UK Treasury publishes report on MMF tokens as collateral for repo and margin

The UK Treasury Technology Working Group published a report on the second phase of its work, focusing on the use of tokens as collateral for money market funds and the role tokenized funds play in a fully “on chain” investment market that will streamline back-office functionality.

The Technology Working Group was established under auspices of the UK government’s Asset Management Taskforce and is supported by the Investment Association (IA).

Tokenization is defined the issuing of units that are recorded on a distributed ledger, as opposed to units that are recorded on more traditional systems of record-keeping. Transitioning the existing operational infrastructure underpinning investment funds onto a distributed ledger is expected to drive further efficiency and transparency within the sector, and improve its competitiveness.

Bim Afolami MP, the Economic Secretary to the Treasury, said in a statement: “As we work to grow the economy, the UK is ideally placed to seize on the transformative capabilities of technology in this industry, combining our expertise in innovation and investment management. This report demonstrates – once again – that the UK is on the side of the pioneers.”

To help develop further momentum in the UK market, the UK Treasury identified two key use cases for fund tokenization and announced that firms will be testing them with support from the UK authorities through appropriate channels, such as sandboxes:

  • fully on-chain investment markets, with tokenized funds investing in tokenized securities such as in the fixed income or other asset classes; and
  • the use of tokenized money market fund units as collateral where eligible under the UK regime for noncentrally cleared derivative contracts.

The report noted that the identification of mainstream assets in on-chain markets will become easier in future as International Securities Identification Numbers (ISINs) and Digital Token Identifiers (DTI) standards become aligned. The Association of National Numbering Agencies (ANNA) and the Digital Token Identifier Foundation (DTIF) will allow the phased introduction of new ISINs to identify crypto assets, working with DTIs that uniquely identify tokens and the network on which they are located.

Money market fund collateral

Money market fund (MMF) tokens as collateral has been successfully tested in other jurisdictions, and involves the tokenization of the MMF unit, either by the issuer or the holder, to enable the token to be pledged in bilateral uncleared trades as margin or used as collateral in the repo market.

This could help secondary market liquidity and relieve redemption pressure on funds in times of market stress, by eliminating the need for investors to redeem from the fund to access the cash. A group of firms will be working through this use case with support from the authorities. Firms are invited to express their interest in participating in this by contacting the Investment Association.

Recent market stresses saw market actors needing to sell their MMF units to meet dynamic derivatives positions with the redemption cash generated, only for counterparties receiving that cash to purchase further MMF units with it. Where MMF units are used to meet margin requirements, this may be instead of such units being sold by investors to raise cash to post as collateral, and so such use may reduce redemption pressures on MMFs.

The tokenization of MMF units for use as collateral may be able to accelerate the relevant settlement process increasing the opportunities for this use case. Tokenized MMF units may be settled faster on DLT-based networks, which may become particularly useful in the context of an uncleared derivatives arrangement where the exposure between the parties can change frequently, in which case variation margin may need to be exchanged daily or even more frequently.

Read the full report

Check out our interview with Tokenbridge about tokenizing mutual funds

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