enjoy.
We’re the back office of the back office
Frank So I’m really excited to have this conversation. I’m really excited to have Ryan Todd joining me for this conversation with the CEO of DTCC, Mike Bodson. This isn’t the first time we’ve met. What was it two three weeks ago?
Mike Bodson Three weeks ago.
Frank FIA Boca. Ryan was asking me about Boca on the car ride over. We’re in Jersey City by the way.
Mike Beautiful Jersey City.
Frank Beautiful Jersey City we made the venture over here from New York. Yeah it was at the wine event.
Mike We had a little cocktail reception for our clients and friends.
Frank And I snuck in right. Technically I don’t even know if I was invited. They just saw me there.
Mike Yeah I think we just saw you walking there and grabbed you and said come on in.
Mike We gave you the cheap wine though.
Frank The Shiraz.
Mike The Shiraz, the bad Shiraz.
Frank So let’s start. I guess the best place to start is what is DTCC? So many people they recognize big financial players whether it’s an investment bank like Goldman Sachs which is not too far downtown or you know a brokerage firm. You know you think the Instinets of the world but behind the scenes of everything is your company, 5,000 people. It’s really the pipes and plumbing of Wall Street.
Mike We are the plumbers of Wall Street.
Frank Exactly clearing, custody, settlement don’t forget settlement.
Mike Don’t forget settlement, it’s very important.
Frank So how do you explain it to you know if you have your 14 year old nephew come up to you and say…
Mike There is no explanation.
Frank Uncle Mike, explain this to me. This makes no sense. What’s a post trade?
Mike What’s a post trade? So we’re probably the most important financial company that very few people know about. And we are the sole providers of the services: clearings, settlement, custody for the US cash securities markets, so stocks, bonds, mutual bonds, treasuries, mortgage backs, across the whole world. And the way the markets work is you know even though you may buy a security today for instance with the stock you’re not going to actually pay for it for three days. So in that timespan there is risk and we help manage that risk. So on a normal day we’ll do about 100 million transactions will flow through us. We get them from about 50 different trading venues, so the stock exchanges as well as individual firms and various other markets that are out there. We take those hundred million trades and we net them down to 3 million. So somebody like Goldman Sachs, you mentioned, will be trading in and out of Apple all day long. So instead of doing every trade individually and saying “I’ve got to pay Morgan Stanley for this; I got to receive stock from Citibank” or whatever. What we do is net them all down and say look Goldman at the end of the day you bought 10,000 shares with this price. So this creates incredible efficiencies for the marketplace. The risk part is when you have a Lehman Brothers or you have, we were talking about Knight Capital before, all those trades that had not settled they’re in essence, they’re creating credit exposure for the street. So instead of them having to go against individual firms we step in, we become the central counterparty. So we liquidate all those trades to make sure the markets keep functioning and minimize any credit losses we’ve had over 40 failures of firms in our history and never once that we have to tap the rest of Wall Street to make up for those losses. So we’re just basically the back office of the back office, so to speak. So it sounds mundane but on a yearly basis we do about 1.8 quadrillion dollars of processing. So we flip the GDP every three days or so. We control 53 trillion dollars worth of securities which are in a vault — most of which are in electronic form. Some are still actually in paper form. But that’s what we do amongst other businesses.
Frank No I mean it’s incredibly interesting and I knew when I saw you down there in Boca I had to come up to you and shill the podcast because I thought you’d be the perfect guest just because it is this massive Wall Street firm and a lot of what you guys touch can be automated can be improved or replaced by blockchain technology. And I remember it was I think it was you guys had a conference in New York, 2018, your fintech symposium and you’re on stage and you said something to the effect of: we want to disrupt ourselves before something else or someone else.
Mike I said if anybody is going to disintermediate us it’s gonna be us. And I think that’s the way you kind of have to go into it, you know the interesting part you said about blockchain. This company’s been around 45 years and it’s owned by the industry by the way, we’re co-operative in essence that’s owned by all the brokers and banks and whatnot that use our services. But when you think about, way back 45 years ago it was all paper based and they would have to stop trading some days you know on Saturdays afternoons and Wednesday afternoon. I think it was.
I mean it was just so much paper that couldn’t keep up with it. So when you think about a bold move somebody 45 years ago decided let’s take all this paper stick it in a vault and put it all on computers and you know that’s it was called “dematerialization” and created massive efficiencies and now the U.S. markets are the most efficient markets in the world because it led the way in that. But think about the risk, can you see going to somebody and saying I’m gonna put it on something called computer tape. People are going to go well what happens if you lose that tape, right?
Frank It’s a single point of failure.
Mike We are a single point of failure. But you know it’s the old thing you put all your eggs in one basket watch that basket. That’s what we do. We watch our basket very closely.
Frank An interesting quote that you had I think it was in WatersTechnology where you say “We are going to disappear” or at least aspects of your business are going to disappear. In terms of being this the words exactly that you used were “a golden copy of trade records.”
Mike I mean the way we work today we are the golden copy, we stand as the central database for all record keeping for the cash security markets in the United States. The point I was trying to make with that comment is given the advent of distributed ledger giving the advent of cloud, A.I., everything else the world as we see it today is not going to be the world in five years, ten years, fifteen years. I think it’s going to be closer to ten to fifteen because legacy technologies are hard to just completely turn off. But what we do in 15 years, I can’t even imagine what it’s going to be like because there’s so much going on at the same time and it’s not just a particular technology to me it is the confluence of all the technologies they’re just going to change the financial markets tremendously. So we can sit back and be dinosaurs and get rolled over and become extinct or we can start reimagining what the future looks like and act not only as the person who provides these services whatever they may be in the future but the bridge from today to tomorrow. Again when I throw out those numbers, that’s a lot of processing that’s going on right now to say we’re automatically going to switch to a distributed ledger technology in the next two years. It’s not going to happen. But how do you migrate from today to tomorrow? How do you go from paper securities which we still as I said have two trillion dollars worth to tokenized securities and what is a smart contract versus the way the paper contracts work in essence of today? How do you do that whole migration? And that’s I think is as critical a role to play in the next five, ten years as reinventing what the future looks like.
We are going to disappear.
Frank When do you think it’s going to happen? I mean like we said at the beginning of the conversation you guys touch settlement, clearing, trading. Where is distributed ledger technology, blockchain technology going to have the biggest impact at this firm and how are you guys preparing for it?
Mike The way Wall Street created its post trade infrastructure and post trade just means that once a trade is executed you have the whole process of clearing and settlement. The change of ownership the record keeping has to go on, it’s a series of databases. We have a big golden copy but every firm has a database to have a trading database. They have an operations database they have a credit database so you have all these reconciliations that are happening all over the place with the same basic information used for different purposes. And there’s no one centralized, agreed upon view of what that data says or what those transactions are what the positions are, etc etc. If you could actually just have one. Just think about the amount of work you could take out and how much you instead of doing replication of work over and over and over again. We just create massive efficiencies. So that’s where I kind of see it going, now you know where we have one major project on the way which is called a trade information warehouse which is another product which is a credit default swaps CDS over-the-counter product.
Frank Sounds a lot like from your world Ryan. Banking, Wall Street World?
Ryan Todd This is way over my head, way above my pay grade.
Mike It is it is a product that created a lot of problems in 2008. AIG, for instance, was brought down by their positions and nobody knew what was out there. So we you know we had this database of these contracts and they are contracts versus securities and we were able to give insights to the industry about what the positions were and specifically Lehman Brothers. There was talks about there were going to be 50 billion, 100 billion, 400 billion dollars worth of payments against Lehman OTC and we knew in reality because we had this database it was 6 billion dollars. So we announced that look we’ve got most of them. We know exactly what’s going on. Stop panicking it’s only six billion dollars worth of payments. So we have this trade information warehouse. It is a database. And with the DLT becoming more realistic in terms of an application we are now in the process of rewriting the trade information warehouse into distributed ledger using smart contracts using cloud and migrating off a traditional database into DLT and that’s actually a very good usage. I think a lot of times when you see new technologies coming out everyone is looking “this a great new technology let’s apply it everywhere.” Life doesn’t work that way right if you force a solution to a question that doesn’t have to be answered you’re just going to waste your time. This actually was a very aligned need and solution set so we’re hoping to launch either later on this year. Hopefully by the end of this year. Right now though a lot of the people who are involved in this are involved with Brexit so their attention is not focused on the conversion. The work has gone very well so far and we hope to you know probably the biggest piece of infrastructure in the financial markets once it gets launched on DLT. A lot is left to be learned. I mean it’s a new programming language you know? How do smart contracts work? How does governance work? Everyone talks about DLT, but who controls the nodes, right? Who has the ability, you’re not gonna have permissionless systems in the financial markets. We can debate that.
Frank That’s a hot take.
Mike I will tell you I just you know in my view somebody thinking that there is no control of who goes in and out of a financial system, what’s done in that financial system. I think that’s pollyannaish. I think there has to be a central control doesn’t mean you’re trying to exclude innovation or exclude members but you want to know who’s in and who’s out. I mean that’s just in my in my world common sense.
Frank Templum which is you know security token whose platform they’re building their platform on a permissioned network because they’re worried about some of these issues of security. You know if this thing forks, what happens?
Mike If you have forks, if you have some sort of error, who is the arbiter and who decides what to do? Who decides what smart contracts go on? And if you modify a smart contract, who is in essence the quality control? All those things are the roles we play right now. It’ll change how we do that. But somebody has to play that role in the financial markets.
Frank There’s a few players that are kind of trying to move over there Hashgraph is looking to roll out a public blockchain for enterprise use, like Nomura is on their global council and they’re trying to build a public block chain that can be used for enterprises. So is Orbs which raised 118 million dollars to do so.
Mike I think there are definitely applications for public blockchain.
Frank In data, just not in finance?
Mike But I think in finance given you know, the old, who is it the the famous bank robber said “Why go to the banks, that’s where the money is?”. I mean why do you go after the financial system, that’s where the money is. So if you don’t have safeguards nobody is going to the trust the systems nobody is going to use the system. So you have to be able to know: Who are you working with? As well where are these securities, whatever form they may take? How do I know I’m going to get paid? How do I know there’s not fraud involved?
Frank What do you think?
I like Banana Coin better than Dentacoin.
Ryan Yeah this is a theme I like to think about a lot and it’s something interesting that I’d like to hear your opinion on. How do you sift through just the PR, quite frankly, B.S. promotions that you see across all these different enterprise solutions? Frank has mentioned a couple others, not saying those are legitimate or not, but this is a consideration or not?
Frank There goes my inbox, thank you.
Mike No, look there are obviously a lot of opportunities and solutions that are out there, a lot of very bright people working in this space.
Frank And a lot of not so bright people.
Mike And a lot not so bright.
Mike I mean I’m not going to get into it. I know nothing about bitcoin. But when Bitcoin was at 18,000 and you looked at who was you know on being interviewed on CNBC.
Frank You called it. In December 2017, you said… I don’t know if it was on TV or in an interview, that you said: “watch out for the hype folks.”
Ryan Singapore CNBC?
Frank No I don’t think it was in Singapore.
Mike But yeah, look, it was hype. You know, I can’t understand what the valuation process is.
Frank You called the market top.
Mike Yeah that was the first and only time and trust me I didn’t short it. So if I had done the right thing I wouldn’t be here right now. But you know we have a team that looks through all the various technologies from both the technology viewpoint as well as market structure viewpoint. You know we’re not a firm that has the luxury of being able to make a bunch of small bets. I mean, I both envy and feel a bit sorry for the some of these firms who are investing into 20 different platforms as they try to figure out both which ones work and then how do they get to interoperate. I mean I had one lunch with one representative of a big bank and he was like “Look I just want one set of nodes I want to have one language and I don’t want to have multiple platforms.” And then he spent 15 minutes talking about you know these five million dollar bets he had done all over the place and I’m like well how do you reconcile those two views? And they’re like “well we don’t know which one’s going to win so we’re going to bet on a whole bunch of them.” And we’re like that’s really not a winning strategy in my book. You’re going to have about 12 that are going to sort of win but none of them are going to really win.
Frank That’s the thing that I think about like crypto, the crypto community, crypto Twitter, they kind of think that folks like Mike and, you know, I don’t know what bank CEO you’re talking about…
Mike I won’t say either.
Frank But he’s clearly talking about nodes, and he has an understanding of this technology, and it speaks the point that Wall Street is definitely paying attention to this market. Right? And even folks like Jamie Dimon who went out and for years going out and saying that Bitcoin is fraud, et cetera. He knows what’s going on. Like all these guys…
Mike Did you read Adam Ludwin’s letter to Jamie?
Frank No what is that?
Ryan Couple of years ago now, right?
Mike It came out a couple years ago it was I actually was down it was at the IAF where Jamie was being interviewed and he kind of went on his famous diatribe against Bitcoin. And Adam Ludwin heard about it and he was, I forget, he was some place here and the story he told me was that his plane got delayed. He was going back to San Francisco and he ended up like six hours at the airport then six hours in the plane, bored silly, and he had seen snippets of this. So he wrote a letter to Jamie Dimon, explaining Bitcoin in the basis of bitcoin et cetera, et cetera. It’s very very well-written, but it was kind of funny that at the end of the day, I think I saw him in Davos the next year, and he was like, you wouldn’t believe who I got a meeting with, I’m meeting Jamie later on. So you know, Jamie knows this stuff. He may have different views.
Frank You said you don’t know anything about Bitcoin which I don’t believe, you definitely know something. How were you first introduced to it and you know where do you sit in terms of your opinion on it as whether it’s a store value or something else?
Mike Well, look I mean if you’re in financial markets between Bitcoin, blockchain, DLT, et cetera, et cetera, what two, three years ago you couldn’t open a newspaper without getting like smacked in the face. I mean, when we announced the TIW project and other things we were doing in this space, it was like, you know, “Wall Street…,” I forget the exact headline, it’s actually in my office, its about like, “Wall Street Stepping Into the Bitcoin Space,” like we weren’t allowed. How dare you Philistines all coming into this, you know, leading edge. Look again, with Bitcoin, the concept of a stored value makes sense. I mean, having a native currency makes a lot of sense. But I think there still has to be… what I still can’t wrap my head around is the basic price formation. Why is 5,000 right versus 18,000 versus 50 dollars? Nobody’s been able to explain that other than scarcity, that there is a limited number of bitcoins that are gonna be out there or you know any other cryptocurrency. But when you hear about, you know, airdrops of, you know, under a hundred twenty-five million dollars equivalence of some coins, you sit down and you go, “you just created that number out of thin air.” And to me, that just devalues all cryptocurrencies because people are going sit there and say, “well how does that happen? You don’t just create currency and say this is what it’s worth. There’s gotta be a conversion.” So we’re, you know, we looked at various aspects of cryptocurrency in terms of, is there a custody role we’re playing. Obviously, there’s a lot of banks who are looking at that space. I think there is an interest of, obviously, in cryptocurrencies as an investable asset. But there has to be safeguards. Again there has to be, you know, people looking for custody and they’re looking for regulatory certainty. You know, being a regulated fund, you just can’t say, “well today I’m going to play in Bitcoin with my clients money and I hope I do well.”
Frank Well you have some background in thinking about what those types of funds might be thinking because of your role at Morgan Stanley right? You were head of…
Mike I was Head of Ops and that was a long time ago. I left there in 2006. I was a much younger man. That was a mere 13 years ago so crypto was not even on the… anywhere in the agenda.
Frank But you can sort of think, you know, if you were in that seat today and folks, you know, young folks coming to you and saying, “hey we need to start investing in this or investing in this for our clients.” What would be the impediments that you would identify to shut that kid up?
Mike You never shut them up they’re usually brighter, a lot brighter than you are. No look, As I said we have a group that looks at this and you have to cut through the hype and try to say is there a real value proposition that makes sense. And I think, unfortunately, you get the cryptocurrencies, blockchain, tokenized assets, native assets versus just simply tokenizing existing assets, all of the sudden becomes a big mush and nobody quite knows what the heck you’re talking about. Right. So I think you’ve got to start breaking it down and say okay, DLT as a technology. Yeah I think everybody understands the benefits and what it can create for the industry. So the point is how do you use it? How do you migrate it? How do you not kill it? I mean I think it’s the Gartner called it that right now we’re in the “trough of despair” or the “trough of disillusionment.” Because it hasn’t saved the world yet. Right. And it’s that we look at and say it’s a kid. You know if you think about your kid.
Frank It hasn’t got me any dates.
Mike I’m an accountant. You should’ve seen all the girls flocking after me after college right? I’m the CPA, oof. So that I think is just the evolution. It’s a fairly new technology in the lifetime of a technology when you think about it. We still got COBOL right. And I ask somebody about where would you go to get off COBOL? And somebody said Java. And I said well COBOL is 40 years old and Java is 30 years old. That seems like not exactly leading-edge thinking here. In terms of tokenized assets that’s just again almost tied back to the evolution of the financial markets and making things much more efficient. You know and I’m careful to say, look ICOs, there are some legitimate ICOs and obviously if you look at what happened in that space, when I heard about Banana coins and Dentacoin you had to wonder whether sanity, I should have called that market top too. I would have been you know rich again.
Frank Short Dentacoin.
Mike I love that call. I love Banana coin actually better. But anyway. But then you get into, this is an investable asset class and what are the characteristics that will allow people to invest in it? And again it is a regulatory construct, it’s legal constructs. You have to know when you’d buy it? how does it settle you? are you… there’s finality. I was at an SEC hearing, Adam was at that one also. And somebody who, unfortunately, was being rather obnoxious. But he was asking a legitimate question: “if you have a problem with a bitcoin settlement, who do you sue? Who’s the contract with?” Right? And nobody really could answer the question. And if you look at some of the frauds that have occurred, who do you turn to, when, you know, that the Canadian fraud where he supposedly died and the laptop sits there untapped. I mean who’s there to protect? We just put out a white paper about you know what would it take for crypto assets to be acceptable and these are just basic fundamental building blocks of any financial markets that you can’t walk away. It’s not to impede progress but nothing’s gonna impede progress more than a whole series of frauds. Right? If a bunch of people get burnt in a hyped up asset class be it a cryptocurrency or ICOs or anything else. You know first it’ll be, “well SEC you know don’t impose your will on these marketplaces because you’re impeding innovation.” And then when the fraud happens you’ll be, “well SEC where the hell were you? Why didn’t you protect the investor?” Right? so you’ve got to kind of walk your way through that whole process and say what are the characteristics we need to have in place?
Frank We put out research I think recently Larry Cermak, our Head Analyst, on just the sheer amount of exchange hacks I think were over 1.3 billion dollars since Mt. Gox or before that even. I mean I know JPMorgan and maybe it was a year ago I think put out research that showed one third of all these venues have been hacked. Is that the biggest problem?
Mike Yeah look it’s losing faith in something that could have value. Be it blockchain or be it ICOs or be it cryptocurrencies at the end of the day you have to trust that when you put your money in it you’re going to get your money out. Look we create trust. All we do…
Frank That’s the business you’re in.
Mike We’re in the business, we know you know…
Frank But bitcoins in the business of replacing trust systems.
Mike Because you don’t trust the system. I think people want a system they can trust. I’ll turn it on its head right. You want to know you’re not, you know the old poker adage if you’re sitting at a table and you can’t figure out who the sucker is. You just did. Right? So you know I think if people feel like the game is gonna be rigged against them they’re not going to go into the asset class. But if they feel like there is transparency, there is control, yeah they’ll go in. This is sounding really geeky, but it is just…
We spend 700 million dollars a year on tech.
Ryan I want to walk back to a comment you made earlier just on real value-added application you’re seeing right now at DTCC is TIW. So in your view what are the potential post trade, immediate, and long term cost savings? How would you size that when you speak and meet with other investors other executives… in your opinion?
Mike We just saw a study by McKinsey. They’re doing work for us and talked about the global capital markets are about 600 billion dollars in revenues cost and they’re coming under tremendous fee pressures because there’s push back on the asset managers for the fees they pay. Are you really getting performance for the fees? You’re seeing this whole shift to ETF’s and you know basically non-managed money which is driving… which is done cheaper, so is driving the fees down for the asset managers. They are the ones who pay Wall Street our fees are coming down. If you look, they estimated, McKinsey, that if you looked at that 600 billion dollars if you look at ops and tech combined it would be about a 120 billion of it, so 20 percent of it, that’s on a global basis. U.S. markets let’s say it’s about 65 billion dollars for equity markets. Their belief is that within five to seven years, I think, that’s 65 is going to go down to 48 billion dollars. So you’ve got this massive pressure on costs. Right. And all the Wall Street firms have done the same things over the last few years, you know. They’ve all tried to modernize but we all sit off old legacy technology. You’ve outsourced, you’ve sent things overseas. You’ve done all sorts of things to try to drive that cost base down but at the same time you’ve got the pressure of compliance and regulation, which is making your costs go back up and now you’ve got the arms race with cyber. Right? We spend more and more and more, cyber is the biggest risk.
Frank How much do you spend on tech overall?
Mike My entire budget for expenses is about a 1.4 billion dollars, and a little above that. And tech is literally 50 percent. So it’s 700 million dollars is tech, you know, 700 plus.
Ryan So would you say a majority of that is cybersecurity?
Mike No a majority of that actually is just running the place. But cyber it’s hard to say…
Ryan Protect investment…
Mike It’s hard to say cause everything we do is designed for resilience and protection right. So if I’m putting in a new network is that cyber or is that just putting it in a new network? And the answer is yes, it’s, you know, you’re designing everything you do… you know everything we do going forward as we redesign, we use blockchain or we look at cloud, we look at A.I., a big piece of it is resilience. How do you protect yourself against cyber? So I think you know where’s the savings going to be? I mean you’ve got that bucket of costs I just talked about, and you know the nirvana is the 50 billion piece, let’s say which is the operations piece probably a little bit overstated but you want to drive that down. Will it make your tech costs go down? I’m not sure. I mean I think tech was gonna be forever going up in one way or another. It was just morphing itself into different parts. It used to be traders. Now you got algorithms. So it’s just the replacement of human beings by technologies is a pattern of history that’s been going on now for 80 years plus it’s not going to suddenly stop.
Ryan And we talk about cost savings, have you seen any value capture on potential new revenue opportunities?
Mike Well I think it’s revenue substitution, right? As I said I think you’re you’re seeing this fee pressure go down. But if somebody comes up with a better mousetrap, a better way of trading, obviously money will go to those who are successful. So I think that’s really the game that can be played. I just think look the financial market is growing up. I mean it’s terrible for me to say this, given I’ve grown up in it, as much as we focus on efficiencies, we’ve always been very silo driven. We’ve always been very product driven, very fragmented in each firm. You know, we and the other firms like ourselves in the financial markets create massive efficiencies but we only go so far. I mean in that realm of what I showed you about 65 billion dollars for the equity capital markets in the U.S. I’m about a billion dollars of it. From my estimation, I should be much bigger because if I’m getting bigger that means I’m taking all the cost out of the rest of the street and that’s the strategy we try to pursue. But we’re relatively a small piece. The rest is just again very fragmented, very customized, very specialized. And what blockchain or you know cloud to a certain extent looks to do is to just take out all those pockets of costs that set across the entire financial markets. It’s hard it’s really hard. I mean you know, as I said, I’m the proud owner I say of 55 million lines of COBOL. We’re in the process of replacing that. You know don’t laugh at COBOL. COBOL is very you know, it’s resilient. It works. We train a lot of kids on COBOL, but we obviously are kind of nearing an end of life situation here that we have to get our heads around. But you know, I have to replace it with a technology and transition to that new technology as well as the rest of the street because everybody else is sitting there on COBOL too. I felt good because one of the big banks was still sitting on Fortran and I was like, I don’t know why but that makes me feel better. Do your listeners know what Fortran is or is this an inside joke?
Ryan I think they might.
You’re about to have a really bad day.
Frank I think they might. You’ve had a long-ish career… I don’t want to insult my guests, and Ryan and I were talking last night about some of the stories that we were thinking about having you share, your first day was an exciting first day for a CEO.
Mike My first day was the collapse of Knight Capital and you know great guys. I mean…
Frank It was a high-frequency trading firm…
Mike It was a high-frequency trading… Well actually we were market makers. So there are people who gather up trades from… let’s say the retail side of the industry and then trade them against the street and make a small spread. They don’t take big positions or anything. But on August 1st of 2012, they were turning on a new order management system. And unfortunately it, unbeknownst to them, triggered another piece of rogue code that had been sitting out there and they basically were the counterpart to every trade.
Frank So that’s the order management system that’s like what they engage with…
Mike Yeah. That’s what they engage with the outside world with in terms of you know buying and selling securities. And they are putting in this new application to trade on the New York Stock Exchange and unfortunately, this rogue piece of code meant they were basically the counterpart to every single trade done on the New York Stock Exchange for the first 15 minutes. So they’ve accumulated a massive position, and this has been written up. They weren’t aware of what was going on and ironically it was the floor traders on the floor of the stock exchange who spotted it and said this is strange why is Knight on every side of the transaction. Called them up and eventually they pulled the plug on it. But by the time they were through they had created about an eight billion dollar gross position which is way beyond what they normally would do. And you know they just didn’t have the capital to be able to take on that sort of position. So technically they were in default at that point. Other firms stepped in and ended up buying the position from them and liquidating the position. But again as I said at the beginning, being the central counterparty if they failed, in that instance, we would have to book that position on their behalf. Any losses to protect ourselves we have something called margin which is almost like a down payment. Because they’re market makers they didn’t have a large amount of margin. So if they had losses we would have had to mutualize it we give it back to the street based on a formula. But we worked with them, we worked with the counter parties, we worked with the regulators, and we helped them basically survive the week and over the weekend they were bought by a firm called Getco and then Getco was eventually bought by Virtu. Getco came in…
Frank first by KCG, and KCG was bought by…
Frank So what was the phone call like?
Mike Well they just called up and said, “you’re about to have a really bad day.” And they were absolutely right. But you know what? This is interesting about this firm, we have to deal with crises.
Frank No CEO orientation? Just straight into the shock…
Mike Well I had been around for five years, so I had a little bit of foreknowledge but no I had a great team. What you learn is, as a CEO, you step back and you let your experts handle the situation and you just try to keep everybody focused and calm. You know what you’re saying about the younger people, I’ve always said that probably the most junior person in the room is going to be the one that has the right answer. So make sure they’re able to speak up and talk and we’ll work our way through it. So we worked with the regulators, we worked with the firm, and as I said the people I had were fantastic and working with them. I mean one of the nicest things that ever happened to me is about two months after Knight happened, one of their heads of operations sent me a box full of Knight baseball hats and T-shirts and all sorts of stuff. And he basically said 170 people, 170 families owe their livelihood to you. And I thought that was really touching. It was like one of those things where you don’t really get thanked a lot for doing the right job and that meant more than somebody else giving me a pat on the back, as that we help people, you know, get through this and not become bankrupt overnight. So that was kind of cool.
Frank The firm would have went out of business?
Mike We could have technically, we could have put them out of business the first day. But again we knew the activity they had we knew what was going on with another firm and we reached a conclusion working with the regulators, working with our board, not to get too mundane but they made the decision that the best thing to do was to help them get through the rest of the week, get to the weekend, with the thought that it was a good company, it had, you know, franchise value…
Frank And that’s kind of like why you guys exist right? To protect the market…
Mike Yeah. We protect the markets. I mean again in the Lehman Brothers we had hundreds of billions of dollars of open positions to liquidate. If you simply dumped it onto the marketplace you’d crush the market. So our role is how do you deal with liquidation or bankruptcy like Lehman but not upset the U.S. cash security markets? In that case again we did very effectively. We actually when we sold all the positions, we used an outside adviser who had expertise that we don’t have. But we actually ended up making a small net profit that we gave back to the company in the end.
Paper stuck to the ceiling, paper stuck to the walls.
Frank Do you think that was the most dramatic moment of your time as CEO or?
Mike Knight Capital? I know the question you could have come up with.
Ryan I admittedly did not know the impact of this story prior to researching more about this but we have to hear about on the ground Sandy, Superstorm Sandy.
Frank Yeah, so the vaults.
Mike The vaults, the vaults. My favorite YouTube video of all time I think was somebody actually said we had the secrets of the 2008 financial collapse in our vaults and that’s why we flooded the building which… We’re good but we’re not that good. We didn’t create Superstorm Sandy.
Frank That sounds something like bitcoin Twitter controversy or conspiracy.
Mike Yeah it is a beautiful thing. Yeah unfortunately when Superstorm Sandy hit. We did, we were at 55 Water Street. Somebody in our company loved to have our buildings on the water we’re on the water here in Jersey City and our backup site in Brooklyn is on the water. But basically the equivalent of five stories on the ground we had a massive vault and had about a million and a half pieces of paper, securities, most of which were not negotiable but they were paper forms, worth about two trillion dollars. And if you think about putting the New York Times Sunday edition in a washing machine and watching it spin around for a while that’s what it did in a massive room. So the water came down, punched a hole through a wall, probably eight feet by six feet and flooded the vault. Took us about three weeks to get the water out but same thing happened, when you pump the water out you’re creating another cycle, spin cycle. So we walked into this room, no power, smelled like oil cause the oil drums for the canisters for the generator were on the ground. It was cold and there was paper stuck to the ceiling, paper stuck to the walls…
Frank These are securities…
Mike These are securities so I won’t go into excruciating detail, but we had to get special firms in and armed guards.
Ryan I saw men in hazardous material suits were down there.
Frank Did you have like a hazmat…?
Mike Didn’t have the helmet on. But you literally were wrapped up in a paper hazmat. Somebody asked me how do you dry them out? I said you get about 30 miles of clothesline and about 2 million clothespins and you stick them out. That’s it.
Frank That’s not what you did though? Is that like proprietary secrets? how you dried these things off?
Ryan No, they froze them apparently.
Mike There you go. You were listening. Yeah we actually had to freeze them and nobody picked us up in the press, which was funny.
Frank Well what about the ink though? Was the ink messed up?
Mike No, this is high-quality printing.
Mike This isn’t ballpoint pen on a scratch pad. This was good stuff. But yeah a long story short we had refrigerator trucks outside which nobody asked “why are there refrigerators trucks all over Water Street with men with large guns?” Freeze the paper, had to drive them down to a plant down in Dallas, Texas. Actually brought them to our building, then to a plant, freeze dried the water out of it and then because it was full of water from the river it was all gunky. We had to send it to a radiation plant, the radiation plant zapped them with gamma rays or something, actually killed everything. And then you had to repackage them bring them back by truck. You didn’t want to fly them in case the plane crashed then you knew you were out of luck but drive them back up and then down on the first floor here, we had like a zero like one of those rooms where the vacuum was pulling everything out and people sat there in hazmat suits, you had to tape your wrist and your ankles and everything.
Frank Why would you need hazmat suits?
Mike Well it’s not really hazmat. It’s just a paper covering you know.
Frank Ryan is feeding me fake news.
Mike It was like an overall it was like a coverall, you know, very very fashionable. But you know everything taped so you couldn’t stick the certificates back inside.
Frank Oh that’s right.
Mike I mean we had watchers and watchers of the watchers and people with cameras on their heads and stuff. And you had to scrape all the gunk off of it and then we re-inventoried and out of a million, I don’t know, three million, five millaion pieces of paper we lost all of about 300. That was it. It was incredible.
Frank What would the value of that have been?
Mike If we lost a whole billion?
Frank No just out of those 300.
Mike 300 was nothing actually, we either got substitutes or we’ve got identifications and stuff like that. We did have something called computer records, which really helped in the end. So yeah we were you know, technically if it was a bearer bond somebody could have presented it we would have been at a loss but we never had that problem. It was an incredible effort. I mean, the vault looked like an old big bank vault. The thing that was amazing was that we had these steel doors let’s say about seven feet, you know circular and the water completely, these were stainless steel doors, the water completely pitted the steel doors. When we got the locksmith to help us open up the doors he said “don’t ever close these again you’ll never get them open again.” So then we had to have guards literally standing outside the vault with guns because you couldn’t close the vault door. If there was ever somebody that said don’t tell the story because everybody will say well there’s a reason to go electronic. I’m like “yea there’s a reason to go electronic, paper is not really safe.”
Ryan I’d imagine if Superstorm Sandy happened in 2017 you’d see that the headlines roll out that blockchain could have prevented all of this.
Frank Oh yeah. The blockchain community would have had a field day. But you guys have made a lot of progress.
Mike Well that’s two trillion. That 54 that’s out of 54 trillion. Right. Almost, you know, the vast majority of what we have is in electronic form. It’s just there’s vestiges there. Small companies that still issue paper stock. There’s some old certificates there. Sometimes you get a one certificate that represents everything. But we’re moving, there’s very little common stock that is in paper form anymore. Probably Walt Disney shares because everybody likes to give their kids current Walt Disney shares but even they stopped issuing stock quite a few years ago. So yeah blockchain would have avoided this whole problem. Therefore the reason, right? You don’t have to worry I mean one of the big things with cyber right, is the destruction of data and who’s got the golden copy? How do you replicate it and Everything else. So one of the things we’re obviously looking at is if you put your data on blockchain and everybody’s got access to it, if somebody gets hacked it doesn’t matter if it’s me or somebody else and I can replay it then the system’s a hell of a lot safer.
Is technology good or bad?
Ryan I guess a question I have on that front. We’ve talked about Knight. We’ve talked about Sandy contingencies. So how would DTCC or institutional custodian running a hypothetical distributed ledger for post-trade services, how would they handle a situation like Sandy? That’s just a massive question.
Mike You know what I’m gonna say blithely, once you get to that point because it is a distributed ledger you’re no longer worried about the one and only, you know, caretaker custodian disappearing. I mean the information is gonna be spread out everywhere else. So that’s why I say when I think about the role we’re gonna play in the future, we’re not going to be that central database per se, we’re not going to be the central custodian. But we’ll be the caretakers over that distributed ledger. We’ll be the ones that again, work with smart contracts, the nodes allow people in and out et cetera et cetera. But the concept of having a central record keeper, that disappears, that’s no longer needed.
Frank And so how many of there are you at that point?
Mike As individuals or as a firm?
Frank Folks working at the firm.
Mike Well right now we’re 45 hundred people. Look, is technology good or bad? You tell me, people will have to learn new skills, people will change into something else. I mean that happens all the time. Ginni Rometty from IBM was on CNBC today, I’m doing a lot of plugs for CNBC somehow. But she was talking about A.I. is going to change everybody’s job but it’s just going to create new jobs. Right? You have to believe in the positive impact of technology. But you know if we’re going to be philistines and stick our heads in the sand and say please you know I don’t want to worry about the changes, we’ll get rolled over.
Ryan Kind of want to shift gears to custody for crypto.
Frank Custody for crypto? Or just custody in general…
Ryan Correct, we haven’t talked about STO’s either, security token offering…
Mike Yeah look I mean security tokens are coming. They exist, obviously there’s a few firms that are out there talking about…
Frank To be sure DTCC is not custodian-ing any cryptocurrency, they’re thinking about it…
Mike Yeah well we’re definitely thinking about it. We are actively thinking about it and determining again, for both, it’s the right thing to do for the marketplace. I wouldn’t say we’re totally altruistic but we do believe we have a role to play to protect the marketplace which is not impeding progress and utilizing whatever technology is best. So I mean yes securitized tokens are going to be out there. But as I said before, the SEC literally just came out with a paper this morning I haven’t had a chance to read it about ICOs and STOs. And it is going to have a structure around it and we’re going to figure out our role to play in there. And it’s not going to happen in five years we’re gonna be looking at it, we’re looking at it right now because you can see the groundswell that people are interested in the process and we think it’s a role we want to play. The last thing we want to see happen is fragmentation of the marketplace. I mean I if I wanted to be a jerk, I can sit here and go look let’s have all these different blockchains of cash securities all over the industry all different platforms. And I’ll sit in the middle and I’ll be the translator between all of them and I’ll just take a toll and basically feed off the inefficiencies in the friction. That’s not the way we think, we really think about what’s the best thing for the financial markets. At the end of the day, people lose sight that you want to drive down the cost for the retail investor. You think about pool money in the U.S., that sounds like I’m on my soapbox but so much of the pool money is pension funds, mutual funds, insurance, et cetera, et cetera. That’s the little guy on the street. So people are very focused on if you drive down the cost you drive the friction out of the system, that means a return to the guy in the street is that much better. And so that we take that role seriously. If we can help that happen so much the better for everybody.
Frank Well that’s great. I think that’s a good place to end. It was a great conversation. So excited.
Mike Thank you, thanks for coming all the way to beautiful Jersey City.
Frank Oh it’s our pleasure.
Mike You owe me a glass of Shiraz.
Frank I do. I do. I’m sure I can find one I only drink red wine really.
Mike There you go. Thank you very much. Appreciate it.
Frank Thank you very much.
Ryan Thanks Michael.
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