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The writer is chair of UK Finance and was a court member of the Bank of England between 2006 and 2009
Disruptive innovation can take time to gain a hold but we have finally reached an inflection point with the tokenisation of securities.
Over the past year, I have seen an upsurge in financial services institutional interest in this area, particularly as central banks move from analogue towards digital. Without continued bold action, however, the UK risks falling behind other jurisdictions.
Tokenisation is not about crypto. What we are talking about is creating digital representations of real financial assets with ownership tracked on distributed ledgers, or blockchains. This is for everything from equities to bonds to illiquid assets like real estate and private equity.
In a new report, jointly prepared by UK Finance and Oliver Wyman, we worked with dozens of the largest banks, financial market participants, regulators, ministers and other bodies to outline the benefits of securities tokenisation and understand the bottlenecks that the UK needs to address.
The UK’s standing as an equity listings venue gains press coverage, but fixed income and post-trade infrastructure are just as important to London’s position as a global financial centre. And the pain points around the cost and complexity of current capital markets infrastructure are real and significant.
The good news for the UK is that tokenisation globally is in its infancy. Even digital bond issuance — the most common usage for tokenisation in mainstream financial assets — is still tiny, totalling about $1.5bn in the year to February, according to S&P Global.
But the reality is that the UK is at risk of falling behind other financial centres, as digital bond issuance to date has been in other places such as Singapore or Switzerland. Despite its reputation for red tape and bureaucracy, the EU has moved ahead in terms of experimentation. Our progress is similar to the US, which could quickly leap ahead given its huge financial resources, deep capital markets and technology knowhow.
There are three main benefits that tokenisation could bring securities markets: lower costs, lower risks and wider access.
Let’s start with costs. There are efficiency gains in reporting, trading and banking infrastructure. A tokenised security could require fewer intermediaries and operational processes for taking on new customers and anti-money laundering measures could be streamlined.
Second, the US meme stock craze of the summer of 2021 highlighted the need to reduce settlement risk from counterparties struggling to meet payments for committed trades. Digital tokens with instant settlement could reduce counterparty, liquidity and operational risks. Collateral requirements could decline.
Finally, tokenisation could widen access. It could increase the customer base for assets, particularly illiquid ones that involve significant paperwork currently. In a tokenised world, investors could buy a fraction of a financial asset rather than the whole thing, increasing the potential pool of retail investors.
For the UK to be a leader here, it needs to build on its plans for a Treasury-led financial market infrastructure sandbox. This is a facility to test new ideas in a controlled environment before they are potentially unleashed on the markets. The UK should seek to develop as a global standards setter and innovation hub in the area, supported by legal and regulatory certainty.
Such certainty is a necessary precursor to success. The UK has a reputation for a leading legal system that is central to the global financial system. The reliance of UK common law on precedent, while offering flexibility as technology rapidly evolves, does not offer the same initial clarity as the specially written codified statutes of civil law jurisdictions in Europe. Good work is however under way here, including the recent report on digital assets from the Law Commission, which made a number of important recommendations such as on what legal tools are needed.
A dedicated tokenisation-related regulatory sandbox, designed by the government and regulators in conjunction with the industry, will provide much needed regulatory clarity. Ensuring property rights, capital charges and custody arrangements are as clear for tokens as for traditional financial instruments will be crucial.
It is not clear how quickly tokenisation will become mainstream, but there is a real groundswell of interest and activity taking place and it looks like a question of when, not if. The UK cannot risk not playing when the rest of the world is. Think about it as a small insurance policy for our world leading financial market industry.
