Ever since the global financial crisis, regulatory and risk management requirements have placed heavier burdens on collateral management and mobility. Financial market utilities’ efficiency-enhancing initiatives are now leading into a potentially significant institutional use case for distributed ledger technology.
DLT, or blockchain, underlies cryptocurrencies and has been put to a number of financial-infrastructure tests, with asset-tokenization efforts currently proliferating. “One of the best use cases for tokenization is the modernization of the post-trade movement of collateral that backstops trading activity,” says a Futures Industry Association report, Accelerating the Velocity of Collateral. “The trading of derivatives drives the movement of collateral worth billions of dollars every business day.”
As FIA president and CEO Walter Lukken asserted in a June speech, “This technology could lead to huge improvements in collateral management and settlement. It will make it possible to move collateral and meet margin requirements on holidays and weekends when banking systems are closed. It also could play an important role in the transition to 24/7 trading.”
Blockchain can facilitate, for example, streamlining of the many steps involved in transactions where money market funds serve as collateral in interest-rate and other derivatives.
“The current workflow has operational risk that can be mitigated with the tokenized MMF structure,” Amy Caruso, head of collateral initiatives at the International Swaps and Derivatives Association (ISDA), said in an interview.
The collateral management use case was cited in a recent joint-trade-association report on DLT in capital markets, along with fixed-income issuance and fund tokenization, as enabling reduced settlement times, improving liquidity and enhancing operational resilience.
“Tokenized money market funds have also witnessed substantial growth, reflecting increasing institutional demand for DLT-based financial instruments that streamline liquidity management and collateral optimization,” said the report’s foreword signed by Peter Stein, CEO of the Global Financial Markets Association and the Asian group ASIFMA; ISDA CEO Scott O’Malia; CEO Sandra Ro of the Global Blockchain Business Council; and others.
Source: The Impact of Distributed Ledger Technology in Capital Markets
ISDA is working with Global Digital Finance (GDF), an association whose “objective is to create a tokenization-agnostic, cross-chain framework to allow money market funds to be used to post initial and variation margin for interest rate swaps,” Stephen Ashworth, chief commercial officer at post-trade automation vendor Tokenovate, said during a June 11 ISDA conference.
Two recent developments involving money market funds:
-- A Bank of New York Mellon Corp.–Goldman Sachs Group collaboration, with BNY employing Goldman-developed technology for MMF-ownership recordkeeping. It marks “the first time in the U.S. that fund managers have enabled subscription for shares of their MMFs via BNY’s LiquidityDirect and Digital Asset platforms, the corresponding value of which will be represented through mirrored record tokenization utilizing GS DAP,” they said on July 23.
BlackRock, BNY Investments Dreyfus, Federated Hermes, Fidelity Investments and Goldman Sachs Asset Management were to participate in the initial launch.
-- Lloyds Banking Group and Aberdeen Investments joined with U.K.-regulated digital-asset platform Archax in collateralization of foreign exchange transactions. They proclaimed it “a landmark collaboration of their trading businesses to advance the use of cutting edge blockchain technology using tokenized real-world assets (RWAs) as collateral.”
“This latest use case for Nest, our permissioned DeFi [decentralized finance] collateral transfer network, highlights the power of regulated digital infrastructure to support institutional-grade needs,” said Archax co-founder and CEO Graham Rodford.
Archax, which tokenized an Aberdeen money market fund on the Stellar Layer-1 blockchain network, announced August 18 that the Stellar Development Foundation “has made a direct investment into Archax Group to support Archax’s mission to bridge traditional finance and blockchain.”
“What we’ve seen in the past few months is new or maturing use cases combining all those traditional capital markets functions with the blockchain rails,” said Sophie Marnhier-Foy, head of client solutions strategy, Nasdaq Financial Technology, in the June ISDA event. She was referring to counterparty credit risk and crypto-derivatives collateral management. “We need to talk not only about the [DLT] solution but how it fits into the [capital markets] ecosystem.”
In April, Nasdaq announced the connection of its Calypso integrated risk, margin and collateral platform with the Canton Network blockchain, resulting from a partnership with QCP, Primrose Capital Management and Canton developer Digital Asset. It demonstrated “that the integration of on-chain capabilities alongside existing institutional workflows enhances collateral mobility across all asset classes for institutional market participants,” and enabled Calypso to “expand its capabilities to support automated 24/7 margin and collateral management across a full spectrum of assets, including crypto derivatives, fixed income, exchange-traded derivatives and over-the-counter derivatives.”
Earlier in the year, Digital Asset joined Euroclear in launching the first phase of the tokenized collateral mobility initiative for the Canton Global Collateral Network (GCN).
Canton on August 12 declared the “successful completion of a groundbreaking transaction on the Canton Network, marking a first in enabling real-time, fully on-chain financing of U.S. Treasuries against [the Circle stablecoin] USDC. The transaction, executed on Tradeweb, surpasses prior on-chain repo activities by providing near-instant, atomic settlement on a public blockchain, outside of traditional market hours, on weekends.”
Bank of America, Circle, Citadel Securities, Cumberland DRW, Digital Asset, Depository Trust & Clearing Corp. (DTCC), Hidden Road, Société Générale, Tradeweb and Virtu Financial were working group members.
“Tradeweb’s deep U.S. Treasury liquidity and electronic execution capabilities, combined with the Canton Network’s interoperable and decentralized framework, enabled this trade to happen outside of traditional settlement windows,” stated Tradeweb Markets chief technology officer Justin Peterson. “It’s an industry first and reflects the power of collaboration in building a more connected, resilient and always-on global capital market ecosystem.”
Deutsche Börse Group’s Eurex Clearing has introduced a DLT-facilitated collateral mobilization service. In a first transaction in July, J.P. Morgan mobilized securities collateral for its client, Dutch pension fund investor PGGM, from another custody location to DB1 affiliate Clearstream Banking for use as margin collateral at Eurex Clearing. The underlying technology is provided by HQLAX.
Nadine Chakar, DTCC Digital Assets
DTCC’s April announcement of a new digital collateral management platform, a product of its Digital Launchpad sandbox program, was followed by a live demo called “The Great Collateral Experiment.”
Dan Doney, chief technology officer of DTCC Digital Assets, described collateral mobility as “the killer app for institutional use of blockchain.”
“Our goal is to highlight how we can enable real-world, institutional-grade digital collateral market infrastructure,” said DTCC’s Nadine Chakar, global head of Digital Assets. “This platform is unique in that we’ve created something that’s more open, flexible, dynamic, and comprehensive than any previous digital collateral initiative . . .
“We plan to continue building on this collateral model, engaging with the industry and our regulators to develop the standard for tokenized collateral across global jurisdictions, working with the buy side to give them more direct market access, and laying out the regulatory and legal path to implementation.”
Kevin Khokhar, head of investment funding solutions at T. Rowe Price, said “uniformity of standards” needs to be addressed, adding, “It’s fair to say that the technology has run far ahead of the legal and regulatory positions. And the technology in some respects is the easy part of this issue.”