In an important speech today, European Central Bank (ECB) director Piero Cipollone proposed the creation of a European ledger, the EU’s version of the Unified Ledger, to support tokenization in the capital markets. He noted the challenges in creating a conventional Capital Markets Union, including the need for greater legal harmonization. The Director highlighted some risks in moving towards digital assets and distributed ledger technology (DLT). But rather than viewing tokenization as a threat, he said the EU should embrace the clean sheet opportunity to create a Digital Capital Markets Union. He was speaking at a Bundesbank Symposium.
A European Ledger
“A European ledger could bring together token versions of central bank money, commercial bank money and other digital assets on a shared, programmable platform,” said Mr Cipollone. “In essence, this would see T2S evolving into a DLT-based, single financial market infrastructure for Europe. While central banks would provide the platform, or the ‘rails’ so to speak, market participants would supply the content, or the ‘trains’.” T2S refers to the EU high value payment system used for the settlement of securities transactions in central bank money.
Since May, the European Central Bank has been coordinating the Eurosystem’s DLT trials for wholesale settlement using central bank money. With 60 private sector organizations taking part, it can see the level of interest and engagement. While the EU’s DLT Pilot Regime, which relaxes some of the current EU laws, has not been embraced by incumbents, the first startups are likely to be approved soon.
A key driver behind the likely launch of the retail digital euro is the loss of sovereignty over payment systems to the likes of Visa and Mastercard. The same motivation applies to the capital markets.
“If we drag our feet while other jurisdictions move faster and produce better solutions, we could see financial activities migrating elsewhere and private entities from outside the EU assuming a dominant position in European capital markets,” said Mr Cipollone.
Talking about the potential for tokenization and DLT, he said, “These technologies do not just have the potential to enhance efficiency. They could also fundamentally reshape the very structure of financial intermediation – a system that has remained largely unchanged for centuries.”
The risks of a failure to act
The Director outlined three potential risks of the move toward the tokenization of financial markets. He noted that to date, many institutional initiatives have focused on issuance, especially digital bonds. The proliferation of issuance platforms has already highlighted increasing fragmentation, more so than the current fragmentation between separate central securities depositories (CSDs). A coordinated approach could prevent this fragmentation.
Secondly, institutions want to use cash on chain. If there’s no central bank cash available, then they will use tokenized deposits of stablecoins.
The third risk is more about the unknown. Tokenized securities carry the risks inherent in securities, but there will be new risks. Some risks depend on the settlement asset. He mentioned liquidity risks without specifically referring to a settlement asset backed by money market funds, that could create heightened volatility during turbulent market periods.
The central banks’ role is to ensure the continued, and perhaps increased role of central bank money and to promote “robust, stable and integrated” capital markets.
Mr Cipollone mentioned the challenge of choosing a technical direction. By adopting a single technology, this will discourage exploration of other technologies during a period of innovation. Hence, the alternative is to encourage interoperability between diverse networks, including existing ones. This is a more flexible approach, although we’d observe it will sacrifice some efficiencies.
DLT trial extension?
In terms of concrete actions, following the settlement trials ending next month, the ECB and Eurosystem are exploring how it can build on that. That implies either extending the timeframe or making some or all solutions permanent. Additionally, it plans to explore allowing DLT-based assets to be used as collateral in the Eurosystem. We’d note that the Swiss National Bank extended its wholesale CBDC trial by two years and already accepts DLT-based collateral.
The director said some interoperability systems are considered a stop gap towards migrating to the longer term vision. This might be a nod to the use of the Trigger solution in the current settlement trials. Instead of providing a digital currency, the Trigger solution links DLTs to the conventional T2S settlement system.
“In embracing this technological shift, we are not merely reacting to change, but actively participating in shaping a more efficient, innovative and resilient financial future for Europe,” Mr Cipollone concluded.
