The Global Financial Markets Association (GFMA) published a report that evaluates the opportunities and risks of distributed ledger technologies (DLT) and DLT-based securities. It also assesses the applicability of existing legal, regulatory, and risk management frameworks.
GFMA estimates operating cost efficiencies of between $15-20 billion in annual global infrastructure operational cost savings, driven by smart contract-driven process automation in areas such as settlement and corporate action administration. The opportunities for savings are particularly concentrated in fixed income and private market assets.
Meanwhile, on freed collateral and other balance sheet efficiencies, the report noted that at the end of 2022, there was an estimated $19 trillion worth of addressable global collateral outstanding across repos, OTC derivatives, and securities lending. This opportunity could therefore range well beyond $100+ billion annually in freed financial resources that could be redeployed to generate incremental returns.
To illustrate the potential of DLT in capital markets, the report examines three emerging use cases: collateral management; tokenization of assets; and sovereign and quasi-sovereign bonds.
On central bank digital currencies
Wholesale CBDC (wCBDC) is the closest proxy to central bank reserves in a DLT-based ecosystem, representing a form of settlement free of credit and default risk, and limited to wholesale market participants who have central bank account access.
GFMA noted that policymakers should seek to ensure opportunities for regulatory arbitrage are minimized and the role of banks in providing credit to the economy is not undermined. For example, the risk of deposit disintermediation – from a CBDC that could be made available to the general population (i.e., a retail CBDC) – could significantly impact bank funding costs and drive either higher borrowing costs for customers or reduce credit provision in the market should banks reduce lending activity. Though many are under research and development, no fully launched wCBDCs exist today.
“Policymakers…should limit CBDCs to special purpose wholesale CBDC limited to banks who have pre-existing access to the FRB’s [Federal Reserve Board’s] payment systems and should subject all market participants to the same prudential standards,” according to the report.
Collateral management
The report noted that delivery versus delivery (DvD) settlement is a type of settlement mechanic gaining unique prominence with the rise of DLT, that consists of swapping one security (or basket of securities) directly for another security (or basket of securities), with no involvement of cash or the traditional custody chain. SS0 (books and record use case) is a predominant model of implementation for this settlement mechanic.
Participants can swap assets in collateral management/repo transactions on a DLT, settling instantly as the DLT provides constant updates to internal custodian Books and Records, and may not need a lengthy settlement process at the central securities depository (CSD).
The HQLAx platform is a market example of DvD settlement, based upon the permissioned R3 Corda network. They have created a DLT-based operating model that enables their clients to exchange ownership of securities, between collateral pools, while the underlying securities remains with the central securities depository and custodian – such certainty in settlement is aided by the permissioned nature of the network on which this solution is based.