GFMA Calls for More Innovative DLT Approach from Regulators

The Global Financial Markets Association (GFMA) together with Boston Consulting Group (BCG), Clifford Chance and Cravath, Swaine & Moore, have published a new report highlighting the potential transformative benefits of Distributed Ledger Technology (DLT) for capital markets. The firms also call for market participants to proactively shape its future use, as well as for greater regulatory clarity from policy makers.

The report, “The Impact of Distributed Ledger Technology in Global Capital Markets” evaluates the opportunities and risks of DLT and DLT-based securities and assesses the applicability of existing legal, regulatory, and risk management frameworks. To illustrate the potential of DLT in capital markets, it examines three emerging use cases: collateral management; tokenisation of assets; and sovereign and quasi-sovereign bonds.

The report finds that DLT could unlock “transformative” cost-saving and operational efficiency benefits (for example, approximately $20 billion annually in global clearing and settlement costs) and innovation-led growth, broader market access, and new liquidity pools when operating at scale (approximately $16 trillion global market for tokenised illiquid assets by 2030).

Despite the growing momentum in developing DLT use cases, the report also acknowledges that, there is still no widespread adoption in securities markets, with most DLT-based issuances to date largely experimental exercises due to the challenges identified.

With this in mind, GFMA sets out five “calls to action”, for industry participants and regulators, to overcome existing barriers to adoption and advance the development of DLT-based capital markets.

These are, the harmonisation of global regulatory and legal frameworks, to provide clear and unambiguous definition of the key terms and the risk mitigants required to support the development of a transparent, disciplined, risk-focused, and effective digital market infrastructure. Additionally, it says the industry must enable interoperability by building consensus on common standards and on a vision for DLT-based markets to guide market linkages with traditional market infrastructure.

The third line is to drive faster adoption by prioritising resources in asset classes where DLT has the most upside potential to help pool and deepen liquidity, particularly for illiquid assets, while the fourth call is for collaboration on the advancement of DLT to promote technical solutions, including around scalability, cybersecurity and regulatory compliance.

Finally, the report says the industry should continue the development of DLT-based payment solutions, such as tokenised commercial bank money and deposits, to facilitate safe and efficient settlement processes.

“Distributed Ledger Technology holds promise for driving growth and innovation,” says Adam Farkas, chief executive of the GFMA. “This potential should not be ignored or prohibited where regulatory oversight and resiliency measures already exist. Policymaking should focus on creating a regulatory framework that supports financial stability and responsible innovation in digital asset markets while also setting out a level playing field for both new entrants and regulated financial institutions. A technology-neutral and outcomes-based approach to regulation is crucial.

“The goal of our latest report is to help policy makers and financial market participants to find a way forward that ensures appropriate stability and protections, while also allowing the industry and economy to harness the benefits of this new technology,” he adds.

The GFMA has also developed an approach to the classification of digital assets that reflects the principle that their treatment should be underpinned by a clear methodology for identifying different types of digital assets’ risk. This will allow for tailored regulatory treatment, to mitigate reputational risks caused by conflating different use cases of DLT, as well as promoting legal clarity and confidence for asset managers, investors, and issuers, the association observed.

“Distributed ledger technology has the transformative potential to further improve efficiency across the capital markets value chain,” says Roy Choudhury at BCG. “However, there are critical barriers to large-scale adoption beyond just legal and regulatory roadblocks, including a lack of cross-industry alignment on use cases, limited operational readiness, and a need to further develop interoperable technology standards and infrastructure. Our report examines these barriers and outlines actions to unlock potentially game changing efficiency and innovation across the capital markets industry. We expect global infrastructure, operational cost, and financial resource efficiencies to deliver more than $100 billion in annual savings and freed capital when adopted at scale globally, driven by smart contract process automation, streamlined back office functions, and lower settlement and counterparty credit risk.”

Simon Gleeson, consultant at Clifford Chance, adds, “The introduction of distributed ledger technology across finance poses a whole new series of challenges for legal and regulatory frameworks. Legal structures must deliver clarity of ownership rights, settlement finality and robust insolvency treatment. Regulatory structures must deliver high levels of investor protection without impeding the development of new products and services. However, those apparently simple objectives require deep and sophisticated thought and analysis. This report is a significant step towards these goals.”

The report also sets out the foundations of a global taxonomy for digital assets to encourage both industry participants and policymakers to work from a consistent baseline with globally harmonised definitions, particularly as frameworks for digital assets continue to emerge.

“Distributed ledger technology offers significant potential to foster financial innovation,” concludes Scott Bennett at Cravath. “It has the capability to accelerate payments, streamline capital markets transaction settlements and enhance liquidity. However, there is significant uncertainty around how existing legal and regulatory frameworks apply to this emerging technology. This report provides industry participants and policymakers detailed analysis related to these issues and a foundation to help support effective market infrastructure.”