The UK Treasury has confirmed plans to launch a pilot project for the issuance of digital gilts, UK government bonds, following information leaks earlier this week. The previous Conservative government had also planned to organize a pilot project. This is seen as a significant milestone for the UK capital markets, especially as the UK has launched a digital securities sandbox for DLT and tokenization pilots.
The UK could benefit more than other countries. One of the flagship applications of blockchain in capital markets is repurchase or repurchase agreements, which involve the exchange of cash for gilts. This allows banks and institutions to either lend excess liquidity or borrow it if they are short.
Conventional repos involve deferred settlement of securities, meaning that the duration of repos is typically overnight. In contrast, blockchain supports instant settlement enabling intraday repo. The ability to manage liquidity for hours is very attractive to banks and other institutions.
Intraday repos are already occurring by tokenizing existing U.S. Treasury bonds. Native digital gilding would make the process much easier. In addition to this, the UK has Fnality, a tokenized cash settlement network backed by an omnibus account at the Bank of England. Fnality is supported by more than 20 institutions.
Therefore, with a digital gilt, the UK will have both digital security and on-chain money.
While the previous government floated the idea, trade body UK Finance worked with EY to draft a digital roadmap for gilts. He submitted it to the government in April, but released it today.
A golden digital roadmap
He suggests two alternative approaches, one more evolutionary while the other is a Big Bang path.
In the tiered approach, he suggests issuing a short-term digital treasury bond in the first six months with only a limited number of market participants.
In the second phase of the first year, a mid-term digital gilt would have more features. For example, it would involve more market makers and a broader group of investors. Most importantly, it would be integrated into the existing off-chain secondary market, with gilts eligible as collateral for pensions. These are essential steps to ensure liquidity.
The third phase, within 18 months, would involve another issuance with both gilt trading and on-chain repo.
The Big Bang approach would essentially skip the first two steps and take place in a more compressed time frame. The UK Finance paper outlines the pros and cons of each route.
A major hurdle could be the legal and regulatory work needed to support the use of digital gilts as collateral for pensions and other purposes. In addition, it is necessary to maintain a sufficient level of liquidity.
Switzerland is one of the most advanced jurisdictions in this area. Its central bank considers the use of digital treasuries for money market operations premature, given the immaturity of the DLT sector. However, Switzerland was the first to launch a digital stock exchange and, unsurprisingly, progress has therefore been slow. In contrast, the ECB’s wholesale DLT settlement trials have attracted strong interest and engagement, with market participants hoping that the trials will not end.
UK Finance believes that with the Digital Gilt program, “the UK can lay the foundations of a robust and innovative digital capital market ecosystem, strengthening its position as a global leader in fintech and digital finance” .
