Last week Benjamin Müller from the Swiss National Bank (SNB) observed that the transition of financial markets to blockchain would be an evolution. “We will not see a Big Bang migration to blockchain and DLT. We think this is not realistic and probably also not good practice for regulated financial institutions,” he said, talking during a panel discussion at the OMFIF Digital Money Symposium.
In 1986 the London markets had an event referred to as the “Big Bang” that involved a raft of regulatory changes to increase financial market competition. They were all implemented on a single day. It catapulted London from a laggard to a leader. And it might be worth studying some takeaways from 1986 to inform the approach to DLT. But more on that later.
Switzerland is widely regarded as one of the leaders in regulatory reform for crypto-assets and DLT. And the SNB has been on the frontline of wholesale central bank digital currency (CBDC) research, in part driven by the desire to have a CBDC for DLT settlement by the SIX Digital Exchange (SDX) – the first fully regulated financial market infrastructure for digital securities.
It has also been working on cross border and DeFi experiments with the Banque de France. The French central bank’s Claudine Hurman, a fellow panelist, spoke of the benefits of tokenization. These include the ability to settle atomically, longer operating hours which could be 24/7, transparency and the promise of DeFi efficiencies.
SNB’s Müller doubled down on other panelists’ comments about atomic settlement. The ability to exchange the asset for the money, delivery versus payment, doesn’t have to be instant. It can be later the same day or the next day, but the fact that both sides of the transaction exchange simultaneously reduces counterparty risk.
The cost of running two systems in parallel
Circling back to the evolutionary approach, he warned that this is relatively expensive. Not only is there a need to invest in DLT infrastructure, but it has to be run in parallel with existing systems. And because two systems are in operation, the targeted efficiency gains are not recognized.
While Müller didn’t mention it, SDX is an example of running two systems in parallel. UBS issued a blockchain bond that is natively registered in the SDX central securities depository (CSD). But it was bridged to the conventional SIX CSD to enable greater liquidity, opening it up to investors who are not yet ready to custody blockchain keys.
The Swiss central banker spoke about different approaches to settling DLT transactions. The latest Swiss wholesale CBDC trials involve issuing a real wholesale CBDC on the SIX Digital Exchange. At the moment, SDX is using tokenized cash backed by central bank reserves.
Müller also mentioned that another DLT-based exchange that is yet to launch would settle transactions through a linkage to its real time gross settlement (RTGS) system, SIC. We are guessing this is Boerse Stuttgart-owned BX Swiss which conducted a trial transaction in late 2022 with Credit Suisse, Pictet and Vontobel. That test also included a bridge to SIC.
Another topic covered was interoperability. The focus is invariably on the interoperability (or lack of it) between different blockchains used to issue securities. Clifford Chance raised the issue of legal interoperability. And the Swiss National Bank’s Müller spoke about interoperability enabling the uniformity of money. Today people are often unaware of the differentiation between commercial bank and central bank money.
Central bankers tend to quickly zoom into fragmentation when talking about digital currency. “Would we move into a stage where you could potentially risk that uniformity of money? Where you have a Swiss Franc stablecoin or a Swiss Franc CBDC on one ledger, that is not necessarily exchanged at a 1:1 exchange rate,” said Müller. “I think interoperability could be the remedy to ensure that uniformity.”
Why no Big Bang?
Meanwhile, the early mention of London’s Big Bang begs the question, why not have a mass switch to DLT? A paper reviewing the lessons learned after 20 years offers some useful takeaways by former UK Chancellor Nigel Lawson.
The Big Bang legislation was one of the first occasions there was broad industry consultation. It resulted in more bureaucracy than was optimal. “Paradoxically, the involvement of practitioners in the regulatory process, which was intended to avoid this, probably exacerbated it,” he wrote and then observed that poachers make over-zealous gamekeepers.
Another observation applies to crypto and tokenized securities. “In general, transparency is always preferable to regulation as a means of protecting the public; but transparency is not always the first choice of the practitioners.”
And finally, one of the things we hear repeatedly is a desire to avoid regulatory arbitrage. Lawson disagreed. “It is not sufficiently recognised that healthy competition in regulatory systems is as beneficial as it is elsewhere,” wrote Lawson.
He opined about the speed needed in 1986 for genuine reform to attract capital to the UK. While the EU’s DLT Pilot Regime should be lauded, it will last three to six years and be relatively small scale. If tokenization is to take off, incumbents must work within current laws to show any timely return on investment.
DLT provides the opportunity to radically transform markets to cut costs substantially and enable new business models. Perhaps there is a need for more regulatory competition and a Big Bang approach.
