Tokenisation
Two weeks ago, I had the pleasure of attending the Risk Management Association’s 20th Annual Sec Finance Operations and Technology Summit in New York, and participating in a lively panel discussion on the topics of standardisation and interoperability. For regular readers to our news and digital-related content, it will come as no surprise that much of the conversation focused on the Common Domain Model (CDM), the use cases under development today, its recent move to an open source repository, the key role that existing software vendors have to play in adoption through forums such as ISLA’s CDM Trading & Doc Digitisation Working Groups, and how the CDM can co-exist with other standards such as FIX and ISO20022 to offer a cohesive interoperable tool set for securities finance market participants.
Returning to the broader agenda for a moment, the Ops & Tech Committee set the tone right at the start of the summit, establishing what became key themes that ran through virtually every panel – collaboration, digitisation and automation, optimisation of collateral, and the nurturing of diverse talent at all stages of the career ladder. That opening panel noted the continuing and increasing burden of regulation, the approach of T+1, and the challenging global economic environment as factors that mean securities financing businesses can no longer operate as they have done to date. ‘Throwing bodies’ at operational challenges is not a valid solution – the industry needs to automate, removing non-value add manual processes to better use quality talent on the complex tasks where humans excel.
To solve the extraneous issues, the industry needs to collaborate through industry bodies such as the RMA and ISLA to mutualise resource, standardise the fundamentals, and push for harmonisation of global regulatory requirements. There was discussion, on a number of panels, for the need to also break down internal silos with businesses coming together. Increasingly, successful securities finance businesses are no longer operating as separately budgeted front office, middle office, and back office, with utility partners in technology. Instead these areas are working as a whole for the good of the business. Data standardisation through the CDM can support these internal harmonies too, for instance by connecting digital master and collateral agreements signed during the onboarding process to the downstream transaction level lifecycle events that those agreements exist to define.
Despite acknowledging that existing platforms and software solutions could be better and more fully utilised by industry participants to achieve a more streamlined operational environment today, my panel struggled to avoid discussing how standardisation and interoperability would be core to achieving the full potential of new technologies such as Distributed Ledger Technology (DLT) and tokenisation of assets; topics covered separately in the panel dedicated to digitisation. That panel laid out a number of use cases, primarily around optimisation and mobility of collateral, where tokenisation of assets and DLT will assist, including examples already reported in the press. One panellist did however note that implementing tokenised assets is not as simple as it often sounds, with more education needed within firms themselves, and externally within the industry. ISLA’s recently published paper on the Commercial Opportunities & Practical Considerations for Tokenisation for the Securities Financing Market discusses those use cases and others in more detail, as well as a number of implementation considerations including regulatory, legal, operational and technical challenges to be addressed when entering into the area of tokenisation. As the paper is reasonably long and detailed, interested parties can also find a more digestible version as part of our Digital Asset Technology in Brief explainer series.
The juxtaposition of the benefit of tokenisation with another heavily discussed topic (the move of market settlement cycles in the US to T+1 in 2024) was striking. One panel discussed the feasibility and benefit of intra-day collateral management with atomic deliveries on a close to real-time basis, against a backdrop of the operational pain of compressing current market settlement practices by an effective 60% when market cut-offs (a concept that is irrelevant in proposed DLT use cases) are taken into account. Movement of all players to a world based on the new technology is on a timeframe well beyond that of the transition to T+1, and it seems to me that market participants are correct to be concerned – there is much digitisation required to improve existing operational and infrastructure processes. These are the processes and infrastructure that have been shown to creak under pressure in times of market stress, such as the recent liquidity volatility during the Liability-Driven Investment (LDI) crisis. Whilst these times of stress could be considered as non-BAU or low frequency events, the underlying issue (that existing processes could not process volumes in a shorter period of time) feels straight forwardly analogous to shortening settlement cycles for an entire market: large volumes need to be processed in a compressed timeframe. Only automation, digitisation and adoption of new solutions can really be expected to solve this. Manual intervention, or more bodies as noted by the Ops & Tech Committee, isn’t viable.
Currently the industry in its exploration of the use of DLT, smart contracts and the like, and are at risk of recreating today’s ecosystem of multiple disparate solutions, potentially adding complexity on top of complexity, particularly as legacy solutions will exist for some time. Standardisation of contract data, lifecycle events and messaging is the only possible way that the new technology will realise its full potential and not exacerbate current issues of processing high volumes. Harmonisation of data is also fundamental to allowing for potential future models of regulatory reporting, and for new activities such as machine learning and AI, tools also discussed by the panel on digitisation, specifically in the context of predicting fails to reduce CSDR penalties. Standardisation and the future are inextricably intertwined when considering a successful future for securities finance and the wider financial industry.
As a final note, whilst sitting in Newark airport awaiting my flight, I finally managed to read the BIS’ paper published in January detailing DeFi models of financing. I highly recommend this paper to anyone trying to understand the future potential of tokenisation and DLT. Whilst the models discussed are decentralised, imagine what networks, smart contracts, and asset pools such as these, in the hands of properly regulated, risk managed institutions, as represented in our membership, could achieve when the regulatory and legal landscapes emerge from their current uncertainty.
David Shone
