The UK’s HM Treasury has confirmed plans to run a pilot for the issuance of digital gilts, UK government bonds, following leaked news earlier this week. The previous Conservative government had also planned to organize a pilot. It’s seen as an important step for UK capital markets, particularly as the UK has launched a Digital Securities Sandbox for DLT and tokenization pilots.
The UK could benefit more than other jurisdictions. One of the killer apps for blockchain in capital markets is repurchase agreements or repos, which involve exchanging cash for gilts. This allows banks and institutions to either lend excess liquidity or borrow it if they are short.
Conventional repos involve delayed securities settlement, which means repo duration is typically overnight. By contrast, blockchain supports instant settlement enabling intraday repo. The ability to manage liquidity for hours at a time is very attractive to banks and other institutions.
Intraday repo is already happening by tokenizing existing Treasuries in the United States. A native digital gilt would make the process far easier. On top of that, the UK has Fnality, a tokenized cash settlement network backed by an omnibus account at the Bank of England. Fnality is backed by more than 20 institutions.
Hence, with a digital gilt, the UK will have both a digital security and cash on chain.
With the previous government floating the idea, industry trade body UK Finance collaborated with EY to draft a digital gilt roadmap. It submitted it to the government in April, but published it today.
A digital gilt roadmap
It suggests two alternative approaches, one is more evolutionary whereas the other is a Big Bang path.
In the multi-staged approach it suggests issuing a short dated digital Treasury bill within the first six months with only a limited number of market participants.
In the second phase within the first year, a medium term digital gilt would have more functionality. For example, it would involve more market makers and a wider group of investors. Most importantly, it would be integrated with the existing off-chain secondary market, with the gilts eligible as collateral for repo. These are essential steps to ensure liquidity.
The third phase within 18 months would involve another issuance with both the trading of gilts and repo performed on chain.
The Big Bang approach would essentially skip the first two steps and happen in a more compressed time frame. The UK Finance paper outlines the pros and cons of each path.
A major hurdle could be the legal and regulatory work needed to support digital gilts being used as collateral for repo and other purposes. Plus, there’s the need to maintain a sufficient level of liquidity.
Switzerland is one of the most advanced jurisdictions in this area. Its central bank considers using digital Treasury bills for money market operations as premature, given the immaturity of the DLT sector. However, Switzerland was the first mover in launching a digital securities exchange, so progress unsurprisingly has been slow going. By contrast, there’s been strong interest and engagement in the ECB’s wholesale DLT settlement trials, with market participants hoping the trials won’t end.
UK Finance believes that with the digital gilt program “the UK can lay the groundwork for a robust and innovative digital capital market ecosystem, bolstering its position as a global leader in financial technology and digital finance.”
