DLT collateral mobility’s five operational hurdles

DEEP LOOK | Harmonisation of legal and regulatory frameworks remains a major obstacle to distributed ledger-based collateral mobilisation, but the scale of the operational challenge should not be underestimated.

As efficient collateral management has become a competitive advantage, it was inevitable that attention would shift to digitising the process by which these securities are moved around.

Perhaps the highest profile development in this space occurred earlier this year when Eurex Clearing introduced its DLT-facilitated collateral mobilisation service.

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One of the key elements in the development of this service was the feasibility analysis conducted in conjunction with clearing members and buy-side clients, explains head of derivatives clearing development, Efthimia Kefalea.

“We now have clients that are using this service every day to post collateral where this collateral is not physically with Clearstream Bank Luxembourg, but we still can see it through the clients’ Clearstream Bank account,” she says. “We are the first CCP to offer such a service and have a full pipeline of clients that are onboarding to it.”

One of the attractions for potential users of this service is that they don’t need to upgrade their in-house technology – communication with the platform takes place via traditional means such as SWIFT.

There is no limitation on the extent to which members of the ecosystem can mobilise collateral. The use of a trusted third party entity – Clearstream International – to maintain books and records over the digital ledger creates legal certainty around ownership.

Learning ledger legalities 

Eurex Clearing’s approach is to offer a hybrid infrastructure where clients can do both traditional and digital business across a common infrastructure. This is important as according to Charlie Amesbury, institutional sales at HQLA-X, the main challenge to mobilising collateral using distributed ledger technology is still adoption of the technology.

“Participants must connect to and trust shared ledgers and this process involves legal, operational and technical due diligence, although this is taking less time as more participants join,” he says. “Collateral mobility relies on assets being recognised and transferable across multiple locations. Therefore the more institutions recognise the legal foundation that underpins the resilience of a digital ledger, the greater the mobility will become.”

He explains that collateral can never be used in two places at one time (double-spend) but can be instantaneously switched between locations where an obligation might arise, without constraints on market hours, in a programmable fashion.

Tracking asset ownership to facilitate servicing

Another obstacle to mobilising collateral using distributed ledger technology is that over the last decade, almost every financial institution has developed its own infrastructure to solve this problem. The last thing any of these institutions would want to do is share that infrastructure with their competitors.

One of the reasons why DTCC has been able to move forward with a digital collateral management platform, suggests Nadine Chakar, global head of DTCC digital assets, is that its members asked it to work with the industry to create a solution to which they could attach their individual systems and compete on service rather than infrastructure.

“The ability to move collateral at the speed of the network means lower funding costs and reduced balance sheet impact in the front office, greater efficiency in the middle office and a single database that the front, middle and back office can all refer to,” she adds.

One of the issues that led to the demise of Lehman Brothers was that collateral was rehypothecated so many times that the chain of ownership was unclear. Because DTCC is a depository it needs to be able to track ownership of these assets in near real time.

“The beauty of tokenised assets is that for a money market fund, for example, because we can track ownership in a near-time manner, we can pay interest irrespective of how long a client has held that fund whether it is days, hours or minutes,” says Chakar. DTCC’s platform provides users with the ability to track ownership, including the ability to rehypothecate should a user choose to do so,  with the knowledge that the client will always know who is holding that token.

“Once you move into native issuance, it’s very different,” adds Chakar. “But right now, what we are talking about is digital twins that allow you to encumber that asset wherever it is and then leverage the token to allow you to do all the operations we have talked about.”

Legacy links

Collateral management is deeply embedded in firms’ middle and back-office systems, requiring investment to add providers or connect to new networks. Because digital networks are by definition new, it can be challenging to attract new participants when there is not yet a critical mass of players active.

“Depending on the nature of the collateral token, it can also take significant time and effort to confirm legal certainty over ownership and collateral transfers,” explains Jan Grauls, senior product manager, collateral management at Euroclear. “Most collateral is still in the form of real world assets with use in distributed ledgers requiring tokenisation. While the token becomes available in the DLT environment, for certain post-trade events such as asset servicing, the link with legacy infrastructure is difficult to break.”

Regulatory clarity and interoperability needed

The technology is ready – the challenge lies in harmonising legal and regulatory frameworks, creating global consistency around how control and ownership of digital tokens are defined and how settlement finality is recognised across jurisdictions. Until then, large institutions cannot confidently treat tokenised collateral in the same way as traditional assets.

That is the view of Kelly Mathieson, chief business development officer at Digital Asset, who also refers to fragmentation of DLT networks. “The constraint is the supporting environment in the form of digital cash rails, legal recognition and risk frameworks that supervisors are comfortable with,” she says. “As those evolve, we will continue to see fewer proofs of concept and more examples of genuine market-wide liquidity efficiencies.”

GreySpark senior specialist, Jennie Brotherston refers to issues around scalability and interoperability. She says the older distributed ledgers are relatively limited in how many transactions they can process in a given time period compared to the major exchanges, for example.

“Interoperability is a more obvious issue – everyone needs to be able to use the technology for it to work and there are questions about whether the various different blockchain platforms can interact,” adds Brotherston. “There are certainly questions about integration with wider technology so there is the potential for it to be a pretty steep learning curve for users.”

According to Kefalea, regulatory clarity will be key to accelerating the digital transformation of the financial industry. “For everything we do right now, we need to ask for guidance from our regulators,” she explains. “In order to be able to invest and innovate more, we need to know what the regulatory framework allows. Sharing experiences with regulators and educating policymakers is one of our main duties as a market infrastructure.”

Like many other market participants, Eurex Clearing believes traditional and digital systems will coexist. “However, if you want to avoid inefficiencies, you have to bring those two strands together and create partnerships, ecosystems that can talk to each other, which is not the case with what we see right now,” says Kefalea. “Traditional and digital players often operate in isolated silos with limited interaction and we believe this fragmentation must be addressed.”

Frictionless and precise ownership transfers of collateral across all collateral management activities – including securities lending, repo and derivatives – will not happen overnight. Even DTCC admits that it has further work to do on its platform.

“We are working through non-functional requirements and consulting with industry and partners,” says Chakar. “But there will be a major enhancement released in 2026 and with shortened development cycles, we will see rapid enhancements in scalability and adoption over the next couple of years.”

Grauls observes that most DLT solutions for collateral require clients to custody assets with a particular custodian, with the DLT network acting as that custodian’s settlement and account keeping system.

“If the promise of DLT is to break down collateral silos and facilitate cross-border collateral flows, much more work will have to be done in demonstrating that interoperability between DLT networks will be more seamless and more efficient than today’s networks,” he adds.

What’s next?

In July, the Canton Network supported a live transaction in which onchain US Treasuries were used as collateral, paired with onchain cash and settled atomically outside traditional market hours. “What is powerful about that moment is that it wasn’t just a demo or proof of concept – it showed the market that both legs of a collateral transaction can be executed and synchronised in real time across independent systems,” says Mathieson. “The path from here is about scale and alignment.”

Brotherston is more guarded, suggesting that transfers across all collateral management activities using DLT is still some way off. “The EU pilot DLT scheme demonstrates that it might be possible and that there is some influential appetite for it but it will need to be embraced a bit more widely – both conceptually and practically – for it to gain traction in the market,” she concludes.