The Commodity Futures Trading Commission (CFTC) has a Global Markets Advisory Committee (GMAC) made up of industry participants. Today the subcommittee on digital assets voted in favor (27-0) of three recommendations to adopt DLT and tokenized assets as collateral for margin. The proposals would need to be adopted by the full GMAC Committee and it’s up to the CFTC to decide whether it proceeds.
The problem addressed by tokenized collateral
Stepping back, the CFTC is the primary regulator for derivatives markets. Typically derivatives require the posting of margin to cover the risk of price swings. Initial margin is provided at the outset, with variation margin during the lifetime of the derivative. Non cash collateral is already allowed by the CFTC but is not used much for variation margin, because moving assets involves multiple intermediaries and hence delays. Plus, assets can only be transferred during office opening hours.
By contrast, tokenized assets are directly transferrable 24/7. The ability to quickly transfer tokenized assets for use as variation margin reduces counterparty and other risks. Plus, it saves money by removing the need to liquidate assets to meet margin calls.
During market panics, the need to post additional cash margin often requires selling collateral that increases market volatility.
Collateral mobility is one of the killer apps for tokenization. Beyond the CFTC and derivatives, there are already significant industry initiatives targeting collateral mobility, including HQLAᵡ, JP Morgan’s Tokenized Collateral Network, and Broadridge’s DLR which supports repo and Treasury tokenization.
The Digital Asset subcommittee proposals
The GMAC Digital Assets Markets subcommittee believes that tokenized assets could be used for margin without the need for regulatory changes. Likewise the use of DLT as books and records (without tokenization), should also not require new legislation. Given non cash collateral is already eligible for margin, it also doesn’t require changes in eligibility rules. Committee members also concluded that existing policies and procedures for managing risks should be sufficient to support DLT.
The assets they had in mind as collateral would be World Bank bonds, government securities, corporate debt, money market funds and gold. Current CFTC criteria for non cash collateral is that the assets are liquid, hold value and lack correlation to counterparty or portfolio risks.
The Global Head of DTCC Digital Assets, Nadine Chakar, commented that “This is an opportunity for us to be able to increase the velocity of collateral in the marketplace without any changes to rules and guidance.”
DRW has been operating a significant digital asset business for years. DRW’s Chris Zuehlke said it has seen the benefits of the ability to move assets in real time 24/7 in practice. He said the company has a different view on risk where there’s a bank wire involved versus real time settlement with a DLT-based asset.
“We often times feel much more confident in our risk management processes when we know we can have a 24/7 real time settlement capability with these counterparties,” said Mr Zuehlke. “I think that will transfer very directly to the collateral management side for derivatives based businesses under the CFTC’s purview. And I’m really excited to see that evolution take place.”
The risk of not proceeding
Christopher Perkins from Coinfund is another subcommittee member strongly in favor. He spent a large part of his career at Citi, latterly as Global Co-Head, Futures, Clearing and FX Prime Brokerage.
There’s been much criticism about a lack of technology neutrality with DLT, with extra hurdles often put in place. He argued for the reverse: that market participants should be incentivized to move to tokenized collateral. He considers the level of ongoing Herstatt risk in the marketplace as too high. “The risk here is being able to tolerate the very inefficient settlement processes today,” said Mr Perkins. “We’re living in a world now where it takes days to settle Yen. Completely unacceptable.” He advocated for using stablecoins for variation margin.
The potential figures involved are massive. Exchange traded derivatives are small fry compared to over the counter (OTC). Global exchange traded derivatives have a notional open interest of $88 trillion versus $742 trillion for OTC. To put that in context, global stock markets total $124 trillion.
Even if the full GMAC committee proposes to advance the recommendation, the CFTC might be slow to adopt. During today’s meeting, Commissioner Pham noted that the CFTC has not yet implemented a recommendation from November 2023. That one aimed to harmonize rules relating to money market funds as eligible collateral.
