the case for tokenisation
Intermediaries
from operating costs to actively mobilising the balance sheet
Despite a heavy focus on crypto (custody) in 2021-22, many participants are now looking to deliver new benefits to their customer ecosystems – harnessing the power of tokenisation to deliver new (hitherto over-the-counter) products to their clients, on the basis of immediate, operational efficiencies.
But as market practitioners, they are also discovering that tokenisation can radically reshape their own operating models….and their balance sheets.
Ever-lower operating costs: moving beyond trade fails and reconciliations
“We’ve already saved the company tens of millions of dollars in costs – and we haven’t even begun to scale yet”
Similarly to issuers, secondary market participants are quickly seeing significant operational savings from the use of tokens. Even today, brokers and banks can use the common and synchronous book-of-record, to eliminate the potential for trade fails and with it in the need for manual exception handling and reconciliations. As STACS, BNP Paribas and Eastspring investments demonstrated, tokenisation can reduce error queues by 80% and save 4 FTE-hours per day in exception management.
But the power of tokens in the secondary market is increasingly sophisticated. Leveraging the power of the ledger, banks and brokers have begun using blockchains to remove some of their most painful areas of book-keeping.
Those investing in many emerging markets are highly aware of the growing tendency towards end-investor / beneficial owner securities accounts – creating a huge book keeping (and funding) burden as securities pass from custodian to broker and market.
Equally, custodians are seeing significant potential cost savings by leveraging the transparency across their different levels of securities accounts. Through more seamless data management, custodians can begin to net transactions at a CSD level across their multiple custody accounts – saving them vast sums in depository fees.
Finally the value of tokenising collateral is also clear – and not just in the fee savings. As Broadridge’s DLR platform has shown, banks can save around 10% of their repo costs simply by tokenising and immobilising their collateral assets. But beyond that, banks are also able to automatically manage the highly complex processes of collateral marking-to-market, managing eligibility, triggering substitutions and recalls – generating much broader savings across the firm.
The common theme: where are we maintaining highly complex data models today?
Balance sheet savings today…
As CSDR has amply demonstrated in Europe, the cost of failing trades extends well beyond the market costs or even the potential penalties that fails may trigger. There is a cost of handling the fail, a balance sheet cost - and an opportunity cost of future expected fails.
In China A-shares, smart contracts are being used to remove trade fails in one on the shortest settlement cycles on earth. In the face of a 4-hour settlement window, HKEX has introduced Project Synapse as a means of transforming trade flows and accelerating settlements. Historically, traditional settlement messages (SIs) have been generated by investors and then passed to brokers, global custodians, sub-custodians and depositories (and back again). In 2023, Synapse will leverage smart contracts to automatically generate an SI and communicate it to all parties in parallel – vastly reducing the risk and time required for a stock settlement, eliminating the reconciliation burden and facilitating T+0 settlement.
This is just the beginning. By removing the risk of fails, tokenised securities create balance sheet savings across the entire chain. Banks no longer need to over-provision for failing or delayed trades or collateral movements.
Leveraging this clarity and reliability, industries such as securities borrowing and lending (SBL) look set to transform. In the face of highly time-critical security movements, firms such as the OCC are already turning SBL into a dependable, low risk activity – improving returns and profitability for all.
In an era of ever-growing focus on settlement velocity and settlement discipline, the long-term value of tokenisation in the secondary listed markets is clear.
…to mobilising the balance sheet
“A lot of banks are sitting on dead assets today. Tomorrow you could repo a loan and really maximise your balance sheet”
But the power of tokenisation extends well beyond simple capital savings.
By facilitating real time price discovery (even for complex, structured assets), blockchains can help banks to risk manage and price all variants of tokenised assets.
Through the reduced risk of trade fails, these same tokens also become much more transferable. Add to that the benefit of factionalising assets and enabling them to be distributed to wider groups of investors and you have a powerful mobilisation effect.
Leveraging these benefits, tokens are beginning to transform the banking balance sheet. Assets that have thus far remained immobile on banks’ balance sheets (notably loans, structured products or commodities) can quickly become eligible for financing and even potentially as collateral.
If a loan can be priced and reliably transferred tomorrow in a more liquid market, why wouldn’t you be able to repo it or pledge it as collateral against another transaction?
Tokenisation can not only remove drags on balance sheets – it can actively mobilise assets and create liquidity for banks.
Crypto and cash convergence
We've spent years preparing to handle crypto - and it's entering the mainstream
Our crypto custody builds in the last few years have often seemed self-contained or - at best - first steps in a loosely defined digital asset journey. Whilst wealth management or investment banking divisions have rushed to handle crypto-currencies, custody departments on the other side of the firm have been busy working on tokenisation experiments - often with little overlap.
But as Paxos and other organisations are beginning to show, we need to be preparing for the convergence of these two worlds soon. Regardless of the crypto-winter, crypto-currencies have become an important new source of liquidity and revenues for banks and brokers - with players quickly moving not just to hold but to finance and leverage these assets for their clients.
Whilst isolated today, that liquidity will make its way back into the mainstream quickly - when we will start to see securities transactions financed in bitcoin or repos using tether.