CBDC and stablecoins (SC) are being investigated, experimented with and, in some cases, already in use within the capital markets. The adoption of CBDC and SC offers potential advantages over today’s settlement methods. This is particularly apt when discussing the settlement of securities on DLT, as the simultaneous exchange of CBDC/SC and securities tokens (aka atomic settlement) is a key attribute of a DLT solution and the creation of a Delivery versus Payment 1 (DvP1) (in central bank money or commercial bank money) settlement solution.
The International Securities Services Association (ISSA) published a concise summary of the potential application of (primarily) CBDC in the existing capital markets post-trade landscape. It provides a broad overview of key use cases, opportunities, threats and considerations for market infrastructures, custodians, intermediaries and service providers to consider.
For one of its chapters, ISSA covered securities financing markets. DLT-based solutions — with their inherent features of providing single source of truth, real-time transaction finality and immutability — can help address the challenges in securities financing markets and provide the following benefits:
- The current securities financing market has been tremendously successful in providing overnight and short-term funding, but operational limitations and the market structure limits its usage on intraday funding. DLT with digital representation of the asset and instantaneous real time atomic settlement provides participants the ability to exchange assets in a highly flexible manner opening new channels for intraday funding and liquidity. DLT networks can help participants improve their collateral mobility and access their collateral across multiple custodial locations, thereby reducing cross border funding needs.
- The securities finance markets are fragmented and involve significant manual operations in the execution, clearing and settlement of transactions. Multiple parties have their individual front, middle and back-office systems and have high level of interactions with their counterparties and service providers to manage the transaction lifecycle, resulting in high costs which results in margin pressure. There is also the operational cost and manual effort spent on reconciliation, margin call and dispute management. DLT and smart contracts can tokenize or digitize the asset, immobilize, and maintain ownership record at all times. This potentially helps multiple parties to view, execute and manage securities financing transactions in real-time, resulting in millions of dollars of savings in operational costs and reduced risk.
- Firms wanting to improve their liquidity tend to execute collateral upgrade transactions which allow the borrower to exchange poorer quality assets for better quality assets at a cost and by posting collateral. The current process is managed across a fragmented custody network and against a rigid settlement window. The settlement process is capital intensive for banks, consuming intraday liquidity and funding. Distributed ledger technology allows a digital representation or tokenization of a basket of collateral which can be swapped atomically. This increases regulatory transparency, tracks the collateral, reduces capital costs and allows real-time collateral upgrades.
As the industry explores DLT and digital money for addressing requirements in the securities finance market, there are a few open items that require thoughtful consideration and leadership:
- How would the presence of a 24/7 settlement network change the securities finance and collateral market? Would it improve liquidity and make it more efficient to move collateral globally and enable intraday trading?
- How will the tokenized markets co-exist with traditional markets? Will there be a fragmentation of liquidity? Will this lead to arbitrage opportunities?
- Will there be a greater bundling of custody, collateral, prime brokerage and execution services in the tokenized securities market? Could this create ‘walled-garden’ models?
- How do providers deal with the legal/regulatory challenges in a distributed world, i.e., enforcing the collateral agreements in case of default or proving that the fiduciary duties have been discharged?
The aspect of the report spotlighting securities finance covers digital money in securities financing and collateral management; key trends and challenges in the securities financing markets; and distributed ledger technology in securities financing markets. Overall, the report covers CBDC and post-trade settlement.