Repo set to soar as tokenization unlocks collateral worth trillions

Key Takeaways

• Incipient tokenized repo market already gaining traction
• Technology boosts cost-savings, liquidity, and efficiency
• Full potential requires better interoperability, regulation

Trading repos through distributed ledger platforms is already worth billions in daily volume but is just getting started. This is a testament to the transformation that tokenization is having on the market.

Tokenization, which converts a traditional physical asset into a digital token that can recorded on a blockchain or hashgraph and which can then be divided into smaller parts, has been instrumental in overhauling the repo market’s complex and inefficient post-trade processes. It has helped unlock collateral and liquidity by enhancing transparency and accessibility.

Citi early last year projected that by 2030, up to USD 5 trillion of debt from non-financial firms and quasi-government entities, repo, securities financing, collateral markets, and alternative assets could be tokenized. Industry forecasts for total volumes are even higher, with a recent Finadium report estimating that the current total collateral marketplace is over USD 25 trillion. Efficient, globally inter-connected securities markets demand digitalised settlement and so it can be assumed that the evolution from physical to digital-based settlement is a question of when, not if.

Platforms such as HQLAx and JPMorgan’s Onyx process billions in repo volumes already and have the potential to grow even larger by expanding to the wider collateral trading markets (e.g. securities lending, OTC derivatives, or inter-company trading).

Distributed ledger technology (DLT) creates digital records of collateral assets and enables unified and efficient collateral pools. This allows for faster movements of collateral, particularly intra-day, which is helpful for reducing friction and increasing flows like variation margin payments in the OTC derivatives market, by leveraging smart contract features like atomic and conditional settlements.

Enhanced liquidity

Since tokenization allows for fractional ownership, it democratises participation in the market, which naturally increases liquidity. Tokenized assets can be traded around the clock on DLT-based platforms, unlike in traditional markets, which have limited trading hours. This constant availability can lead to higher trading volumes and improved liquidity.

Tokenizing assets makes it easier for investors from different parts of the world to participate in the repo market. This global participation can increase the overall liquidity and depth of the market.

A 2023 report from the Global Financial Markets Association finds that DLT offers transformative cost-saving and operational efficiency benefits, including new liquidity pools when operating at scale–an approximately USD 16 trillion global market for tokenized illiquid assets by 2030.

Cost and efficiency savings

As noted, the repo market is labour-intensive. Tokenization means automating processes and reducing the need for intermediaries, which can significantly lower the costs associated with repo transactions and increase collateral fluidity. For example, system automation via smart contracts, which constantly monitor and manage contacts throughout their lifecycle, means less manual effort, with the technology performing most of the work.

DLT’s automation and real-time capabilities can streamline many aspects of the repo process, including reducing interest charges by allowing intra-day transactions, simplifying recordkeeping, and improving counterparty and liquidity risk reporting.

Access to collateral

Collateral is king in repo markets, and tokenization significantly improves market participants’ options.

By accelerating and improving the digitization of new asset classes, tokenization expands the range of available and acceptable collateral beyond traditional assets. This will significantly increase the choices available to market participants when selecting non-cash assets as collateral in the securities lending or repo markets.

Coupled with the holistic benefits, collateral management globally may be more efficient, transparent, and relevant in new asset classes, including real estate, art, commodities, and other non-traditional assets. This broadens the pool of available collateral and provides more options for lenders and borrowers.

Tokenization challenges

While the use of DLT in repo and securities lending markets is rising exponentially, challenges and obstacles remain.

The first is disparate regulatory and legal frameworks. Global harmonisation is needed to support the development of a transparent, disciplined, risk-focused, and effective digital market infrastructure.

Second, more interoperability is necessary across providers and platforms, although there are signs this is coming. In June this year, Fnality, the firm developing regulated distributed ledger-based wholesale payment systems, and HQLAx, the fintech developing DLT for securities finance and repos, announced they had successfully completed the first cross-chain intraday repo settlement– more transactions of this type will surely follow.

A digital future

Tokenization is already transforming the repo market, easing many of the burdens on market participants and offering a more secure, efficient, and cheaper future.

As fintechs evolve to offer more platforms, DLT will spread yet further, but there must be a willingness to work together and suitable support from joined-up policymaking.

The market is still at the beginning of its tokenization journey and other technologies will continue to play a pivotal role in achieving more efficiencies through digital transformation. From order management systems, cloud-based architecture, APIs and artificial intelligence, market participants are spoilt for choice when it comes to replacing their legacy systems.